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Tax on employee stock options impairs companies in talent war

Tax on employee stock options impairs companies in talent war
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First Published: Sat, Mar 03 2007. 12 02 AM IST
Updated: Sat, Mar 03 2007. 12 02 AM IST
Mumbai: Some Indian corporations and leading tax experts say the government has made retaining employees difficult at a time when competition for talent is hotter than ever. They are reacting to finance minister P. Chidambaram’s 2007-08 Budget proposal to apply fringe benefit tax (FBT) to employee stock options (ESOPs).
“The real issue for companies like us—the knowledge industries like financial services, pharmaceutical, telecom—is that the way we can compete with international organizations is the retention of our people through ESOPs,”says K. Ramkumar, group head of human resources for ICICI Bank.
However, the rate or the manner in which FBT will be computed has not yet been explained. Experts say the use of ESOPs was on the rise, but this provision could deter employers from giving out stock options because of the added cost and potential uncertainty.
“Attracting and retaining talent will be more costly,” says Deepak Ghaisas, CEO of i-flex Solutions Ltd, which provides IT consulting to the financial services industry. “ESOPs will become less attractive, unless they come out with a more rationalized solution.”
ESOPs are, typically, part of the pay package for higher-level executives. They are used to attract candidates with the glitter of high returns. More importantly, it gives them a direct incentive to grow the company’s stock price. Employees who are granted stock options have the right to buy company stock at a future date at a set price called the exercise price.
However, they cannot exercise this right for a certain period called the vesting period, which is set by the company and used as a device to keep employees from jumping to a competitor. Ghaisas says no other incentive has the ability to retain people like ESOPs.
“We find more and more companies going the stock option route because that is where employees get a sense of ownership and feel they are sharing in the results of a company and are motivated to do their best,”says Pranav Sayta, partner at Ernst & Young India
But with this new tax, advisors and employers are not sure whether ESOPs will continue to be effective—particularly cost-effective—as they look at the potential extent of the tax burden. They have many questions that the law does not yet tackle.
Does the tax apply to options granted years ago that have not yet been exercised? If an employee leaves, does this tax still apply? How is the fair market value calculated? If a foreign parent grants the options, but employees are on the Indian company’s books—then who pays?
Some of the concerns could be addressed through a clarification, but companies would still be subject to uncertain costs because the law requires FBT to be paid on the difference between the fair market value of the stock and the exercise price.
“This is open exposure for companies,” points out Bobby Parikh, managing partner at BMR & Associates, a tax advisory firm. Companies will not be able to predict the absolute cost of the tax when they give out options because they cannot know when employees will exercise and how much the market value will be.
In addition, T.V. Mohandas Pai, board member and director of human resources, education and research and administration at Infosys Technologies Ltd, notes that the law has no equity under the current structure, “If you want to tax for a perquisite you need to give me a deduction.” ESOPs are usually associated with information technology companies like Infosys, but have become more popular in all industries where companies compete for intellectual capital.Infosys, in fact, has stopped offering stock options to its employees.
While companies across sectors will be affected, some experts are skeptical about how many would be able to change their behaviour. “Given the growth in the Indian economy, there is a huge demand for well trained qualified people,” Jairaj Purandare, executive director-in-charge at PricewaterhouseCoopers Pvt. Ltd, says. “There is a war for talent on so it is difficult to compromise on the benefits.”
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First Published: Sat, Mar 03 2007. 12 02 AM IST
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