Companies will have to pay fringe benefit tax (FBT) on stock options offered to their employees.

After examining post-Budget suggestions to shift the incidence of tax on stock option plans to the employee, the finance ministry has veered around the view that the tax has to be paid by the employer. This means the government will go by its original Budget proposal to impose an FBT on Esops. The decision was taken late last week while finalising the amendments to the Finance Bill 2007.

From a pure academic perspective, the best option would have been to tax stock option plans in the hands of the employee. However, we considered the fact that the employee may not have the wherewithal to pay tax at the time of exercising his or her stock option. Cash-flow problems is one of the major reasons that has prompted the government to go with the original Budget proposal, said a government official.

FBT on Esops would ensure quick flow of revenues to the kitty and would be easy to administer. The employer, in any case, has the option to pass the burden to the employee. This was an arrangement which had to be independently worked out between the employer and the employee, the official said.

Companies pay a 30% FBT on a defined base on various categories of expenses, including employers contribution to superannuation funds. These contributions are an incentive offered by companies to retain their senior-level employees. Companies pay FBT on contributions above Rs 1 lakh to the superannuation funds of their employees. The entire amountover Rs 1 lakhis taken as a base for valuation of FBT.

Esops too are a popular retention tool offered by several IT companies, including start-ups. Sources said that the base for valuation of FBT on Esops will be 100%. The Central Board of Direct Taxes (CBDT), as per the original Budget proposal, will prescribe the method to value the fringe benefit on the date of exercise of the option.

In a stock option plan, options vest with the employee for a stipulated periodthree-to-seven years. During the period, the employee cannot transfer or sell the options. Once the period is over, the employee acquires the shares by exercising the option. He does not have to pay tax on the date of exercise of the option. However, if he chooses to sell shares (listed equities) before one year, he has to pay a 10% short-term capital gains tax. If he off-loads shares after a year, he does not have to pay long-term capital gains tax.

The valuation norms are well laid out for listed companies. However, for unlisted companies, the finance ministry plans to unveil norms separately. At least two options are availableSebi rules relating to valuation of shares and wealth tax rules. In both cases, book value is the basis on which share valuation is done.