Restricted Stock Units(RSU): Meaning, Taxation

What are Restricted Stock Units (RSU)?

A restricted stock unit serves as a form of employee compensation wherein the employer grants shares of its stock to the individual. The recipient has the freedom to sell these shares at their discretion unless they are still within the predetermined vesting period.

The vesting period denotes a specific duration during which the recipient is prohibited from selling the restricted share units. Companies implement vesting to ensure that the benefits are only realized when specific conditions are met. For instance, the vesting period for RSUs may conclude after the employee achieves performance milestones or after remaining with the employer for a specified period.

Regardless of the conditions, until the vesting schedule concludes, those holding restricted stock units cannot capitalize on them to generate a profit.

What are the Restrictions on RSUs?

RSUs can have various restrictions in India that can make their vesting period longer. Given below are the different types of restrictions on RSUs -

• Time-based restrictions:
  RSUs are often provided by the company as a reward for their loyalty to the company. Therefore, the restrictions on the vesting period of RSU can depend on the employee's decision to retain his/her position in the company for a previously determined period.
• Restrictions based on milestones:
  Apart from the time-bound restrictions, some restrictions are also based on the employee’s achievement of a predetermined milestone. Once the employee achieves the given milestone, the vesting period on the RSU ends. For example, a salesperson can unlock the restriction on RSU after achieving a certain sales figure.
• Restrictions based on both time and milestones:
  Sometimes, the restrictions on RSU can be based on both time and milestone. This means the employee has to achieve both a certain time period and a performance milestone to be able to unlock the restrictions on RSU.

What to do with RSUs?

After the completion of the vesting period, the employee can sell the units of RSU either in part or in full and earn substantial gains. Depending on the market prices and future expectations, one can decide to either sell the stocks or hold them further.

Advantages of Restricted Stock Units

Restricted Stock Units (RSUs) offer various advantages for both employers and employees within a company. Here are some key benefits that you should consider:

• Employee Retention: RSUs act as an incentive for employees to stay with the organization for an extended period, fostering long-term commitment.
• Morale Boost: RSUs contribute to a positive work environment by boosting employee morale and motivating them to perform at their best.
• Capital Gain Opportunities: Holding onto RSUs until the full allocation is received provides individuals with the opportunity to acquire capital gains, subject to the condition that the company's stock value has appreciated over time, minus any deductions for income tax liabilities.
• Cost-Efficient Tracking: Unlike actual stocks, RSUs, being notional in nature, do not require companies to incur substantial expenses for recording and tracking purposes.

RSUs, through these benefits, contribute to employee satisfaction and retention and can align the interests of employees with the company's overall success.

Disadvantages of Restricted Stock Units

While restricted stock units (RSUs) offer advantages, they also come with certain limitations. Here are some of the drawbacks to consider:

• No Dividend Payments: RSUs do not entitle the holder to receive dividend payments since they represent notional shares rather than actual ownership in the company.
• Forfeiture Risk: If an employee decides to leave the company before the completion of the vesting schedule, any remaining unvested RSUs are forfeited. For instance, if an employee like Ravi was set to receive 2000 RSUs over a four-year period but left after three years, he would forfeit the remaining 500 shares.
• Limited Financial Flexibility: RSUs can't be utilized in times of financial need unless specific conditions are met. This lack of liquidity restricts employees from relying on RSUs for immediate financial assistance during emergencies.

What is the Taxation on RSUs?

The taxation of RSU in India is similar to the taxation of any other equity share. The fair market value of the Restricted Stock Units must be considered for taxation purposes. Fair market value refers to the price at which these shares are sold on the stock market at the date of vesting.

Tax on RSU is applicable to both the vesting and when the company sells his/her holdings.

• Taxation of RSU on Vesting
  There are three possibilities in this case, as given below -
  • Sell to Cover: Suppose Mr.X is promised by his company to receive 4000 company shares as RSU. As per the vesting schedule decided, he will get 1000 shares every year after achieving a 10 million sales target and completing 1 year with the company.
    If Mr.X receives 1000 shares and falls within the 30% income tax slab, then the company will sell 300 shares out of 1000 on behalf of Mr.X and pay the proceeds as tax, and the proceeds are paid as tax. As a result, Mr.X will receive 700 shares in net.
  • Same-day Sale: In this case, all the shares received by the employee during the vesting period are sold on the same day. The tax applicable is paid to the government, and the rest of the proceeds are transferred to the employee. In this method, the employee does not receive any actual shares but a cash equivalent of the sale proceeds of the RSU.
  • Upfront Payment: In this method, the employee can choose to pay the entire tax value at the same time and get a hold of all the shares under question.
• Taxation on the Sale of RSU Holdings
  When an employee sells their RSU holdings, any profit resulting from the transaction is categorized as a capital gain. The taxation of this capital gain is determined by the duration for which the shares were held. This tax obligation applies regardless of whether the shares are listed on the Indian stock exchange.
  In the context of RSUs, the holding period extends from the date of vesting to the date of the actual sale of the shares. The applicable tax rates are given below:
  

In the dynamic landscape of RSUs, understanding their restrictions and taxation becomes extremely important. Whether understanding time-based constraints, milestone achievements, or a blend of both, employees must strategize their approach. Also, it is important to learn about the taxation of RSU in India to ensure proper compliance with tax laws. Understanding the tax landscape and creating your financial strategy becomes easier with the help of professional guidance. Tax2win’s tax experts are highly experienced CAs with over a decade of industry experience who are committed to helping you with tax matters. Contact our Tax Advisory Service Today!