21 June 2023
A recent change to the Tax Collected at Source (TCS) rate means that outward remittances from India under an employee share plan will be subject to a 20% withholding tax from 1 July 2023.
That sounds alarming! What is TCS?
TCS is a tax which is withheld from outward transfers of funds under the Liberalised Remittance Scheme (LRS), including transfers under an employee share plan. Any outward remittance under the LRS must be made through an authorised dealer (a licenced foreign exchange bank) and the TCS is withheld by the authorised dealer and paid to the tax authority. Currently, TCS is 5% and only applies to outward remittances under the LRS over INR700,000. But from 1 July 2023, the rate will increase to 20% and will apply to any outward transfer of funds. There are limited exceptions for medical and education costs (where TCS will remain at 5%), but as a general rule, TCS at 20% will be imposed on all outward remittances under the LRS. For outward remittances under a contributory employee share plan (e.g. a share purchase or matching plan or option plan), the amount of each remittance of employee contributions will likely be reduced by the TCS (unless the tax is collected from elsewhere).
Remind me why the LRS applies to employee share plans?
Following a major reform of the Indian foreign exchange regime last year, all outward remittances from India under an employee share plan now come under the rules and limits set out in the LRS - and, as mentioned above, TCS applies to outward transfers of funds under the LRS. The LRS allows Indian residents to send up to USD250,000 offshore each year without the need for any further regulatory approvals. We covered the foreign exchange reforms in more detail in our alert (here).
So, how is TCS paid?
On 9 June, the Indian Finance Ministry promised that it will clarify how and in what manner TCS is to be collected, but we are yet to see any update. The mechanics are therefore unclear and might differ as to how they work in practice for each company, and for each plan type. The general rule is that withholding TCS is an obligation on the authorised bank rather than on the employer, so it is not withheld by payroll. Instead, the tax is withheld by the individual’s authorised dealer when the outward remittance is made. Technically, the withheld TCS can be reclaimed by the individual when they file their annual tax return, although we understand that getting a refund isn’t always easy or timely, and might be practically more difficult for some employees than others.
Where does this leave contributory share plans for our Indian employees?
At the moment, it isn’t entirely clear but there is a very real concern in the share plan community that if TCS applies as anticipated, it will have a major impact on the viability of contributory share plans for Indian participants. TCS will likely reduce the amount of each outward remittance by 20%, with the knock-on effect of reducing the number of shares that an employee can purchase in each purchase period under a share purchase plan. Even if the TCS is repaid to the employee at the end of the tax year, they will still have lost out on the full benefit of the share plan.
This is a disappointing change and is likely an unintended consequence of bringing employee share plans within the LRS, but we have not seen any suggestion that an exception from TCS will be introduced for share plans. We continue to discuss with local counsel if there are any workarounds that will mitigate the impact of the TCS. For example, if the employer or parent company lends the employees the funds (i.e. the 20%) to purchase the full entitlement under the share plan with the employee then repaying the loan when they receive the tax rebate. We are also waiting to see what clarity and guidance is provided by the Indian Finance Ministry, and how local practice develops on the issue. In the meantime, if you will be affected by this change then we recommend seeking specific advice in relation to the operation of your plans.
Sally Blanchflower and Sharon Thwaites