Ambiguity In Valuation Of Employee Stock Options Removed - Government Issues Valuation Norms For Taxation Of Perquisites
The Central Board of Direct Taxes (“CBDT”) on December 18, 2009 has finally issued the much awaited rules for valuation of perquisites. The Finance Act, 2009 had inter alia brought into the purview of the definition of ‘perquisites’, shares issued or allotted to employees under stock options schemes (“ESOPs”). As a result of this amendment, shares acquired under stock option schemes/plans by employees are now regarded as salary income for the employee.
As a result of this amendment, the employers are required to withhold taxes at the time of exercise of options by the employees, i.e. when the shares are issued / allotted to the employees on the difference between the fair market value of the shares on the date of exercise and the exercise price paid by the employee. Until now it was uncertain as to how the fair market value of shares would be calculated in order to withhold taxes. However, the Government has finally cleared this ambiguity by issuing the valuation rules for perquisites to take effect from April 1, 2009.
Valuation Rules for ESOPs1
The valuation rules for calculating the fair market value of shares allotted to employees is substantially the same as compared to the fringe benefit tax (“FBT”) regime. Employers once again have to obtain a valuation from a Category 1 Merchant Banker to determine the fair market value of the shares for unlisted companies. This may particularly be cumbersome and expensive for smaller unlisted companies as they may have to engage the merchant bankers depending on the exercise schedule under the stock option plan. In fact, as was with the erstwhile FBT regime, listed foreign companies whose stock prices may be readily available, would still be required to obtain a valuation certificate from a Category 1 Merchant Banker.
Further, the method to be used by the merchant bankers has yet again not been clarified in the rules. This would essentially mean that the merchant bankers can use valuation methodology at their discretion.
In the erstwhile FBT regime, the CBDT has issued FAQs which had clarified to a great extent taxation of stock options, however, this time around CBDT has not yet done so. Further, the CBDT has also not clarified whether FBT already paid by the employers with respect to stock options exercised after April 1, 2009 shall be adjusted with future tax liabilities or whether a refund will be available for the same.
Until now since the valuation norms had not been released, several employers may not have been able to deduct tax at source with respect to stock options that may have been exercised from April 2009 onwards. In this regard, since the valuation norms have been released now, such employers may be making late deduction and payment of taxes which may attract a levy of interest under the Income Tax Act, 1961. When FBT was introduced by the Government, CBDT had specifically waived interest levy on late payment of advance tax for that particular year as the valuation rules for FBT were released in December 2007 whereas FBT was introduced by the Finance Act, 2007 with effect from April 1, 2007. However, the CBDT circular does not provide for waiver of this interest levy this year even though the valuation rules for ESOPs have been released only in December 2009.
Further, taxation of other equity based incentives such as stock appreciation rights, despite their increasing popularity have not been specifically addressed by the CBDT.
Although the circular could have been more comprehensive and covered some of the abovementioned aspects with respect to taxation of ESOPs, the ambiguity with respect to withholding taxes on exercise of ESOPs has been settled by the CBDT by way of this circular. In a way it is also a relief that there are no surprises in this circular as the rules prescribed are the same as provided for in the FBT regime.
1 Notification No. 94/2009/ F.No.142/25/2009-S O (TPL), dated 18-12-2009