Restricted Stock Units (RSUs) Simplified

Restricted Stock Units (RSUs) are increasingly becoming an important component in corporate compensation packages. Most young corporate professionals today receive RSUs as a reward during performance appraisals. Middle- and/or top-level management executives typically receive 30-60% of their compensation in the form of RSUs. Optimising RSU benefits therefore becomes an important part of these individuals’ financial plans. It is therefore important to understand what RSUs are, how they work and how to make the best use of them. 

About the author: Akshay Nayak is a SEBI-registered investment adviser and a member of Fee-only India, a group of fixed-fee-only advisors. You can contact him via his website akshaynayakria.com.

The Concept 

RSUs are essentially a category of bonuses paid to employees. They are paid by way of shares of the employing organisation’s stock rather than cash. Once ownership is granted, employees are free to hold or sell the stocks as they please. RSUs are paid out at set intervals of time typically quarterly/ semi annually/annually. This gives the employee a reason to stay with the organisation over long periods. This fundamentally reduces employee attrition. Employees are also naturally incentivised to perform to the best of their capabilities. Better performance usually translates into a higher stock price for their RSUs. 

Key Conceptual Terms 

To fully understand the dynamics of a transaction involving the grant and sale of RSUs, a few key terms must be understood. These are : 

Grant Date : The date on which RSUs are promised to the employee. All units of RSUs that an employee is eligible for are typically promised to them in one shot. 

Vesting Schedule : Vesting of RSUs represents the date on which employees assume full control of the RSUs promised to them. It is usually executed in a phased manner. The overarching period of time over which an employee assumes control over the RSUs promised to them is known as the vesting schedule. A typical vesting schedule is taken to be 4 years. Say that an employee is granted 100 RSUs during a particular vesting schedule. Vesting of RSUs is to be executed at annual intervals. This means that the employee would gain control of 25 units of RSUs in years 1, 2, 3 and 4.

The Cliff : The period between the grant date of RSUs and the first vesting date during the schedule. Say that an employee has been granted a certain number of RSUs on 1st November 2026. Vesting of RSUs is to be executed annually. This implies that the first vesting date during the schedule would fall on 1st November 2027. Therefore the period between 1st November 2026 and 31st October 2027 would be considered as the cliff.  If the employee leaves the organisation during the cliff, they would not receive any RSUs. This increases the probability of the employee remaining with the organisation until at least the first vesting date. 

Fair Market Value (FMV) : A metric used to ascertain the cost of RSUs granted to an employee. It is typically considered as the cost of RSUs granted when the employing organisation is not listed on a stock exchange. Where the employing organisation is listed, the prevailing market price of the stock is taken as the FMV and therefore the cost of the RSUs. With regard to taxation, RSUs are considered as perquisites (commonly known as perks). The FMV therefore becomes vital with regard to ascertaining the taxable value of the perquisite when RSUs vest to the employee. It is also used to compute capital gains when an employee sells or redeems RSUs.

How RSUs Are Taxed 

RSUs are typically taxed at 2 distinct points. First, they are taxed as a perquisite in the hands of the employee at the time of vesting. The FMV of the RSUs on the date of vesting is considered to be the taxable value of the perquisite. Capital gains realised from the sale of such RSUs are also taxed in the hands of the employee. 

When RSUs are sold, profits realised on such sale are taxed as capital gains in the hands of the employee. Capital gains are segregated into Long Term Capital Gains (LTCG) and Short Term Capital Gains. To understand the tax treatment of capital gains from RSUs look at the table below. 

The first 1.25 lakh of Long Term Capital Gains realised on sale of RSUs of listed Indian companies are exempt from tax. The exemption is unavailable in the case of RSUs of unlisted Indian companies and listed foreign companies. 

Handling Concentration Risk 

RSUs essentially represent ownership of the employer’s stock. When one holds a sizable chunk of RSUs it implies a significant investment in just one stock. This concentrates risk in the individual’s equity portfolio. This is a serious risk to the individual’s equity portfolio and their overall net worth. Consider the following hypothetical case study to understand this fact. 

