The proposed law effective April 1, 2007 has shifted the focus from employee taxation to employer taxation on Esops. The benefit arising at the time of exercise of shares by the employees will be liable to FBT at an effective rate of 33.99%. Correspondingly, any benefit on account of Esops as perquisites is out of employee taxation.
Potential FBT impact is uncertain around the value of FBT to be taxed in the employers hands. Let us consider an example where employee A and employee B are granted Esops on the same date but they exercise on different dates. The exercise price is Rs 10.
Employee A exercises his options in year 3 when FMV on exercise date is Rs 30 and employee B in year 4 when FMV is Rs 40. The value of taxable benefit for FBT purposes will be Rs 20 and Rs 30 respectively. Therefore, even a different date of exercise could impact the FBT liability. Companies find themselves in a quandary as to which other factors may influence their FBT liability. In case of a globally mobile work force, there will be issues around double taxation where foreign companies grant Esops to their employees.
Foreign companies may be liable to pay FBT on Esops in India and the employee may suffer personal taxes in the home country on the same benefit, leading to double taxation.
Confusion also surrounds the impact of the proposed law on Esop variants such as restricted stock units and stock appreciation rights and nothing has been clarified at present. Some clarifications from the Government in this aspect are necessary. Taxation of Esops in the hands of the employer is something which does not find precedent in other countries. In fact, it is surprising to note that the government has sought to bring Esops within the FBT ambit, as clearly these are not in the nature of collective benefits but are employee specific.
In the United States, tax treatment of Esops depends on whether the stock option plan is qualified or nonqualified. Options provided to employees under qualified plans are not subject to tax at the time the option is granted or at the time the employee exercises the option and buys the stock. Tax is only levied as capital gains tax when the employee sells the stock.
Options provided to employees under a nonqualified plan are taxed when it is granted, if the option has a readily ascertainable FMV at that time. The exercise of a nonqualified stock option triggers a taxable event. An employee recognises ordinary income in the amount of the value of the stock purchased, less any amount paid for the stock or option. When the stock is sold, the difference between the sale price and the FMV at the date of exercise, if any, is taxed as capital gain.