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March 2, 2007
Employee
Stock
Options: Till Tax Do Us Part
In
an entirely unexpected move, the Finance Minister of India (FM),
in the Finance Bill, 2007 presented to the Parliament on
February 28, 2007, proposed to bring within the Fringe Benefits
Tax (FBT) net the benefit received by employees upon
exercise of options under employee stock option schemes formulated
by the employer company.
The
FM has proposed to delete the provision in the Indian Income-tax
Act, 1961 (ITA), which exempts the value of benefit
to the employee at the time of exercise of options under an
employee stock option plan which is in accordance with the
guidelines issued by the Indian Ministry of Finance (Department of
Revenue) in 2001. It is proposed to delete this provision with
effect from April 1, 2007. Since this benefit is now proposed to
be covered under FBT, it would be excluded from the purview of
"perquisites". Accordingly, from April 1, 2007, while no
employee would be subject to tax on stock options as such benefit is no longer a
perquisite, all employers would be subject to FBT. It is to
be noted that FBT is not a deductible expense or a tax creditable
against the corporate income tax of the employer. Thus, it is an
additional cost burden.
The Finance
Bill, 2007 provides that the FBT value would be calculated
based on the difference between the fair market value of the
shares on the date of exercise and the exercise price paid by
the employee. The entire difference would be treated as
taxable value of the fringe benefit and thus subject to FBT
payable by the employer. However, the actual effective rate of
FBT is unclear since the rules for valuation have yet to be
announced by the Central Board of Direct Taxes (CBDT).
The FM has stated in a television interview that these rules
would determine the rate of FBT. It
is unclear whether the exercise of stock options granted by a
foreign parent company to the employees of Indian subsidiary would
attract FBT and if it does, which company would be liable to pay
the same. It is expected that the Finance Bill, 2007, in its final
form, or the CBDT, would clarify this position. Implications: With
this unprecedented move, there will be a substantial increase in the
cost of granting stock options to employees. It is unlikely that
companies, especially start-ups, will be able to bear the
additional burden of the FBT and it remains to be seen whether
they would pass the tax on to their employees at the time of
exercise of options. In the event the FBT is passed on, the
employees may end up paying tax on the notional gain at the time
of exercise, and thus be out of pocket to the extent of the amount
of FBT. Such tax would be in addition to the tax payable on
capital gains at the time of sale of shares. Till such time as the
rules are notified, there would be substantial uncertainty.
Employers will soon need to start thinking of other innovative
compensation structures to reward, attract and retain talent!
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