Mr A is a 33 year old senior software engineer in a leading multinational software company. The company is listed on an overseas stock exchange. He has an overall net worth of Rs 2.5 crore. Rs 1.5 crore is held in equity and the remaining Rs 1 crore in debt. Within the equity portfolio Rs 90 lakh is held in RSUs from Mr A’s employer. The remaining Rs 60 lakh is held across ELSS funds and actively managed mutual funds. He currently has long term capital gains worth Rs 5 lakh in this part of the portfolio. 

Notice that Mr A has a fairly balanced 60-40 allocation across equity and debt. But as much as 60% of his equity portfolio is in his employer’s RSUs. This represents 36% of his overall net worth. This makes for a highly concentrated portfolio. Now assume that the value of the RSU component drops by 50% over 2 weeks. This means the RSUs worth 90 lakh would now be worth just Rs 45 lakh. The drop of 45 lakh represents 30% of Mr A’s equity portfolio and 18% of his overall net worth 

Such an intense and rapid drop would likely be too much for him and most others to stomach. Calibrating exposure to RSUs therefore becomes very important. It is typically considered prudent to limit RSU exposure to no more than 20% of the overall equity portfolio. We now apply this principle to Mr A’s case. 

Value of overall equity portfolio = Rs 1.5 crore (150 lakh) 

Required exposure to RSUs = 150 × 20% = Rs 30 lakh 

Current exposure to RSUs = Rs 90 lakh  

Excess exposure to RSUs = 90 – 30 = Rs 60 lakh

The calculations show that Mr A needs to move Rs 60 lakh out of RSUs. But doing this is likely to attract a significant tax liability for Mr A. It is therefore important to understand how to transition out of RSUs in the most tax efficient way possible. 

Tax Efficient Redemption Of RSUs

To begin with, Mr A works for a listed foreign entity. So the exemption limit of Rs 1.25 lakh on realised long term capital gains would be unavailable to him. The minimum holding period for the RSUs to qualify as a long term capital asset would be 24 months. In light of these facts an illustrative plan for tax efficient redemption of Mr A’s RSUs is laid out below. 

As seen earlier, RSUs typically vest at regular intervals over the course of a vesting schedule. This means RSUs typically vest in lots to employees. When deciding how to go about redeeming RSUs a few points must be considered. First, it is almost always more tax efficient to redeem RSUs that have satisfied the LTCG holding period. This allows one to leverage the benefit of being taxed at lower rates. The FMV on the vesting date for each lot also becomes an important consideration. 

An important point to note here is that Mr A holds overseas RSUs. Vesting and current market prices for overseas RSUs are typically denominated in dollars. But Indian tax laws require capital gains to be computed in rupee terms. Mr A must therefore use the SBI Telegraphic Transfer (TT) Buying Rate as of the last day of the month immediately preceding the month of vesting or sale for all currency conversions. Not doing this would render his capital gain calculations incorrect as per Indian tax laws. There are three distinct scenarios possible as far as FMVs on the vesting date are concerned :

Scenario 1 – Current Market Price < Vesting FMV : Such lots represent a capital loss for the employee. Capital losses are not taxed under Indian tax laws. Capital losses can be carried forward and set off against current or future capital gains for upto 8 Assessment Years. Such RSUs represent an opportunity to benefit from tax loss harvesting. Such lots should therefore be given first priority when redeeming RSUs. 

Scenario 2 – Current Market Price ≈ Vesting FMV : Such lots represent those where the current market value is approximately equal to the vesting FMV. Any taxable gains from the sale of such lots would naturally be minimal. They should therefore be preferred after lots giving rise to capital losses are used up. 

Scenario 3 – Current Market Value > Vesting FMV: Such lots represent those that give rise to considerable taxable gains. Gains from such lots would be taxed at 12.5% with an exemption for the 1.25 lakhs of gains (where applicable). Redeeming from such lots should therefore be a last resort if tax-efficient redemption is the objective. 

