Rewarding employees through performance incentives is becoming de rigueur in the corporate sector, especially at the medium and top echelons. While this is a cash salary that hinges on individual, group and company performance, which falls into the tax net without much ado, the non-cash variant of it in the form of company's shares has strangely got the taxman's indulgence. The proviso to clause (iii) of Section 17(2), introduced from April 1, 2001, bails out this form of reward from salary computation for tax purposes.

The rule that brought the difference between the market price of the shares given under such schemes on the date of acceptance of the offer and their offer price into the salary tax net has thus proved to be one of the most short-lived provisions in the annals of the income-tax law in India.

Volte face

What made the Government make such a U-turn in its thinking and capitulate to the demands of the employees of the IT sector who, in particular, were miffed by the rule that brought the difference into the tax net? This happened because of excellent lobbying done by the industry whose representatives cried on the shoulders of the then Finance Minister, Mr Yashwant Sinha, citing practical difficulties in paying tax on this particular component of the salary being a notional income, tax thereon gave no option to the employees but to sell either all or some of the shares just to pay the tax.

Moved by their plea, the Government gave in. It did not occur to it that there is a parallel in the Income-Tax Act, 1961 itself which handles the difficulty, deftly balancing revenue's and taxpayers' considerations admirably when one converts his capital asset into stock-in-trade, the notional transfer gives rise to capital gains tax liability and the same difficulty articulated by the IT sector employees of there not being sufficient cash to pay off the liability.

The government of the day resolved this difficulty by ordaining that the tax liability would be postponed to the point of actual sale of stock-in-trade, but at that point of time the entire profit would be divided between capital gains and business income with the difference between the fair market price on the date of such conversion and its cost attracting capital gains tax and the difference between the selling price of the stock-in-trade and the fair market price attracting tax under `Profits and gains of business'. This was done by introducing Section 45(2). An excellent via media indeed.

Correct the wrong

The Finance Minister, Mr P. Chidamabaram, should correct this wrong inflicted on the Revenue by taking a cue from Section 45(2). He should balance revenue and employee's concerns by providing for a regime akin to the one described in the context of capital assets converted into stock-in-trade. Tax on salary on this account should be postponed to the point of actual sale of share at which point of time the entire profit should be neatly divided between salary and capital gains.

There is no tax on long-term capital gains from shares. Only a piffling Securities Transactions Tax (STT) has to be paid. That these days the offer price under the employee stock option schemes are aligned more towards the prevailing market price does not detract from the intrinsic merit of the case made for the Revenue by this article.

S. Murlidharan
(The author is a Delhi-based chartered accountant.)