FBT on stock option plan: A tax on notional benefit that may not arise
March, 17th 2007
By now, you might have heard many a sob about FBT on ESOP. Yet, when the collective discontent is wide, and the rancour runs deep, about the levy of fringe benefit tax (FBT) on employee stock option plans (ESOPs), it does pay to hear an expert once again. So, here is Mr Kaushik Mukerjee, Executive Director, PricewaterhouseCoopers, arguing why the proposal introduced in the latest Budget is a flawed one, on more than one count.
On the gaps in the rationale.
FBT was introduced to tax cumulative employee benefits. The stock plan benefits accrue to employees individually. The proposal therefore goes completely against the declared purpose of introducing FBT.
The current proposal seeks to charge FBT for any exercise made on or after April 1, 2007. This would tax exercises under previously qualified stock plans.
While the employee should not logically be taxed on the benefit on which the employer pays FBT, the proposed amendments do not strictly take care of this.
The tax will be levied on notional benefit that may not ultimately arise. The market value of the shares can be higher when the employee exercises this option but when he ultimately sells the shares, the value may have gone down substantially. Hence the employer can end up paying FBT on an assumed benefit never delivered to the employee.
On new hassles for employers.
It will be extremely difficult for employers to implement the tax payment. Employees will be exercising their options on different dates. It will be impossible to keep track of each exercise, especially where the number of employees is huge, and pay tax on such basis.
Also, the employee will have to obtain his cost of acquisition from his employer. Consider a situation where an employer is faced with thousands of such requests.
On the practical implications, for foreign companies and expat employees.
Many companies, especially the subsidiaries of overseas MNCs do not have visibility of the exercise. The schemes are operated by stockbrokers through portals/web sites. Further, the stocks are quoted in overseas stock exchanges only. It will be a Herculean task to identify the date and quantum of exercise and the corresponding value of the shares for payment of tax and also to prove such facts during FBT assessments.
Foreign companies deputing employees to Indian subsidiaries may be brought under FBT if the employees exercise the option (received earlier) while in India.
In the case of expatriate employees, it will amount to double taxation. As FBT is the employer's liability, tax credit will not be available in the home country.
On how the levy compares to what prevails elsewhere.
Internationally, benefits/gains under stock plans are taxed at two stages. The difference between market price and exercise price is taxed as employment benefit. The balance gain is taxed as capital gain on alienation of shares. In some countries, the employee can elect to defer the initial tax liability to the point of sale/transfer.
In the US there is no tax on employment benefit in the case of qualified plans. The entire gain is subject to capital gains tax at the point of sale. To my knowledge the benefits/gains are taxed in the hands of the employees only and nowhere the employer pays tax on such benefits.
Given the above, it would be better to retain the current position of taxing the employee on stock plan gains depending on the qualified/non qualified status of the plan.