Several co-founders and top executives of unlisted start-ups are facing income-tax scrutiny for alleged non-disclosure of foreign company shares allotted to them as Employee Stock Options(ESOPs), said people with direct knowledge of the matter. These start-ups in the past had set up companies in Singapore popularly called externalization structures which eyed foreign listing. These Singapore-based companies typically own operating businesses based in India.
However, some of the ESOP holders of such startups did not disclose these foreign holdings prompting the Central Board of Direct Taxes(CBDT) to issue notices under the Nudge initiative.
The list of executives receiving such notices includes those from at least 2 financial services firms and one business to business(B2B) platform. The executives took possession of these foreign shares in the period between FY20 to FY24, the people cited above added.
Foreign shares are subject to tax in India once they are disclosed and are subject to tax in India including capital gains tax in the range of 12.5-20%. In some cases, residents can avail international treaty benefits. However, if the same foreign holdings were not disclosed and tax department unearths the transactions, then they can be subjected to 30% tax under the head “Undisclosed Foreign Income”.
Several Indian start-ups typically created structures wherein a foreign holding company is created, and the Indian entity is made a subsidiary of the foreign holding company. Indian rules don’t permit unlisted companies to directly list overseas. Creating overseas holding companies allows the start-up to directly seek listing of the holding company.
Subsequently some of these companies made India the corporate headquarters by merging the overseas entity with the Indian company, a phenomenon widely known as ‘reverse flipping.
An email sent to Finance Ministry remained unanswered.
Reverse Flip Transactions
“Some specific cases have come to light during the reverse flip transactions, and these residents may not be subject to not just tax penalty but also consequences for violation of anti-money laundering rules,” said first person cited above. “Given the amount of data Indian government is receiving from foreign governments through global treaties, it is advisable for the individuals to proactively disclose such holdings.”
On November 27, CBDT announced the launch of second phase of its ‘Nudge’ initiative targeting taxpayers with undisclosed foreign assets and income. This is based on information Indian government received from other foreign governments as a part of the international OECD framework.
The development assumes significance as Indian residents are required to disclose foreign shares, they own including ESOPs.
“If such foreign holdings are not disclosed, the Black Money Act empowers the Assessing Officer to levy a flat ₹10 lakh penalty for the relevant year, and where the holding is treated as an ‘undisclosed foreign asset’, it can be taxed at 30% of the value and also attract a penalty equal to three times the tax, apart from prosecution exposure. Such notices should be responded forthwith by making appropriate disclosures, especially since non-disclosures have dire repercussions,” said Binoy Parikh, partner, Katalyst Advisors.
MNC Employee ESOPs
Not just start-ups, even the top India executives of large Multi-National Companies(MNCs) also receive foreign ESOPs. Experts however say the compliance amongst such MNC employees is better since most of these large MNCs are listed globally and have transparent disclosure norms.
“Individuals who have received Nudge Notices should treat them as an opportunity for voluntary compliance rather than as an adversarial proceeding. The first step should be to conduct a thorough review of their tax return to identify any gaps in disclosure of foreign shares, ESOPs, or related income. Where omissions are identified, corrective action such as filing revised returns, where permissible, should be considered promptly. Additionally, one can evaluate the facts of the case and if permissible can also consider filing an updated return,” Said Hemen Asher, leader, direct tax at Bhuta Shah & Co.
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