Now consider the following hypothetical data pertaining to Mr A as of 1st October 2026: 

Notice that all units have been held for more than 24 months. They therefore satisfy the LTCG holding period given that the RSUs belong to a listed foreign company. It is clear that there is a capital loss from the 2023 lot, and gains from the 2022 and 2021 lots respectively. Mr A needs to redeem RSUs worth Rs 60 lakh. We now calculate the value of gains and losses from each lot. 

2021 Lot 

There is a capital loss from this lot. Mr A would therefore be better served selling off the entire lot. This would see him realise Rs 30 lakh. The underlying calculations for the capital loss from this lot are given below. 

Loss per unit = Vesting Price – Market Value Per Unit  = 3000 – 2500  = Rs 500 per unit 

Total capital loss on the lot = Loss per unit × Lot size  = 500 × 1200  = Rs 6,00,000

2022 Lot 

There is a minimal capital gain from this lot. Mr A can therefore sell off this lot entirely. This would see Mr A realise Rs 20 lakh. Underlying calculations for the capital gain from this lot are given below. 

Gain per unit = Market Value Per Unit – Vesting Price  = 2000 – 1995 = Rs 5 per unit 

Total capital gain on the lot = Gain per unit × Lot size  = 5 × 1,000   = Rs 5,000

2023 Lot 

This lot has a considerable capital gain. It is also important to note that by now Mr A has realised Rs 50 lakh out of the Rs 60 required (Rs 30 lakh from the 2021 lot and Rs 20 lakh from the 2022 lot). This means Mr A only has to realise Rs 10 lakh from the 2023 lot. The market price per unit for the 2023 lot is Rs 1400. Therefore : 

Number of units to be sold to realise Rs 10 lakh = Amount to be realised/ Market Value Per Unit  = 10,00,000/1,400 = 714 units

Underlying calculations of the gains realised from this lot are given below 

Gain per unit = Market Value Per Unit – Vesting Price  = 1,400 – 1,000  = Rs 400 per unit 

Total capital gain on the lot = Gain per unit × Number of units sold  = 400 × 714 = Rs 2,85,600

The 2023 lot has 2,857 units out of which 714 units are being sold. This means 2,143 units are retained at a market price of Rs 1,400 per unit. The market value of the retained lot would be Rs 30,00,200 (2,143 × 1,400), which was the intended result at the start of the exercise. 

Now let us look at the ultimate tax liability for Mr A as a result of these operations : 

Long Term Capital Loss (2021 lot) = Rs 6,00,000

Long Term Capital Gain (2022 lot) = Rs 5,000

Long Term Capital Gain (2023 lot) = Rs 2,85,600 

Remember that long term capital losses can be set off against current or future long term capital gains (up to 8 Assessment Years). It is clear that the long term capital loss from the 2021 lot is sufficient to absorb the gains from the other two lots. 

Unabsorbed capital losses carried forward = 6,00,000 – 5,000 – 2,85,600  = Rs 3,09,400 

Also remember that Mr A has long term capital gains worth Rs 5 lakh from his ELSS and active mutual fund component. This amount can be used to absorb the remaining long term capital loss amount of Rs 3,09,400. But Mr A would now be taxed on the residual capital gains at the rate of 12.5%. Underlying calculations are laid out below. 

Unabsorbed capital losses = Rs 3,09,400 

Long term capital gains from ELSS and actively managed mutual funds = Rs 5,00,000

Residual long capital gains = 5,00,000 – 3,09,400 = Rs 1,90,600

Remember that Mr A’s ELSS and active mutual funds are domestic equity funds. Therefore the first Rs 1.25 lakh of these gains would be completely exempt from tax. Accordingly :

Taxable Long Term Capital Gains = 1,90,600 – 1,25,000  = Rs 65,600 

Tax on long term capital gains = 65,600 × 12.5% = Rs 8,200

The amount realised from the redemption of RSUs, ELSS funds and actively managed mutual funds can be channelled into large cap index funds. 

