How to manage employees’ equity in India

In today's competitive business world, granting equity to your employees isn't just a recruitment strategy—it's an investment in your company's future. It motivates your team, fostering a shared sense of purpose and a commitment to the long-term success of your business. When your employees have a personal stake in your company, they're not just employees—they're partners. 

If you're operating in India, you might be wondering how to implement and manage equity plans effectively—and with complex local and regional regulations that can vary, it's no easy feat.

In this article, we'll break down the essentials and offer guidance on how to manage employee equity in India to help you navigate the nuances of the regulatory landscape. Let's get started.

Equity 101: stock options, RSUs, and ESPP

Before we dive into employee equity in India, let's define the most common types of equity compensation: stock options, RSUs, and ESPP.

• Stock options give employees the right, but not the obligation, to buy a certain number of shares in the company at a predetermined price, known as the "strike price," within a specific period of time. Companies often offer stock options as part of a compensation or benefits package to incentivize employees and align their interests with those of the company. The advantage for employees is the opportunity to profit if the company's stock price rises above the strike price, allowing them to buy shares at a discount and potentially sell them at a higher market value.

• Restricted Stock Units (RSUs) are a form of employee compensation that offers the right to receive shares of company stock after meeting certain conditions, often tied to time (known as vesting) or performance metrics. Unlike stock options, RSUs have intrinsic value from the start, even if the company's stock price drops. This means that RSUs provide a guaranteed level of compensation. However, until the RSUs vest, the employee doesn’t actually own the shares and, therefore, doesn’t have any shareholder rights (such as voting). Once vested, the RSUs are converted into company shares, which the employee then owns outright.

• An Employee Stock Purchase Plan (ESPP) is a company-run program that allows employees to purchase company stock at a discounted price. ESPPs are often set up so employees contribute a portion of their salary over a predetermined period through automatic payroll deductions, making it a convenient way to invest in the company. At the end of that period, the accumulated contributions are used to purchase company stock at a discount, usually below the fair market value.

What are the rules for foreign companies granting equity awards to employees of their Indian entities?

When granting employees equity in India, it's crucial to stay compliant with local laws and regulations.

Under new rules introduced on August 22, 2022, employees and directors who receive shares under an Employee Stock Ownership Plan (ESOP) offered by a foreign company are considered to have received an Overseas Portfolio Investment (OPI) and the local Indian entity must comply with the requirements under the new Indian Overseas Investment Regulations (OI Regulations).

Under the new OI Regulations, foreign companies granting equity awards or stock purchase rights to employees and directors of their related Indian entities under an ESOP or similar plan must comply with the new general permission. There is no longer a separate exemption for cashless stock options or similar awards (such as RSUs).  

Further, the Reserve Bank of India (RBI) also revised the Master Direction—Liberalized Remittance Scheme (LRS Master Direction) in connection with its overhaul of the exchange control rules. The revised LRS Master Direction no longer applies to the acquisition and holding of shares in a foreign company by employees and directors of their related Indian entities under an ESOP, but requires that all such transactions be completed under the new OI Rules. 

Under the new general permission:

• The ESOP must be offered on a globally uniform basis (e.g., on the same general terms as applicable to other subsidiaries of the issuing company); and
• The Indian entity must now submit semi-annual reports on Form OPI to the RBI through its Authorized Dealer Bank. The reports are due for the periods ending March 31 and September 30 and must be submitted within 60 days after March 31 and September 30, respectively. 

Further, the repatriation requirements were modified such that, if an individual acquires securities that represent (in the aggregate) less than 10% of the company's share capital, the individual will be required to repatriate any proceeds related to the securities within 180 days of receipt (unless the amounts are reinvested by the individual in compliance with the new rules within the 180-day period). In the unlikely event that the individual acquires securities that represent (in the aggregate) 10% or more of the company's share capital, the individual will be required to repatriate the proceeds within 90 days of receipt. It remains the individual's responsibility to comply with the repatriation requirements.

Note: If you are using an Employer of Record (“EOR”) to hire employees in India, the applicable local rules and regulations may differ.

How do I assign equity to employees?

An equity compensation program serves multiple purposes: helping your company attract and retain talent, aligning employee incentives with company performance, and sharing the rewards of company success. The steps below give a brief overview of how to assign equity to employees.

1. Create an allocation strategy. You could distribute equity evenly among all employees, or weight it according to seniority, role, or performance. Keep in mind that equity is a finite resource, so you need to strike a balance between generous grants that motivate your employees and preserving enough equity for future needs, like hiring and fundraising.

2. Choose the type(s) of equity you want to offer. This could be stock options, RSUs, or participation in an ESPP. Each has its own implications for taxation, dilution, and administration, so you might want to consult with a financial advisor or attorney to understand what's best for your situation.

3. Establish a vesting schedule. Typically, equity awards vest over a period of time to encourage employees to stay with the company. A common vesting schedule is four years, with a one-year "cliff," meaning the employee receives no equity until they've been with the company for a full year.

4. Determine the exercise price. If you're offering stock options, you'll need to set an exercise price. This is usually the fair market value of the stock at the time the options are granted. It's important to get this right, as setting an exercise price that's too low could have tax implications.

5. Document your plan. Finally, be sure to document everything in an equity incentive plan that lays out the terms of the equity awards, and provide each participating employee with a grant agreement that details their specific award.

Taxes and deductions for employee equity in India