Impact of Fringe Benefit Tax Imposed on Esops

The proposed law effective April 1, ’07 has shifted the focus from employee taxation to employer taxation on Esops. The benefit arising at the time of exercise of shares by the employees will be liable to FBT at an effective rate of 33.99%. Correspondingly, any benefit on account of Esops as perquisites is out of employee taxation.

Potential FBT impact is uncertain around the value of FBT to be taxed in the employer’s hands. Let us consider an example where employee A and employee B are granted Esops on the same date, but they exercise on different dates. The exercise price is Rs 10.

Employee A exercises his options in year 3 when market value (MV) on exercise date is Rs 30 and employee B in year 4 when MV is Rs 40. The value of taxable benefit for FBT purposes will be Rs 20 and Rs 30 respectively. Therefore, even a different date of exercise could impact the FBT liabilility. Companies find themselves in a quandary as to which other factors may influence their FBT liability. In case of a globally mobile work force, there will be issues around double taxation where foreign companies grant Esopsto their employees. Foreign companies may be liable to pay FBT on Esops in India and the employee may suffer personal taxes in the home country on the same benefit, leading to double taxation.

Confusion also surrounds the impact of the proposed law on Esop variants such as restricted stock units and stock appreciation rights and nothing has been clarified at present. Some clarifications from the government in this aspect are necessary. Taxation of Esops in the hands of the employer is something which does not find precedent in other countries. In fact, it is surprising to note that the government has sought to bring Esops within the FBT ambit, as clearly these are not in the nature of collective benefits but are employee specific.

In the US, tax treatment of Esops depends on whether the stock option plan is qualified or nonqualified. Options provided to employees under qualified plans are not subject to tax at the time the option is granted or at the time the employee exercises the option and buys the stock. Tax is only levied as capital gains tax when the employee sells the stock.

Options provided to employees under a non-qualified plan are taxed when it is granted, if the option has a readily ascertainable MV at that time. The exercise of a non-qualified stock option triggers a taxable event. An employee recognises ordinary income in the amount of the value of the stock purchased, less any amount paid for the stock or option. When the stock is sold, the difference between the sale price and the MV at the date of exercise, if any, is taxed as capital gain.

Esops may soon be history


ESOPS may soon be history. The proposed amendment in Budget ’07 may even eliminate the whole concept of Esops from the Indian scenario.

Why Esops will not be attractive now: First, the employer will be burdened with an effective post-tax cost of 45.54%, which is a huge cost for any company as it will hit its bottomline. Second, the employer is being made to pay tax on the benefit derived by the employee due to appreciation in the shares due to market forces and not because of any cost incurred by the employer. For example, say a new start-up company had granted options five years back at the face value of Rs 10 each.

The company is now listed and its shares are traded on the Indian stock exchange. The employee’s exercise period has commenced and he is entitled to exercise his options and covert them into shares. Say, now the fair market value is Rs 120. Due to the proposed amendment, the employer will have to pay FBT on Rs 110 ( Rs 120 less Rs 10). Third, the exclusion from the taxability as perquisites has been removed. Therefore, effectively, it means that the benefit still remains a perquisite.

Accordingly, it may still be taxed as a benefit in the hands of the employee, besides FBT, resulting in double taxation of the same benefit. Fourth, in most of the countries, the benefit arising under Esops is taxed in the hands of the employee. Therefore, if this benefit is taxed both in India and overseas, then the employees will not be able to claim credit for the same under the respective Double Taxation Avoidance Agreements between India and other countries.

Then, many foreign companies grant Esops to the employees of their subsidiary companies in India. As clarified by CBDT earlier, FBT is payable by the foreign company only if it has employees based in India.

Therefore, an issue arises whether there will be no FBT in case of Esops granted by foreign company if there is no employee based in India. Further, it remains to be seen whether FBT is payable by the foreign company or the Indian employer. There are many interpretation issues in the proposed provisions which may lead to unnecessary prolonged litigation. For example, it as not been clarified whether the provisions will apply to new Esops or the FBT will get triggered even in respect of the old Esops where grants have been made in the earlier years.

If the second one is the intent of the proposed legislation then it will be unfair to the employers as they have been caught unawares and are being made to pay tax for the contractual arrangements (Esops) entered into with employees based on the prevailing tax law in the earlier years, i.e. when there was no income tax either for the employee (personal tax) or for the employer (FBT) when the Esops were granted.