Understanding Restricted Stock Units (RSUs) and their tax implications is important for employees who receive company shares as part of their compensation package. RSUs are a form of employee benefit in which a company promises to deliver shares once specified conditions are satisfied. These conditions may relate to the employee’s length of service, performance targets or other vesting requirements.
This guide explains the meaning and full form of RSUs, the different types of vesting restrictions, what employees can do with vested shares and how RSUs are generally taxed in India.
What Are Restricted Stock Units (RSUs)?
The full form of RSU is Restricted Stock Unit. An RSU is a form of equity-based compensation in which an employer promises to grant shares to an employee after the employee fulfils specified conditions.
RSUs typically follow a vesting schedule. Before vesting, the employee generally does not own the underlying shares and cannot sell them. Once the applicable vesting conditions are met and the shares are delivered, the employee can usually hold or sell them, subject to the company’s share plan, trading restrictions and applicable securities laws.
For example, a company may grant an employee 400 RSUs that vest over four years. If the units vest in equal annual instalments, the employee may become eligible to receive 100 shares each year, provided the relevant conditions are met.
Vesting requirements help companies retain employees, reward performance and align employee interests with the company’s long-term growth.
What Are the Restrictions on RSUs?
RSUs may have different vesting conditions depending on the company’s compensation policy. These conditions determine when the employee becomes eligible to receive the underlying shares.
1. Time-Based Restrictions
Under time-based vesting, RSUs vest after the employee completes a specified period of service with the company.
For example, an employer may grant RSUs that vest over three or four years. The employee must generally remain employed for the relevant period to receive the shares scheduled to vest.
2. Performance-Based Restrictions
Some RSUs vest only after the employee or company achieves specific performance targets. These may include sales goals, revenue growth, profitability targets or other measurable business objectives.
For example, a salesperson may receive RSUs that vest after achieving a predetermined sales target, subject to the terms of the company’s equity compensation plan.
3. Combined Time and Performance Restrictions
Certain RSU plans combine service-based and performance-based conditions. In these cases, employees must satisfy both requirements before the units vest.
For instance, an employee may need to complete two years of service and meet specified performance objectives before receiving the shares.
The exact vesting conditions, treatment of unvested units upon resignation and other restrictions depend on the employer’s RSU plan.
What Can You Do with RSUs After Vesting?
Once RSUs vest and the underlying shares are delivered, employees generally have the option to sell the shares or continue holding them, subject to applicable restrictions.
The decision should take into account the share price, personal financial goals, investment diversification and tax implications.
- Sell the shares: Selling vested shares allows you to convert your equity compensation into cash. The sale may result in a capital gain or loss, depending on the sale price and the tax cost of the shares.
- Hold the shares: You may retain the shares if you believe in the company’s future prospects. However, their market value can rise or fall, and holding them may increase your exposure to a single company.
- Sell a portion: Selling some shares and retaining the rest can help balance liquidity needs with your investment preferences, subject to trading-window and other applicable restrictions.
For Indian tax purposes, the value of RSUs when they vest and the gain or loss when the shares are subsequently sold are generally treated as separate tax events. Employees receiving RSUs from Indian or foreign employers should understand the applicable tax rules before deciding when to sell.