New Delhi: Finance minister P. Chidambaram introduced a tax on stock-option programmes in Budget 2007; now, his ministry is figuring out how to value stock options so that the tax, payable by companies for options they issue their employees, can be administered.
Sources in the government who did not wish to be identified said the ministry could tax the difference between the market value, or fair-market value of the shares on the date the option vests with an employee, and the exercise price of the option.
Employees who receive stock options do not immediately get control of the shares; these “vest” with them after a period of time, usually three-five years. The exercise price of the option is the price at which the shares are issued to the employee and are usually the market price of the share on the date the option is issued.
The employee can choose to exercise the option, or buy the shares at the specified price, any time after the option vests.
The government believes that this difference between the market value of the shares on the date of vesting and the exercise price is a perquisite, or a perk that is provided by companies to their employees. Budget 2007 seeks to impose a fringe benefit tax (FBT) on this.
Thus, if the fair-market value of a share is Rs500 on the day an option vests with an employee, and the exercise price is Rs200, the company will have to pay a tax on the difference, that is Rs300.
Fringe benefit tax, or perquisite tax, is usually applied at the rate of 30%, although it could be different for certain categories of expenditure.
The government is yet to decide on how it will arrive at the fair-market value of the shares. There are several methods for doing this, including the popular Black Scholes model that factors in variables such as the price of the underlying asset, volatility, the time to vesting, and prevailing interest rates.
Companies use stock options to reward and retain employees. Several companies in the US are in trouble with regulatory authorities for backdating stock options (or issuing the options on a certain date but at a lower price pertaining to an earlier date) to give their executives a better deal.
The government proposes to use the prices at which stocks trade in the exchanges to determine the fair-market value of shares in the case of listed companies.
In the case of unlisted companies, the government could resort to the guidelines prescribed by the erstwhile Controller of Capital Issues (CCI), the previous stock market regulator that was disbanded in the early 1990s.
The CCI used these guidelines to determine the offer price for companies that were making an initial public offering.