ED probes alleged ESOP misuse to launder money, bypass LRS rules

Mumbai: The Enforcement Directorate seems to have caught wind of another way to launder money and dodge foreign remittance controls that may have hitherto escaped its radar. The central agency makes a cryptic mention in its annual report released Thursday that issuance of employee stock options (ESOPs) by foreign companies to India-based employees has come under its lens.

According to market sources, giving out fake ESOPs has been an avenue to either whitewash undisclosed funds stashed overseas or jump the hurdle in the liberalised remittance scheme (LRS). LRS allows a resident individual to transfer a maximum $250,000 a year abroad to buy stocks and properties, or meet travel expenses.

Besides ESOP misuse, non-reporting of options, sometimes unwittingly, in Income tax (I-T) returns can invite the glare of ED which administers laws to curb money laundering and violation of foreign exchange regulations.

"Issue of ESOPs that are not genuine by an overseas related entity and later selling the unlisted stock after a gap of two years can be a way to legitimise undeclared money parked overseas at minimal tax cost. Also, since fund remittance for option exercise is not part of LRS, sham options can be misused to transfer any amount," said Pankaj Bhuta, founder of the CA firm P. R. Bhuta & Co.

The cost entails a 30% I-T on the difference between the exercise price and stock fair value (deliberately kept low), and a 10% capital gains tax when sold at a much higher price in the unlisted market abroad.

"While real ESOP frameworks remain a legitimate and accepted form to incentivise employees, regulators are probably examining whether such instruments are being used to facilitate questionable cross-border fund flows or indirectly circumvent LRS limit. What may internally be viewed as a standard employee benefit arrangement can, from a regulatory standpoint, involve significant FEMA compliance, reporting and remittance considerations, all of which require careful evaluation," said Moin Ladha, partner at the law firm Khaitan & Co. Also, it is common for foreign startups to grant Restricted Stock Award (RSA) to Indian advisors based on what is allowed in their home jurisdiction, even though such issuances are not permitted under FEMA, said Bhuta.

RSAs, unlike options, are grants of shares for free or at nominal cost.

Since there is no remittance from India, and it doesn't involve tax withholding by foreign companies, these transactions are not captured under FEMA and I-T reporting, he said. However, holding such foreign shares is a FEMA contravention even if disclosed in I-T return.

According to Siddharth Banwat, partner, S Banwat & Associates LLP, the report highlights issuance of No Objection Certificates (NOC) by ED which can play a gatekeeping role in the FEMA compounding framework.

"By screening contraventions to separate bona fide commercial lapses from cases involving serious financial wrongdoing, ED can be an enabler to ensure that the RBI's compounding mechanism remains a credible resolution channel. It would preserve regulatory integrity and give businesses a timely path to legal closure - particularly, for offences committed due to lack of awareness," said Banwat.