The Hindu Business Line : ESOPs still plagued by many unanswered questions

Chennai May 5 Ever since the Finance Bill, 2007 proposed to bring ESOPs (employee stock options) under the FBT (fringe benefit tax) regime, a lot was said about the harsh tax treatment meted out to an incentive that recognised talent and performance. Yet, these pleas seemed to have predominantly lost out like voices in the wilderness; for, the latest amendments, announced on May 3, have not taken the whole sob out of the ESOP story, frets Mr Nikhil Bhatia, Partner, BSR & Co, a firm of chartered accountants, interacting with Business Line, in the aftermath of the denouement ESOP has faced.

Excerpts from an interview.

On the initial proposal.

Impact of the proposal was that employers had to dole out FBT at 33.99 per cent on the difference between the FMV (fair market value) of the shares on the date of exercise less exercise price of the option. FBT payable would not be a deductible expenditure while computing the profits of the company leading to effective cost of 45.54 per cent post tax. The irony being that employer had to pay tax on a benefit accruing to the employee. Further, such tax was computed in relation to a future valuation of the share determined by market rather than a value controlled by the employer.

On what the industry demanded.

Post Budget, many representations were made urging the Finance Minister (FM) to reconsider the proposal and either withdraw or tone down the provision on account of the inequities it created. Corporate circles were eagerly hoping for an amendment, which directly taxed this benefit in the hands of the employees instead of collecting the same from employers.

On the positives in the latest twist.

The Finance Bill, now approved by the Lok Sabha with some amendments, has addressed the concerns of the corporate sector partially. A welcome change is that FBT will now be payable by the employer company on the difference between the FMV on the date the option vests in the employees as reduced by the exercise price. Earlier, the value to be considered was on the date of exercise, which is a date subsequent to vesting. Therefore, the FBT blow may be reduced to some extent, especially in start up companies, as the value on the date of vesting would be lower than the date of exercise.

Further, from April 1, the employer company is also authorised in law to recover the FBT paid at the time of allotment, from the employees by varying the agreement or scheme under which the options were granted.

On sale of the shares, the employee would need to pay the capital gains tax on the difference between the sale price and the FMV on date of vesting. The holding period shall be reckoned from the date of allotment/transfer of the security.

On the new worries, unattended concerns and open questions.

FBT is still payable by the employer in the first instance. There is, therefore, no respite to employers in this respect. FBT is still payable on the date of allotment/ transfer of the specified security, i.e. the date when the shares are actually given to the employees.

Even if the employer recovers the FBT from the employees, there is no clarity on whether this recovery will be treated as income in the hands of the employer? On top of that, what would happen if the employee contends that he does not have sufficient funds to pay the taxes at the time of allotment? There would perhaps then be a need to put a mechanism in place where the employee has to sell his shares to fund the taxes. If that happens, employees will have to pay short-term capital gains tax as well.

Also, could such recovery from employees be considered as detrimental to their interests? It would be interesting to note that any variation in the terms of the ESOP which is detrimental to the interests of the optionee-holders is not permitted by the SEBI Guidelines on ESOPs (as applicable to listed Indian companies).

While the employer may suffer a hit to the P&L (profit and loss account) on the notional benefits to the employee at the time of grant of the options (equal to the discount in relation to the prevailing market value), there is still a question mark on the corporate deductibility of this expense.

On the impact of the new law on mobile employee and foreign companies.

Mobile employees rendering services in overseas countries during the lifecycle of ESOPs between grant and exercise may end up paying taxes in the overseas country on some part of the ESOP benefit. This may result into economic double taxation as the FBT payable in India by the employer, even if recovered from the employee may still not be creditable against the employee tax in the overseas country and vice versa.

There is still no resolution on FBT liability for foreign companies, which have issued ESOPs to employees of the subsidiary companies. Where foreign companies have employees based in India and consequently an FBT liability on ESOPs, there ought to be exclusion for proportionate value of benefit attributable to the employees' services rendered outside India. There is no specific provision in this regard.

Could there have been a better alternative?

The revenue's objective could have been achieved by shifting the tax burden on ESOP benefit on the employee directly by considering it as a taxable perquisite in his hands and getting the employer to do a withholding at the time of exercising. Such a change would have taken care of a lot of the above open issues. However, by following a roundabout approach, the FM has left the corporates to do a lot more work for the past ESOPs as well as thinking and planning for future equity incentive plans.

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