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After the gain, some pain
July, 08th 2010

Infoscians will be taxed for their free shares, both at allocation and selling stages.

One can feel the excitement in Infoscian Yojita Pais voice. This 23-year-old will soon be the proud owner of seven shares of Infosys Technologies. Last week, the company, to mark its 30th anniversary, allocated a minimum five equity shares to every eligible employee. In addition, every employee will get an incremental share for each year of service.

For Pai, with two years service, it translates into seven shares. This is her first direct investment in the stock market, at zero cost. The company has claimed the shares, to be allocated at no cost to the employees, may not attract tax. The distribution will not result in a taxable event. However, you should consult your own legal, tax and financial advisors on the implications of this distribution, said the company notice.

However, its not that simple. While the likes of Pai believe this is tax-free income, experts differ. Homi Mistry, tax partner, Deloitte Haskins & Sells, said: Employees will be taxed according to the norms applicable for perquisites earned.

Such taxation occurs in two stages, on allocation and sale.

On allocation: When the company allocates shares to you, they will be liable for taxation by taking into account fair valuation. Pais seven shares will be valued by the companys merchant bankers. This is the average of the opening and the closing price of the share on the date of allocation, says the Income Tax Act.

After this, assume that the fair market value per share is Rs 2,500. The perquisite value will be Rs 17,500 (2,500x7). The amount will be added to the employees overall income and taxed according to the applicable slab. This is because Infoscians are getting these shares free of cost; hence, these will be considered a perquisite.

If the employees were allocated these shares at a discount, the amount paid would have been deducted from the total perquisite value and taxed as income.

For instance, in Pais case, the numbers would work out in this manner. Say, the market value of the share is Rs 2,500. If the purchase price was Rs 100 per share, Pai would pay Rs 700 for her shares.

The value of the perquisite would reduce from Rs 17,500 to Rs 16,800. This would be added to Pais income and taxed.

On selling: This is the second stage where taxation comes into play. Depending on the time period an employee holds the shares, long-term or short-term capital gains tax will be applicable.

If one holds the shares for more than a year, there will be zero long-term capital gains tax. But, if an individual sells the shares within a year of allocation, he/she will have to pay the short-term capital gains tax of 15 per cent.

Since Infosys is not charging the employees, the fair market value will be treated as the purchase price and capital gains calculated accordingly. In case of a capital loss, an individual can either set it off against any capital gains in the same financial year or carry it forward for the next eight years.

Though the Infosys Trust is distributing the shares among its employees, the time span for which the shares were held by the Trust will not be taken into account.

Since the Trust was not holding the shares as any individuals nominee, the benefit of the holding period cannot be passed on to the beneficiaries, said Amitabh Singh, tax partner, Ernst & Young.

On deputation abroad: Here, things are a bit more complex. There is no clarity on the issue. There are two possible views on how to tax employees on deputation abroad, but the scenario is not very clear. The guidelines on perquisites that were issued last December are silent on this, added Mistry.

Tax experts feel there will be two broad scenarios. In the first case, if you were abroad when the shares were vested with you, zero tax is applicable on the perquisites when you return. In the second case, The view is that the individual be taxed in proportion to his/her presence in the home country, said Mistry.

Say, in a financial year, you were on deputation for eight months and were present in India for only four months. Tax experts said the income earned in India should only be taxed for the four-month period and not the entire year.

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