Tax Scrutiny Intensifies for Startup Founders Over Undisclosed Foreign ESOPs
A number of co-founders and senior executives from unlisted startups are now under the meticulous gaze of income-tax authorities, following allegations of failing to disclose foreign company shares allotted to them in the form of Employee Stock Options (ESOPs).
Sources familiar with the situation indicate that these startups previously established entities in Singapore, often referred to as externalisation structures, with aspirations for foreign listing. Typically, these Singapore-based firms control operational businesses within India.
However, several holders of ESOPs from these startups have neglected to report these foreign holdings, prompting the Central Board of Direct Taxes (CBDT) to dispatch notices under its Nudge initiative.
The recipients of these notices include executives from at least two financial services corporations and a singular business-to-business (B2B) platform. The shares in question were acquired during the fiscal years from 2020 to 2024, according to the aforementioned insiders.
Foreign shares become subject to taxation in India once disclosed and are liable for capital gains tax, ranging from 12.5% to 20%. Although residents can occasionally benefit from international tax treaties, failure to disclose foreign holdings may lead to a steep 30% tax under provisions related to “Undisclosed Foreign Income” should these transactions come to light.
Many Indian startups have devised frameworks whereby a foreign holding company is established, rendering the Indian entity a subsidiary. Regulations in India prohibit unlisted enterprises from direct overseas listings. By creating offshore holding companies, startups can pursue listings for the holding entity directly.
Subsequently, some of these companies have integrated the overseas entity into the Indian firm, a practice commonly termed ‘reverse flipping.’
Communications sent to the Finance Ministry regarding this matter went unanswered.
Reverse Flip Transactions
Reports indicate that various specific cases have emerged during the reverse flip transactions, where implicated individuals could face not only tax penalties but also implications for breaching anti-money laundering regulations.
“In light of the extensive data the Indian government receives from foreign jurisdictions through international agreements, it is prudent for individuals to disclose such holdings proactively,” noted one source.
On November 27, the CBDT announced the launch of the second phase of its ‘Nudge’ initiative, aimed at taxpayers with undeclared foreign assets and income.
This initiative is predicated on information acquired by the Indian government from other nations through the OECD framework.
This development is particularly notable, as Indian residents are obligated to declare any foreign shares they own, including ESOPs.
Failure to declare such foreign holdings may result in punitive penalties under the Black Money Act, which empowers tax officials to impose a flat penalty of ₹10 lakh for the corresponding year.
Additionally, if the holdings are classified as ‘undisclosed foreign assets’, they face a 30% tax on the value, along with penalties amounting to three times the tax, not to mention potential criminal prosecution.
Such notices should be addressed promptly through appropriate disclosures to mitigate serious repercussions,” cautioned Binoy Parikh, a partner at Katalyst Advisors.
MNC Employee ESOPs
It is not only startups that face scrutiny; top executives of major multinational corporations (MNCs) also receive foreign ESOPs.
Experts, however, contend that compliance among employees of these large firms is generally more robust, as these organisations are typically listed globally and adhere to transparent disclosure standards.
Individuals who receive Nudge Notices should recognise them as opportunities for voluntary compliance rather than viewing them as adversarial measures.
The initial step involves a comprehensive review of one’s tax return to identify any discrepancies regarding foreign shares, ESOPs, or associated income.
If discrepancies are found, corrective measures such as filing amended returns should be undertaken promptly.
Furthermore, individuals can assess the specifics of their situation and, if appropriate, consider submitting an updated return, advised Hemen Asher, leader of direct tax at Bhuta Shah & Co.
Source link: Moneycontrol.com.
