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Stock options: The costly ambiguity
September, 13th 2007
In the ambiguity surrounding fringe benefit tax (FBT) on employee stock option plans (ESOPs), the biggest affected party is possibly the Government, according to Mr Kaushik Mukerjee, Executive Director of PricewaterhouseCoopers.

The first instalment of FBT was due on June 15, which was postponed by the Government to September 15. If the notification had been issued in time, 45 per cent of the tax would have been collected by September 15. In the absence of rules, the Government cannot collect FBT, he said in an email interaction with Business Line.

Excerpts from the interview:

First, a background about the tax in focus.

The Finance Act, 2007 has, with effect from April 1, 2007 introduced tax on fringe benefit arising to an employee out of allotment/transfer of specified securities (like shares, debentures, bonds, etc.,) or several equity shares by the employer under a stock option plan.

How is the FBT to be valued? And when is the tax payable?

The fringe benefit is to be valued at the fair market value (FMV) of the security or sweat equity share on the date of vesting of the option minus any amount paid by/recovered from the employee for such security or shares.

The FMV is to be determined as per the method to be prescribed by the Central Board of Direct Taxes (CBDT).

The employer company is required to pay advance tax of estimated FBT progressively: 15 per cent by June 15, 45 per cent by September 15, 75 per cent by December 15 and 100 per cent by March 15 of the fiscal.

Do we have the rules for the purpose of determining FMV?

Not yet. The Finance Bill was presented in Parliament on February 28 and the Finance Act received Presidential assent and was enacted on May 11.

However, the rules prescribing the method of determining FMV of securities/shares have not yet been notified by CBDT. It is understood that CBDT is finalising the notification and will issue it soon.

A spokesman for the Finance Ministry had announced last week that the notification will be issued by September 8, but it is yet to see the light of the day.

What can be expected of the rules?

There is a huge variety of stock plans implemented by the employers.

Hence, in order to make the FBT legislation truly effective, the rules for determining FMV of securities/shares will need to be comprehensive enough.

While the charging provisions for FBT on stock options are generic, the valuation rule, which is the machinery provision, will need to be exhaustive and specific so that the charging provisions can be implemented properly.

Simply said, what is conceptualised in the Income-Tax Act and the Finance Act will need to be put into implementation through the rules.

A tough task?

Stock plans have been developed over the years by various industries and innumerable varieties have been worked out by experts.

It is indeed difficult to develop the rules covering such a wide variety of stock plans issued by employers in different types of industries, over a short span of a few weeks/months.

The indefinite postponement of the notification is leading to uncertainties.

How does the delay in notifying the rules affect companies?

The delay affects the Government, as I explained earlier. The delay affects the employer companies too. For, in absence of the valuation rules, it is difficult to estimate and budget for the tax.

Systems also need to be put in place for collecting the data to compute FBT. The Finance Act has made it lawful for employers to recover FBT from the employees.

Let us not forget that exercise of options is taking place regularly. But in absence of the valuation rules, FBT can neither be calculated nor collected from employees.

And the impact on the IT industry

As we know, the IT/BPO industry, which is one of the biggest beneficiaries of stock option schemes, has one of the highest rates of employee attrition.

The delay in the notification of the rules will make it difficult, if not impossible, for employers to recover the FBT from the ex-employees.

What other apprehensions do you think are legitimate, even as taxpayers wait for the rules? And what can be the reassuring thoughts?

The legal provisions for FBT on stock options/sweat equity shares are quite ambiguous.

In absence of the rules, positions cannot be taken with certainty on the interpretation of the provisions.

It is still not clear whether FBT will apply in case of many types of stock option plans, for example stock appreciation rights.

Since the Government is taking its time to notify the rules, it is expected that the rules will be comprehensive and unambiguous and will provide clarity on the application of the FBT law to different kinds of stock option plans.

It should not add to the ambiguity in the law that already exists.

However, the repeated postponement without any clear communication from the Government is leading to indefiniteness and uncertainty for taxpayers.

Hopefully, the rules will come out soon.

The Government should again extend the due date for payment of the second instalment of advance tax (which is September 15) by a reasonable period so that taxpayers can duly put their systems in place to rightly calculate/estimate the FBT liability and pay the same in time without incurring interest.

D. Murali

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