The incongruity of the tax basis arises largely from the fact that, unlike in any other country, India now seeks to tax the employer for a benefit/income which accrues to the employee, most of it without the employer having granted it or having any control over it.
The recent proposal in the Budget for levying Fringe Benefit Tax (FBT) on employers Employees Stock Option Plans (ESOPs) is a complete reversal of the policy on the issue in place over the last 5-6 years.
The current scheme exempts employees from taxation if they sell the scrips got in an ESOP plan within one year from exercise. The proposed amendment throws up issues of technical interpretations and the tax impact for the employer. Some of these may become clearer once the rules prescribing the Fair Market Value (FMV) for the purpose of valuing fringe benefits are notified. But till such time employers are saddled with a problem they never bargained for and will have to work out solutions to mitigate the unexpected problems.
This article aims to briefly list out the harshness or multiple-wammy created by the introduction of this new provision. It also looks at the reasons which seem to be prompting the Finance Minister to introduce such changes and suggest some alternatives which may lead to a more rational way of taxation, should the Finance Minister wish to take away the concessional tax treatment granted to ESOPs.
The key concerns from the employer's perspective are:
To start with, the employer suffers a hit to its Profit and Loss Account of the notional benefits to the employee at the time of the grant of the ESOP, equal to the discount in relation to the prevailing market value.
While the P&L takes a hit, there is a question mark on the deductibility of such "expense" for the purposes of computing employer's taxable income.
On top of that, the employer is required to pay the FBT not only on the discount at the time of the grant but also in the appreciation of the value of shares in future (over which the employer has no control).
To compound matters, such FBT paid by the employer is not tax-deductible and effectively equal to much higher post-tax expenditure.
Further, as a lot of these employees who receive ESOPs may be mobile and render services in different tax jurisdictions between the grant and exercise of the stock option, they may end up having tax obligation abroad on some part of the benefits arising out of the ESOPs. While they may not themselves suffer double taxation, there would be an economic double taxation on account of the FBT paid by the employer not being creditable against the tax paid by the employee abroad.
Lastly, foreign companies having presence in India by way of a branch/Permanent Establishment/presence of employees may also end up having additional burden of tax by way of FBT on ESOPs, thereby substantially raising their effective tax in India.
Apart from the above, quite a few interpretational issues are being debated in industrial/professional circles, andinclude:
Will the FBT for employer be 33.99 per cent or a lower rate, based on valuation rules to be prescribed?
What is the cost basis for employee for the purposes of determining capital gains when the options are sold at a later date?
In fact, some quarters are also debating whether the proposed amendments will take away the obligation of the employees for payment of taxes on the stock option.
Can the employer contractually/tax-efficiently recover the FBT from the employee?
Leaving aside the interpretation issues for the moment, it is suggested that, at a conceptual level, if the benefits of stock options are to be taxable, the levy must fall on the person deriving the benefit. Even where the benefit is sought to be taxed in the hands of the giver, it should be limited to the extent of the benefit granted and not beyond that. Such a scheme of taxation should also provide for matching deduction and credits so that economic double/multiple taxation is avoided. Unless such equity is bought about in the taxation, the concept of stock option may have a premature demise.
In the light of the above, conceptually, the following changes should be considered by the Government in the scheme of stock option taxation:
The FBT on the employer, if at all, should be limited to the discount to the market value on the date of the grant, as is required to be debited in the books of accounts under the accounting standards/guidelines applicable.
Correspondingly, such expenditure should be clearly allowable as a deduction against the taxable income of the employer.
Any forfeiture of such options resulting in disentitlement for the employee and reversal of such benefits should culminate in a corresponding deduction in the FBT obligations in future.
The benefit to the employee in the appreciation of the share price over the exercise price may, if at all, be taxed in the hands of the employee at the time of the exercise. However, ideally, as the employee does not realise any gain at that stage, there should be no taxation then, but only post ultimate sale of shares. When such profit, which is in the nature of capital gains, accrues, it should be treated just like capital gains on shares, as applicable to any other investor.
Given the importance of stock options to the growing economy of India, which is competing to reward its human resource, the industry should make a strong representation to the Finance Minister to withdraw the proposed amendments or to introduce a grand-father clause which seeks to apply the changes in law only prospectively.
Nikhil Bhatia (The author is Partner, BSR & Co, Mumbai.)