In modern-day businesses, especially start-ups, incentive through ownership is a popular concept to align the interests of employees with shareholders/promoters and thereby improve overall business performance. Employee Stock Ownership Plan (‘ESOP’) is a method of compensating and incentivizing employees whereby eligible employees are granted a right/option to purchase/obtain shares of their listed employer company or its listed group companies.
While ESOP is an umbrella term used for employee compensation plans linked to shares of listed companies, businesses may have various types of schemes to implement the same with customized terms and conditions tailored to suit their requirements. Broadly, the schemes may be divided into two categories as under:
Schemes involving actual issuance of shares to employees – This category would cover schemes such as:
Schemes not involving actual issuance of shares to employees – This category would cover schemes such as Stock Appreciation Rights (SAR) or Phantom Equity Plan (PEP) whereby employees are given payments based on appreciation in share price of listed employer company or its group company without any issuance of shares (i.e., without dilution of equity).
Controversy on GST implications of schemes involving issuance of shares to employees
These schemes typically involve issuance of shares to employees in lieu of their services. Services of employee to employer in relation to employment are covered under Schedule III to the Central Goods and Services Tax Act, 2017 (‘CGST Act’) and hence, do not constitute a supply.
Further, as per definition of ‘Goods’ under Section 2(52) of the CGST Act, securities are excluded from scope of the said term and hence, transactions in securities would not constitute supply of goods. The definition of ‘Securities’ as per Section 2(h) of the Securities Contracts (Regulation) Act, 1956 (made applicable to the CGST Act by virtue of Section 2(101) of the CGST Act) is wide in ambit and covers shares of any incorporated company or a body corporate. Considering the same, transactions of issuance of shares per se, whether issued to employees or any other person, do not constitute supply of goods and remain outside the purview of levy of GST.
However, the controversy as regards applicability of GST on ESOP where employees are issued shares of employer’s listed group company has been doing rounds for quite some time. In such cases, the transaction usually involves three parties namely, employee, employer company and listed group company. While the employment contract is between employee and employer company, the shares issued pursuant to ESOP scheme are of employer company’s listed group company (listed within or outside India). In such cases, typically, the shares would be directly issued by the listed group company to employees. The amounts required to be borne by the employee for such shares are usually collected by the employer group company and reimbursed to the listed group company. In some cases, the employer company may reimburse the balance cost of shares (so as to ensure that the listed group company receives the market price of shares) and in some other cases, even the cost, fee, etc. for administering the entire scheme.
The payments made by the employer company to its listed group companies in such cases (towards reimbursement of amounts paid by the employee, and/or balance cost of shares and other payments) have been scrutinized by the tax authorities in various cases and preliminary allegations as regards applicability of GST on the same have been levelled. Such allegations mainly stem from the fact that while payment for shares is made by the employer company to its listed group company, the corresponding issuance of shares is to employees. Due to this peculiar nature of the transaction, there were apprehensions as regards such payments being treated as consideration for services rendered by the listed group company to the employer company. Any such allegation would result into significance tax demand in hands of the listed group company (if an Indian company) or in hands of the employer company on reverse charge basis (if the listed group company is located outside India).
The industry at large has always believed that such transactions do not involve any element of supply since the same are in nature of issuance of share capital (from the perspective of listed group company) and payment of employee compensation (from the perspective of the employer company). The concept of ESOP as envisaged under the Companies Act, 2013 as well as the SEBI Regulations is wide enough to cover transactions of issuance of group company’s shares as employee compensation. Such ESOP schemes have also been believed to be in the nature of stewardship function as the resultant benefits of the improved employee performance are realised at the group level.
Circular pursuant to recommendations of the 53rd GST Council Meeting
Pursuant to recommendations of the 53rd GST Council Meeting, the CBIC has now issued Circular No. 213/07/2024-GST dated June 26, 2024, clarifying that the transactions of issuance of shares by the foreign holding company to employees of domestic subsidiary company under ESOP/ESPP/RSU and corresponding reimbursement of cost of shares (on cost-to-cost basis) by the domestic subsidiary company do not constitute supply of services. It has been clarified that such reimbursements are towards issuance of shares which do not constitute supply of goods or service and hence, not liable to GST.
The Circular further clarifies that any payment made to the group company over and above cost of shares issued to employees would however constitute consideration for supply of services of facilitating/arranging the transaction in securities/ shares by the foreign holding company to the domestic subsidiary company and would attract GST.
It is noteworthy that the Circular in question has been issued in the context where the Indian company is an employer company and shares being granted are of its listed foreign holding company. However, the rationale should be equally applicable even in cases where listed group company is an Indian company.
The clarification as regards non-taxability of reimbursement for shares is a welcome step and would put an end to dispute on this issue for the companies already facing scrutiny of such reimbursements. Given the nature of such transactions, the stakes involved are usually very high, recurring and hence a timely clarification in this regard comes as a huge sigh of relief for the industry.
It is pertinent to note that the various payments made to group companies involve complex accounting and the underlying amounts are represented vide multiple ledger heads. To avoid disputes qua reimbursements towards the cost of shares, it would be important to ensure that such amounts are clearly and separately identified in the Financial Statements and the policies followed for accounting of the same are documented. If and where additional payments are made over and above the cost of shares, it would be advisable to record the same separately to reduce the possibility of litigation. As an icing on the cake, where the employer company is entitled to full ITC, the Circulars regarding acceptance of the value on the invoice or acceptance of value as NIL where invoice is not issued, further simplify this otherwise complex and potential issue.
ESOP as a mode of employee compensation is a win-win for employers as well as employees. Any applicability of GST on the same could have impacted attractiveness of this widely used method and made it commercially less viable. The certainty brought by timely issuance of Circular on the issue would save cost and efforts of litigation for the industry, and also positively impact ease of doing business in India.
While issuance of ESOP is an incentive from employer to employee, issuance of the Circular clarifying non-applicability of GST on the same is definitely an incentive from the Government to employer companies!
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