Taxation of Share-Based Long-Term Incentive Plans (LTIPs) in India
- tax comply
- May 18
- 4 min read
In the competitive global business environment, share-based compensation has emerged as a powerful tool to retain and motivate employees. One of the most commonly used instruments in this category is the Long-Term Incentive Plan (LTIP)—a structure that grants employees equity-linked benefits over a defined period. However, taxation of LTIPs—especially in India—requires careful understanding of the Income Tax Act, valuation norms, and cross-border implications.
What Are LTIPs? Common Names
LTIPs are essentially deferred compensation mechanisms tied to company performance and employee tenure. They come in various forms and are often referred to by other names, including:
Employee Stock Option Plans (ESOPs)
Restricted Stock Units (RSUs)
Stock Appreciation Rights (SARs)
Employee Stock Purchase Plans (ESPPs)
While the structures may differ in mechanics, their tax treatment in India is governed by similar principles, especially when shares or rights vest or are exercised.
Taxation of LTIPs in India
In India, LTIPs are taxed as salary income in the hands of employees at the time of exercise or allotment. The taxable value is:
Taxable Income = Fair Market Value (FMV) on date of exercise – Exercise Price paid
This amount is taxed under the head “Income from Salaries” and employers are required to withhold tax (TDS) accordingly.
FMV Determination for Tax Purposes
1. For Shares Listed on Recognized Stock Exchanges in India:
FMV = Average of Opening and Closing Prices on the date of exercise on the exchange with highest trading volume
If no trading on that day, use the closing price of the preceding trading day
2. For Unlisted Shares or Shares Listed Overseas:
FMV must be certified by a Category I SEBI-registered Merchant Banker
Valuation date can be the exercise date or any date within 180 days before
Capital Gains on Sale of Shares
Upon eventual sale of the shares, capital gains tax applies:
Cost of acquisition = FMV already taxed as salary
Capital Gain = Sale Price – FMV at exercise
Holding period determines if it is short-term or long-term capital gain
NRI and Cross-Border LTIP Taxation
As more Indian professionals work abroad or become NRIs, understanding how India and other countries tax the same LTIP income becomes essential.
Double Taxation: The Core Issue
Double taxation occurs when the same income is taxed in two countries—for example:
India taxes LTIP income as salary when exercised for Indian employment.
Another country (e.g., USA or UK) may also tax it when the employee becomes a resident there.
This leads to a potentially unfair burden on the employee, unless mitigated by a Double Taxation Avoidance Agreement (DTAA).
How Double Taxation Arises in LTIPs
Global mobility: Employee works partly in India and partly abroad during the vesting period.
Tax residency shift: Employee becomes NRI but exercises ESOPs linked to prior Indian employment.
Mismatch in tax timing: One country taxes at grant or vesting, while India taxes on exercise or allotment.
Foreign Tax Credit (FTC) – Relief Under DTAA
To avoid double taxation, India allows relief through Foreign Tax Credit (FTC) under Section 90 and 91 of the Income Tax Act, read with Rule 128. Here’s how it works:
Eligibility for FTC
The taxpayer must be a resident of India in the year the foreign income is taxed.
The income must be double taxed—i.e., taxable in both India and the foreign country.
The foreign tax should be actually paid, not just withheld.
How FTC is Claimed
FTC is available up to the Indian tax liability on the same income.
Must file Form 67 before filing the income tax return in India.
Supporting documents required: tax return filed abroad, tax payment proofs, and foreign income computation.
Example
Suppose:
You were granted RSUs during Indian employment.
You moved to the US and exercised them there (taxed in the US).
India also taxes them as salary since they relate to past Indian service.
If you're still filing Indian tax returns (as a resident), you can claim credit for the US tax paid against the Indian tax liability on the same RSU income.
Practical Issues and Recommendations
Split-source employment: Determine how much of LTIP benefit is attributable to India.
Understand DTAA terms: Some DTAAs specify which country has taxing rights over equity compensation.
Plan vesting and exercise dates carefully: Align with residency to minimize overlapping tax.
Use professional advice: For cross-border taxation, expert guidance is crucial to avoid penalties or missed credits.
Start-up Tax Deferral for Employees (Since 1 April 2020)
Eligible start-up employees can defer tax payment on LTIPs until the earliest of:
5 years from fiscal year of exercise
Date of exit from the start-up
Date of share sale
Tax must be paid within 14 days of the triggering event. This relief is aimed at reducing immediate tax burdens on illiquid shares.
Conclusion
Share-based compensation like ESOPs and RSUs can be highly rewarding, but their tax treatment—especially across borders—can be complex and burdensome if not planned properly.
For NRIs and cross-border employees, double taxation is a real risk. However, relief through foreign tax credits under DTAA offers a legitimate way to avoid paying tax twice.
Employers must ensure accurate valuation and tax reporting, while employees—especially those mobile across jurisdictions—must plan proactively and seek professional guidance to optimize their tax outcomes.
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