Restricted Stock Units (RSUs) - The Why, What and How...

Are you an employee who is offered RSUs as a part of your compensation package and wondering about its taxability?

Or, Are you an organisation looking at incentivising your employees for better retention and effective contribution to your organisation?

This short read will clear your doubts!

What are RSUs?

RSUs, which stand for Restricted Stock Units, are a mode of compensation to employees of an organisation whose value is equal to that organisation’s common stock. Though the concept of RSUs existed for more than 2 decades, we are now seeing more and more Companies, especially MNCs, adopt this method of incentivising employees, in the recent years. While RSUs are targeted primarily towards encouraging retention of skilled and talented employees in the organisation, they also incentivise employees in sync with the growth of the organisation. RSUs granted to Indian employees could be units of their employing entity in India or its holding foreign company / group company.

The RSU Grant Agreement or a RSU Grant Plan is the formal document outlining the grant of a vested interest in the stock of the Company to its employees, which is awarded at a specified time in the future, according to the plan’s vesting schedule.

How does it work?

Companies grant RSUs to its employees which will be allotted to them on a future vesting date after satisfying the vesting conditions laid out in the Agreement. These vesting conditions can be in relation to passage of time eg. RSUs vesting after completion of 5 years of employment with the Company, or they can be in relation to performance eg. RSUs vesting post achieving defined performance milestones such as sales, etc.

Unlike stock options where the employees have an option to exercise the right to acquire the shares of the company, RSUs get vested automatically on satisfying the vesting conditions. Once they are vested, the units are converted into common shares, and they carry all the rights of existing shareholders of the Company. There is no concept of expiry of RSUs as the RSUs vest automatically on vesting date.

Can the employee sell them?

As the name says, RSUs are ‘restricted’ for sale until the Vesting period is complete. In other words, they can’t be sold as soon as they are granted, as the employee doesn’t get ownership rights on such RSUs until the Vesting conditions are satisfied as we discussed above. One has to complete the vesting schedule requirements, and then gain the right to hold or sell such shares which are underlying the RSUs. In case of partial vesting, only those which are fully vested can be sold. Post vesting, these need not necessarily be sold back to the Company, but these can be sold to any outsider too as these are in the form of shares of the Company, unless, the Agreement has any restrictions in this regard.

How will the employees know the value of their RSUs?

Unlike stock options, RSUs do not have a face value. Also, RSUs don’t have any value until they are vested. That is, upon grant of RSUs, the employees would not know what the value of such RSUs is, as the same is linked to value of the Company / stock price of Company as on a future vesting date. Post vesting, as the underlying of the RSUs is the Company’s share, the value of the same can be determined as follows –

1.??????In case the RSUs granted are that of a Listed Company – the value of the RSUs shall be equal to the current market price of the shares on the exchange.

2.??????In case the RSUs granted are that of an Unlisted Company – the value of such RSUs shall be the Fair Market Value as determined by a Valuer.

How to decide on selling or retaining RSUs?

Post the vesting date, the employee can either decide to sell his stocks, which is typically done in case of a volatile market or he/she feels that the Company’s stock is already at its peak, or decide to retain them if he is positive about the company’s performance and thus its potential to grow in value in the future. ?

Do you need to pay any taxes on RSUs?

The short answer is YES! However, at the time of grant of RSUs there is no taxation in hands of employee as he doesn’t own such RSUs yet. Subsequently, the employee shall have to undergo the 2 stage taxation structure under the prevalent Income Tax laws in India as explained below. ?

First, at time of vesting of RSUs, the Fair Market Value (FMV) of the RSUs would be added to the salary of the employee as a perquisite. This shall be chargeable to tax as per the applicable slab rates of that employee. The employee will be required to pay the tax immediately, or such tax can also be deducted in form of proportionate units’ equivalent to the tax amount. FMV shall be determined by as discussed above.

Second point of taxation is at the time of sale of such shares, which is taxed as follows –

·??????Short Term Capital Gain – in case of sale of RSUs within 2 years from the date of acquisition, the tax on gains (ie. difference between sale value and FMV as on date of vesting) shall be as per the slab rates of the employee.

·??????Long Term Capital Gain – in case of sale of RSUs after 2 years from the date of acquisition, in which case, the tax on gains shall be at 20% with indexation benefits.

In case of RSU of foreign company, certain share units may be deducted towards the taxes, and balance will be available for sale in hands of employee.

In case there is any exercise price (in rare cases), such needs to be deducted from the FMV of such RSUs as on date of vesting. Later, difference between sale price and FMV shall be considered as capital gains on sale as explained above.

What should an employee be careful about while filing the Income Tax Return?

In the ITR, the employee needs to –

1.??????If the RSUs allotted are that of a foreign company, the employee needs to disclose the same under the Foreign Assets clause in the ITR. This needs to be disclosed every year starting from the year of vesting until the year of sale. Net units with the employee, i.e. after deducting units sold to meet the related taxes, shall be disclosed here.

2.??????If the RSUs are sold, the employee needs to disclose the sale under the heading ‘Capital Gains’ and offer the same to tax as explained above.

3.??????In case there are any Long Term Capital Losses and / or Short Term Capital Losses which the employee has incurred on any other investment or RSUs, then the same can be set off with Gains on sale of RSUs. Please note that, the Long Term Capital Losses can be set off only against income from Long Term Capital Gains, whereas, the Short Term Capital Losses can be set off against income from Long Term Capital Gains as well as Short Term Capital Gains. In case such set off is not sufficient, there are carry forward provisions as well for up-to 8 years. This is one way an employee can reduce the tax burden as per law.

4.??????In case the employee earns any Dividend from these shares, the same shall be disclosed under ‘Income from Other Sources’ and the employee needs to pay taxes on the same as per his applicable slab structure. The Company is bound to deduct tax at source (TDS) at the rate of 10% on dividend amounts exceeding Rs. 5,000 in a financial year, so the employee needs to consider this as well at the time of filing ITR. This information can be found in Form 26AS of the employee.

5.??????In case an employee is allotted RSUs of a foreign entity, which is subjected to such country’s rate of tax which is higher than his effective rate of tax as applicable in India, the employee needs to claim the credit of such foreign tax at the time of filing ITR.

Who are RSUs beneficial for – Employees or Employers?

Providing RSUs is mutually beneficial to both the employer and employee. An employee is incentivised to stay in the organisation and also has skin in the game to work for the betterment of the Company; and for the Company, just like any other stock option plan, RSUs help in lessening the burden on their funds through the vesting period clubbed with minimal costs associated with grant of RSUs. RSUs don’t have voting rights, hence until vesting the Company need not bother about dilution of decision making and other controls that shareholders generally exercise. RSUs also have a good potential to produce a substantial income to employees. RSUs offer the necessary security for companies in retaining talented employees as they tend to stick on at-least till the vesting period is complete.

Conclusion

As discussed above, RSUs are a win-win instrument for both the employees as well as the employers. When the RSU Plan is implemented with an objective that is in line with the ethos of the entity and also in sync with the entity’s growth aspirations, these instruments provide an excellent way of compensating employees as well as building a wealth strategy.