Employee stock option plans (Esops), considered as an important tool to attract and retain employees, were tax exempt in the hands of employees in the pre-fringe benefit tax (FBT) regime, subject to certain parameters. Further, even when FBT was introduced in 2005, Esops were kept out of its net.
However, the Finance Act, 2007, amended the provisions of the Income-tax Act to provide that employers will be liable to pay FBT on the value of Esops allotted and transferred to employees. It is important to bear in mind that the original purpose of FBT (as stipulated in the finance minister’s speech) was to tax collective benefits enjoyed by employees and hence, this amendment made was certainly in variance with the original intent.
This shift of the levy from employee to employer has resulted in a double whammy for employers. First, the employer effectively bears the cost of Esops and second, the employer ends up bearing the tax burden. Although the employer has the option of recovering the FBT liability on Esops from the employee, it is often difficult to do so, primarily due to the serious talent crunch.
Once Esops were brought under the FBT net, Indian firms awaited the valuation norms to be prescribed. The government introduced the valuation norms for securities in October 2007; this cleared the air for listed companies in India. But the norms said unlisted firms (including foreign firms) were required to appoint a merchant banker for valuation of their securities. This created considerable confusion, especially in the context of foreign firms issuing Esops to employees of their Indian subsidiaries.
The Central Board of Direct Taxes (CBDT) has now sought to address these ambiguities by issuing circular no. 9/2007 dated 20 December 2007. Much of the circular deals with issues relating to foreign companies and multinational corporations operating in India. But some important issues still remain unanswered.
As an employer-employee relationship is a prerequisite to the imposition of FBT liability, a question that arises in cases where foreign firms issue shares to the employees of their Indian subsidiaries is, who is to bear the FBT liability? The circular says the Indian subsidiary would be liable to pay FBT even if the parent allots its shares to the employees of the Indian subsidiary, irrespective of whether the parent firm recovers the cost from the Indian subsidiary or not.
It is common for multinational companies to allot their shares to employees of their Indian subsidiaries. The CBDT circular clarifies that companies whose shares are not listed on any Indian stock exchange would be governed by the valuation norms of unlisted firms.
Such firms, in spite of being listed abroad, will have to approach merchant bankers in India for getting their shares valued. Additionally, the valuation done by the merchant banker itself has been left open for review by the tax authorities, if they find such valuation to be “perverse”. In effect, the valuation report issued by the merchant banker loses its significance and the employers face the risks of non-acceptance of the valuation report.
The circular seeks to address several other issues:
• Because the employer has the right to recover the FBT liability on Esops from the employee, a doubt arose as to whether the sum recovered from the employee would be taxed in the hands of the employer. The circular says that such recovery cannot be taxed in the hands of the employer.
• Today, mobility of personnel is inevitable. The question that arises in such a scenario is whether the FBT liability would be determined based on the residential status of the employee or would depend on the place where services are rendered during the grant period (the period between the date of grant of Esops and the date of vesting of Esops). The circular specifies that only a proportionate amount based on the length of the period of stay in India of the employees based in India would be liable to FBT.
• The government has imposed the FBT liability on employers, especially foreign firms, only if they have employees based in India. The term “employees based in India” is subject to various interpretations and has not been addressed.
• The circular has clarified that no deduction would be allowed in computing the taxable income of the employer if the employer allots the shares from its own share capital, whereas, if the shares are purchased and then transferred to the employees, the expenditure incurred by the employer in purchasing those shares would be allowed as a deduction in computing the taxable income. This distinction, though not logical, is in accordance with the existing legal framework.
The circular has certainly resolved some of the ambiguities. But it does not address the valuation of options/rights granted to employees similar to stock appreciation rights. Also, one wonders if things could have been made simpler for foreign firms by making them subject to valuation rules similar to Indian-listed companies, that is, valuation on the basis of stock prices on overseas stock exchanges only. Because most companies issuing Esops are listed on exchanges, the possible concern of the government of prices not being reflective of the company’s value does not appear to be well founded.
Overall, it appears that the last word has not been said on the subject and perhaps addressing some of the above issues may help in bringing further clarity to the situation.
Ketan Dalal is executive director of PricewaterhouseCoopers. Your comments and feedback are welcome at firstname.lastname@example.org