Applicability Of Schedule FA And Form 67

An individual is required to declare their RSUs in Schedule FA where they hold either or both of the following : 

1.  RSUs granted by an overseas company
2. RSUs granted by the Indian arm of an overseas company (Google India or Amazon India for instance)

Indian tax laws consider both of these as foreign assets. Mr A holds RSUs granted by a listed foreign company. Such RSUs are typically held in overseas brokerage accounts. That is why Schedule FA is mandated in Mr A’s case. Not declaring foreign assets in Schedule FA would trigger a flat penalty of Rs 10 lakh under the Black Money Act. Mr A must also remember that Schedule FA requires foreign asset holdings to be declared in accordance with the calendar year rather than the financial year.

When overseas RSUs are sold, the overseas broker may withhold taxes. This may give rise to an instance of double taxation (once each in India and overseas). To avoid this Mr A must file Form 67 before filing their ITR. 

What Next? 

Once RSUs are redeemed the post tax sale proceeds are typically channelled back into the portfolio. It is important to remember to maintain the desired asset allocation of the portfolio while doing this. In Mr A’s case the Rs 1.2 crore realised from the RSU redemption can be added to his existing holdings in large cap index funds. Doing this would see the equity component of the portfolio being structured as follows : 

Index funds = Rs 1.2 crore (60 lakh from ELSS and active mutual funds + 60 lakh redeemed from RSUs) 

RSUs = Rs 30 lakh (Residual component retained after redemption) 

This represents an optimal proposition for Mr A on multiple levels. He only pays taxes of Rs 8,200 on total realised long term capital gains of Rs 7,90,600 (5,000 from 2022 RSUs + 2,85,600 from 2023 RSUs + 5,00,000 from mutual funds). The majority of his equity portfolio would now be parked in large cap index funds. This would make the equity portfolio a lot simpler and more streamlined. The value of the equity component would remain very close to the original Rs 1.5 crore. The overall 60-40 split between equity and debt at the net worth level also remains intact. But the concentrated exposure to RSUs is now a thing of the past. This fundamentally reduces portfolio risk for Mr A.

The Section 54F Exemption 

Consider an individual who owns a significant chunk of RSUs and wishes to buy a property. The individual can leverage the exemption available under section 54F of the Indian Income Tax Act. It exempts capital gains arising from the sale of any long term capital asset apart from residential property. The entire consideration received from the sale of such an asset must be utilised to purchase residential property. This means that the individual can sell their RSUs and reinvest the sale proceeds to buy a property of their choice. It is important to note that this exemption cannot be availed if the individual already owns more than one residential property. 

Answering The Golden Question 

A central dilemma for those who receive RSUs is as to whether to hold vested RSUs or sell on vesting. Answering this question requires one to consider the relationship between the two key pillars of their wealth. These are human capital and financial capital. Human capital refers to our ability to work and earn. Financial capital refers to our investment portfolio. By holding vested RSUs from our employer, we would essentially tie our human and financial capital together. 

This could prove to be very dangerous if the employing organisation goes through a turbulent phase. Weak corporate performance would translate into the value of the RSUs plummeting. This would adversely impact the individual’s financial capital. They may also be laid off as a consequence of the employer’s weak performance. This would compound their problems further by cutting off the source of their human capital. Holding vested RSUs may therefore not always be the best option. 

Individuals must therefore learn to view their RSUs as a bonus rather than an investment. They must then ask themselves the following question : 

1.  Am I confident of remaining with my current employer for the next 5-10 years?
2.  If I were to receive this bonus in cash rather than stocks, would I use the money to buy the employer’s stock at the prevailing market price?

If the answer to both these questions is a confident yes, they may hold their RSUs (as permitted by their intended asset allocation). If not, they may be better served in selling off their RSUs. 

Wrapping Up 

Awareness of the dynamics and implications of holding RSUs is becoming increasingly important. This article is sufficient to give readers working knowledge of the most important aspects pertaining to RSUs. It would ensure that they avoid fundamental errors when handling RSUs and leverage their benefits optimally.