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ESOP fable the tree-fruit debate
March, 10th 2007
Capital which produces income is like a tree and income is a like a fruit and, hence, the tree ought not to be taxed.

Nothing perhaps has raised the hackles of the corporate sector, particularly its pinstriped executives, more than the proposed Fringe Benefit Tax (FBT) on Employee Stock Option Plans (ESOPs). How can you tax capital formation, whined a commentator with a look of injured innocence.

What he meant was sweat equity is supposed to spur entrepreneurial instincts by making employees part-owners of a company and, hence, the payout in the form of shares at a concessional price vis--vis the ruling market price ought to be viewed as a capital receipt.

Taxing the same at the corporate tax rate is patently unfair, he thundered. His fulmination would have assumed feverish pitch had the Finance Minister reverted to the aborted, nay, almost still-born, practice of taxing the concession as a perquisite in the hands of the employees direct with some fine-tuning so as to postpone the denouement to the point of actual realisation of funds, as canvassed by yours truly in these columns. If his argument were to be accepted, the income-tax law should take the Privy Council edict in the celebrated Shaw Wallace case capital which produces income is like a tree and income is a like a fruit and hence tree ought not be taxed as a holy-writ.

That it has been followed more in breach than in compliance would be evident to avid followers of the Indian tax system which taxes retirement benefits in excess of prescribed limits, gains from sale of property (although at concessional rates after allowing quite a few tax shelters) and compensation for loss of agency as income.

The point is the distinction between capital receipt and revenue receipt is getting increasingly obfuscated and blurred due to deliberate fiscal policies as well as loosening of purse strings that has virtually transformed receipts, once having the aura of capital, into revenue.

If the disingenuous argument in favour of ESOPs were to be accepted, can't those receiving salaries in crores of rupees press the same argument?

For, they can also say with equal plausible conviction that what they are piling up is actually capital given the innate shortness of their tenure because of the high-expectations factor. Ditto for a film star who can say what he receives in one year is actually towards building a war chest or alternatively a rain check.

Professionals such as doctors and lawyers can also similarly set store by making-hay-while-the-sun-shines argument. Why, even winners of contest like KBC and lotteries can clamour for relief on the ground that what they earned was through divine grace that smiles but once in one's lifetime.

The present regime, however, goes to the other extreme and taxes windfalls at the maximum marginal rate of tax that is 30 per cent-plus.

Specious arguments

The Government should not allow itself to be taken in by such specious arguments. When shares are given as or as a part of salary, it should suffer tax like any other salary income. The Finance Minister has rightly realised that offer of shares either free or at a concessional price is a benefit to employees.

Where he has erred is to shift the tax burden to the corporates, which have become his favourite whipping boys, instead of taxing the same in the employees' hands. There is a view that in the wake of FBT on ESOPs, intrepid employers are already thinking in terms of passing on the tab to the employees. This makes it all the more important for the Finance Minister to rethink his decision and impose the tax on ESOPs transparently in the hands of the employees direct.

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

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