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Fair market value of stock option for FBT
July, 21st 2007

Ideally, in the case of stock options, the valuation should be done of the options per se, in accordance with the methods used for valuing stock options.

Vikas Vasal

The Fringe Benefit Tax (FBT) is levied on the benefit arising to employees under an Employee Stock Option Plan (ESOP).

FBT is to be to be levied on the difference between the fair market value (FMV) of the specified security or sweat equity shares on the date of vesting and the amount paid by the employee (generally referred to as exercised price). FMV refers to the v alue determined in accordance with the method prescribed by the Central Board of Director Taxes (CBDT), and is yet to be notified.

It is pertinent to note that on the date of vesting, till the options are exercised, it is only the stock options (and not the shares) that exist.

Therefore, ideally, in the case of stock options, the valuation should be done of the options per se, in accordance with the methods used for valuing stock options such as Black and Sholes.

It however appears that the valuation to be done for the purposes of FBT is in respect of the shares of the company instead of the stock options. While valuing a distinction has to be made between listed and unlisted shares.

Listed shares

In the case of listed shares, it is likely that the FMV would be linked to the quoted market price in a stock exchange.

Key issues in respect of quoted market price would be whether it would be opening price, closing price, average of the high and low on the date of vesting, the particular stock exchange whose quotes can be used as the basis for computing the FMV.

Unlisted shares

There is a greater challenge in determination of FMV in the case of unlisted securities.

In this connection reference could be drawn from the erstwhile CCI guidelines, valuation rules under the Gift Tax Act, the Wealth Tax Act, etc.

Broadly, the following methods merit attention: a) net asset method; b) multiple-based method; c) discounted cash-flow method.

Under the net asset method the value is computed by deducting debts and liabilities from the assets. The value of the net assets could either be based on the current book value of the assets or on the replacement value of the assets. Under the multiple-based method, estimated earnings of the business on a sustainable level for a future period are estimated and multiplied by an appropriate multiple to arrive at the capitalised value of the business. The multiple varies from sector to sector.

Under the discounted cash-flow method future, cash flows are discounted back to the present date to arrive at the net present value of the cash flow stream of the business.

As the method is to be used mainly for computing FBT and not for the purchase/sale of business per se, the prescribed method should be simple to compute the FMV. Also, necessary clarifications/guidelines should be issued along wit h the valuation rules to avoid any ambiguity while computing the FMV.

(The author is Director, KPMG.)
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