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Taxation of ESOP scheme

What is the change that has been effected in respect of taxation of ESOP (Employees Stock Option Scheme), which was proposed to be shifted from employees to employer by levy of FBT?

There has been considerable criticism of the proposal for shifting an ascertainable income tax liability on the benefit to the employees under the ESOP scheme from the employees to the employer as Fringe Benefits Tax (FBT). Revenue has chosen to meet the criticism by inserting Sec. 115WKA enabling the employer to recover from the employee the fringe benefits tax to which such employer is made liable. This is hardly a solution. If the employer wanted to pass on the burden to the employee, he could have simply adjusted the same in the option price by enhancing the option price and limiting the benefit to the extent of tax to be borne.

It is not clear, whether the employees will be able to get deduction of FBT recovered from them, if recovered, because, presently, there is no provision for such deduction from salary income. On the other hand, the amount so recovered will be liable to tax in the hands of the employer, because it cannot be reduced from FBT in the absence of any provision for the same. Probably, some instructions on these aspects allowing the deduction in the hands of the employee and exempting the recovered amounts may be forthcoming.

There is yet another significant change in substituting clause (ba) under Sec. 115WC(1) shifting the date of liability for FBT on such concessions under ESOP scheme from the date of exercise of option by the employees to the date on which option vests on them.

It may be pointed out that date of exercise of option has been the relevant date thus far accepted in Indian law and the Board Circular No.779dated September 14, 1999 (1999) 240 ITR (St.) 3 in following the decision of House of Lords in Abbot v Philbin (1962) 44 ITR 144 (HL).

Option has been defined in the Explanation to this new clause to mean "a right but not an obligation granted to an employee to apply for the specified security or sweat equity shares at a pre-determined price". Since the vesting of such right would be earlier to the date of exercise of option, liability for FBT gets preponed to the date of vesting. One result will be that, even where an employee may not ultimately exercise the option, the employer will be liable for FBT, so that liability for FBT may be on an amount larger than the value of benefits availed by the employees.

The reason given by the Finance Minister for the amendment is that, this is the method adopted in other countries, but in such countries, where it is adopted, deduction is allowed for the employer on the value of concession from chargeable profits, so that it has become necessary to adopt date of vesting of option. Indian law does not allow any deduction to employer for the concessions given to the employees, though it is a perquisite to employees and should, therefore, be a charge on the profits. Taxation of the perquisites without allowing the deduction in the hands of the employees will be in continuation of the existing anomaly.

The precise extent of liability for the employer is also not spelt out either in the Bill or in the Act, since the fair market value will be determined in accordance with the method to be prescribed by the Board.

This amendment proposed in the Bill was not fair and the amendment to the Bill by the Act does not make it any better. In some respects, it is worse.

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