The Finance Act, 2007, amended the provisions of the Income-tax Act to provide that employers will be liable to pay fringe benefit tax (FBT) on the value of employee stock option plans (Esops) granted to employees.
Before proceeding, let us look at the big picture: FBT was introduced with an intention to levy a tax on the employer in relation to the fringe benefits enjoyed by employees, in cases where it was not possible to identify the individual benefit. This would be clear from the finance minister’s speech and also the explanatory memorandum issued at the time of introducing FBT, which states:
“The rationale for levying a fringe benefit tax on the employer lies in the inherent difficulty in isolating the ‘personal element’ where there is collective enjoyment of such benefits and attributing the same directly to the employee.” Accordingly, it is obvious that in relation to Esops, this levy seems to be against the intention of the legislature while introducing FBT.
The value of Esops for the purposes of levying FBT would be the fair market value (FMV) of the Esops on the date of vesting of the options (as reduced by the amount actually paid by or recovered from the employee).
The long-awaited valuation norms are finally notified now vide notification No. 264/2007 dated 23 October 2007. Unfortunately, these have not cleared the air, especially regarding valuation of Esops for unlisted firms, and have also created several other issues.
The valuation norms for listed companies are simple and unambiguous (but not necessarily appropriate). The FMV for Esops offered by listed companies would be the average of the opening and closing price of its shares on the stock exchange on the vesting date.
But logically (and especially where there is huge volatility in stock markets), the average of the opening and closing price of a share on the vesting date may not be an appropriate solution. The shares may trade at a very high or very low price on a particular date, which may not give its true value. Instead, similar guidelines issued by the Securities and Exchange Board of India in connection with takeover regulations could have been adopted.
The valuation norms for unlisted companies have several issues. The rules prescribe that for unlisted companies, the FMV would be the value determined by a Category-I merchant banker, either on the vesting date or within the preceding six months. But the methodology to be adopted by the merchant banker has not been prescribed, thus shifting the onus on the merchant banker. An issue may arise, as various valuation methods could give different results and thus lead to a dispute between the tax payer and the revenue authorities.
The norms imply that the merchant bankers have the freedom to decide a date within six months prior to the vesting date. These provisions may provide firms as well as revenue authorities flexibility to decide the date and this is bound to cause litigation.
Limitation of choice
While the new norms limit the choice of valuers to merchant bankers, they are often reluctant to undertake the exercise of valuing the shares of a company, unless it is part of a transaction. At the same time, the companies will have to expend considerable amounts of management time—and incur heavy costs—in getting such a valuation done.
Additionally, a situation could arise where a company may have to part with important and confidential information to arrive at a proper valuation of its shares. This is particularly important because an unlisted company issuing Esops usually does intend to go for an initial public offering, and the availability of such important and confidential information with different market intermediaries could be a confidentiality issue for the company concerned.
In any case, instead of restricting the option for the unlisted companies to obtain the valuation report from merchant bankers only, the inclusion of chartered accountants as valuers could have widened the option available to unlisted companies.
There is some doubt whether FBT is at all payable in relation to Esops granted by parent foreign companies. Assuming that it is so payable, the norms seem to suggest that firms whose shares are not listed on any stock exchange in India would be governed by the valuation norms of unlisted companies. This is because the norms refer to only recognized stock exchanges as per the Securities Contract (Regulation) Act, 1956, which refers to Indian stock exchanges.
Thus, multinational companies, although listed abroad, may have to approach merchant bankers in India for valuing their shares in cases where they are liable to FBT. Practically, the implementation of this position is seriously in doubt. It appears to be a clear drafting oversight and will presumably be addressed shortly by the government.
Although these long-awaited valuation norms have addressed some issues, they have also thrown up several new issues. Further, they do not address the valuation of options/rights granted to employees in the nature of or similar to Restricted Stock Units, Stock Appreciation Rights, or in respect of overseas listed securities for which further guidance/clarifications would be required.
One hopes the government will quickly address all these issues with appropriate clarifications in the very near future.