"But how can we pay the tax?" remonstrated the Nasscom man.

"Why, what is the problem?" asked the minister arching his eyebrows.

"But Sir, where is the income, I mean liquidity", sputtered Nasscom man.

The minister nodded his head sagely as if a new pearl of wisdom has been dinned into his ears and promised to scrap the scheme. The Nasscom team thanked the minister profusely grinning from ear to ear and went away. It was perhaps the first and the last business lobby to go back completely pleased.

The above conversation is purely fictional, but not its outcome. The IT industry, which was on a high then as indeed it is even now, particularly fond of rewarding its employees through stock options, was naturally miffed when the Finance Act, 1999 sought to introduce a regime to tax the difference between the market price of the shares on the date of the exercise of option and the offer price as a perquisite.

The IT sector was aghast and made its point tellingly. If the market price is Rs 4,000 per share and the offer price is Rs 400 per share, how can an employee to whom 1000 shares have been offered pay tax on Rs 36 lakh, asked the sector, genuinely horrified at the prospect of having to pay tax on notional income, given the fact that the shares admittedly have not been sold.

Undisguised delight

The then minister capitulated. The result was withdrawal of the offending provision the very next year and with an express alternative provision in the opposite direction nothing in this regard is taxable. The employees were jubilant. That they have to pay tax in any case when they sell the shares obtained under ESOP did not worry them a wee bit. For, they knew what they made on sale was capital gain. They also knew that if they sat tight on those shares for one full year, they would don the robes of long-term capital assets. They further knew that long-term capital gains from shares are taxed lightly. Later on to their undisguised delight, tax was completely abolished on long-term capital gains earned through recognised bourses. The bottomline no tax at all either at the time of exercise of option or at the time of sale.

Beneficiaries spared

Seven years later, the emperor has struck back, but not at the employees as he must have but at their employers. Yes, Budget 2007, proposes to impose Fringe Benefit Tax (FBT) at 33.99 per cent on the same amount which the Minister in 1999 had calculated. If the then minister was guilty of complete capitulation, Mr P. Chidambaram is now guilty of not taxing the beneficiaries who admittedly are the employees.

The employee lobby was right when it said that no one should be taxed on an unrealised gain. What the then minister ought to have done is to postpone the tax liability to the point of sale at which point tax could have been collected under two heads difference between market price on the date of exercise of option and the offer price being taxed as salary, and the difference between the selling price and the market price on the date of exercise of option being treated as capital gains. Because no one can seriously gainsay the fact that the concession in the offer price vis--vis the market price is purely due to employer-employee relationship.

That such concession is slowly dwindling does not detract from the intrinsic merit of this argument. There is a parallel for postponing the tax liability to the point of actual sale when there is a dual tax liability Section 45(2) that provides a fair regime for taxing the gains on account of conversion of one's capital asset into stock-in-trade.

FBT should be resorted to, if at all, only to vicariously reach out to difficult-to-pigeon-hole categories of beneficiaries of company expenses. The callous use of the FBT regime to tax as many employee-related expenses as possible does injustice to employers, besides being soft on the employees. On this touchstone, the ESOP benefits springing out of employment ought to be taxed in the hands of the benefiting employees and not in the hands of the employers providing them. The Government ought not to abandon equity in pursuit of ease-of-collection.

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