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ESOPs and advance tax payment
September, 20th 2007

It will be better if the Government also includes advance tax on capital gains payable by employees in its Circular on deferment of advance tax for FBT on ESOPs

Kaushik Mukerjee

The Finance Act, 2007 introduced Fringe Benefit Tax (FBT) on securities or sweat equity shares transferred or allotted by employers under Employee Stock Option Plans. The FBT is to be paid on the Fair Market Value (FMV) of the shares on the date of vesting of the stock option minus the price paid by the employee for such securities or shares.

The method of determining the FMV is to be prescribed by the Government. The rules are, however, yet to be notified.

The Government has extended the due date for payment of the first and second instalments of advance FBT payable by the employer to December 15, 2007.

As a result, the non-payment of advance tax till that date will not attract interest under Section 234C of the Income-Tax Act, 1961 on the employer-companies.

The employees acquire securities/shares upon exercise of the stock options. Any gain arising upon transfer/sale of the shares is liable to capital gains tax.

The employee is liable to pay advance tax on such capital gains in three instalments by September 15, December 15 and March 15 of the fiscal year. If the employee does not pay the requisite percentage of advance tax within the said dates, he incurs liability to pay interest under Section 234C.

The capital gain on the sale/transfer of shares by the employee is to be computed at sale price minus the FMV of the shares on the vesting date (that is, the FMV considered by the employer in computing FBT).

The Government press note extending the due date for advance tax mentions only about the FBT payable by the employer, but does not say anything about the capital gains tax payable by the employees.

The question is whether the employees will have to pay interest if they do not pay their first instalment of advance capital gains tax by September 15, 2007. The answer is No.

Cardinal principle

Just as the employer cannot compute the FBT in the absence of the rules determining the FMV of the shares, the employee also cannot compute his capital gains tax in the absence of such FMV.

It is a cardinal principle of taxation law, supported by a plethora of court decisions, that where the machinery provision of a tax law is absent, the charging provision cannot be applied.

While capital gains tax is leviable through the charging provision, the computation of the tax is governed by the machinery provisions. The FMV being a part and parcel of the machinery provision in this case, the absence of the rules for determining FMV makes the charging provision for computing capital gains inapplicable.

Therefore the employees will not be required to pay capital gains tax on sale of such shares, till such time the rules for FMV are prescribed.

However, it will be better if the Government also includes advance tax on capital gains payable by employees in its Circular on deferment of advance tax for FBT on ESOPs. This will clear any ambiguity in this matter and save litigation in future.

(The author is Executive Director, PricewaterhouseCoopers. )
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