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Corporate Taxation Review by mujB2kr

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									ESOS – Employees Stock Option Schemes


                 ICAI, EIRC

                                  by
                        CA Milan Chakravarti
                               4th July, 2011
     Agenda


   Evolution
   Relevant provisions of the Income Tax Act &
    amendments therein over different points of time
   FBT & ESOSs
   Current status of taxation of ESOS
   Elementary case
     Evolution - why ESOS resorted to ?



Human talent – A vital ingredient for business

Stock Plans –
     Time tested employee retention tool perennially
      deployed in developed economies
     Tax efficient compensation component ???
     Employee motivation tool – stakeholder’s role
     Changes in relevant provisions of Income Tax
     Act


 Up to Finance Act 1998 i.e till AY 1999-2000 no
structured provisions existed in the provisions of the Act
for addressing ESOS as such ……
barring capital gains tax on sale, basis period of holding
of shares
       Changes in relevant provisions of Income Tax
       Act

Finance Act 1999 w.e.f 01.04.2000 (AY 2000/01)
   amended relevant provisions & addressed tax on ESOS …..
   Prov. of Sec 17(2)(iiia) stipulate ... Perquisite includes …
   value of any specified securities(SSs) allotted by employer
   free of cost/at a concessional rate to employee
   …. Provided that where allotment/transfer of SSs made in
   pursuance of an option exercised by an individual, value
   of SSs taxable in PY in which option exercised by such
   individual ( timing of taxation )….

                                                       contd…
       Changes in relevant provisions of Income Tax
       Act

Explanation…
(a)   Cost means amount paid for acquiring SSs & where no
      money paid, cost Nil
(b)   SSs means securities as defined in SCR Act & includes
      ESOS
(c)   Value means difference between fair market value
      (FMV) & cost of acquiring SSs
   Changes in relevant provisions of Income Tax
   Act

Sec 49 (2B)
   Where capital gains (CG) arises from transfer of SSs
   as referred to in Sec 17(2) (iiia), the cost of
   acquisition of such SS = Fair Market Value(FMV) on
   date of exercise of option
    Changes in relevant provisions of Income Tax
    Act

Finance Act 2000 w.e.f 01.04.2001 (AY 2001/02)
inserted further in Provisio to sec 17(2)(iii) …..
Provided that nothing in sec. 17(2)(iii) apply to value of
any benefit provided by a Co. free of cost/at a
concessional rate to employees by allotting shares etc. of
a Co. under ESOSs
However, sec.17(2)(iiia) got omitted…..
Various Explanations defining cost, value continued as
such as in AY 2000/01…..
Sec 49(2B) too got omitted
    Changes in relevant provisions of Income Tax
    Act

Finance Act 2001 w.e.f 01.04.2001 (AY 2001/02)
inserted further in Provisio to sec 17(2)(iii) …..
Provided that nothing in sec 17(2)(iii) apply to value of any
benefit provided by a Co. free of cost/at a concessional
rate to employees by allotting shares etc. of a Co. (any
ESOS of a Co. offered to such employees in
accordance with guidelines issued by Cent. Govt.)*
*addendum
sec.17(2)(iiia) got omitted even earlier. Various
Explanations defining cost, value continued as such in AY
2001/02                                            contd…
 Changes in relevant provisions of Income Tax
 Act

Sec 49 (2AA)…..
Where capital gains (CG) arises from transfer of
shares, debentures or warrants (shares etc.) value of
which considered for computing perquisite u/s
17(2)(iii) cost of acquisition of such shares etc. will be
valued under said sec.
     Changes in relevant provisions of Income Tax
     Act

Guidelines by Cent. Govt.
   Notification No 323/2001 dt 11th October, 2001 issued
   u/s provisio to 17(2)(iii) re applicability of provisio to
   shares etc. allotted under ESOS
           Guidelines

Salient features of Not. No 323/2001 dt 11th October, 2001
Provisio applicable to Shares/Debentures/warrants allotted
under ESOS in accordance with following guidelines
       To be treated as part of salary paid in ESOS/ESOP/SAR form
    Plan to be documented in writing. Certain specified things
    to be incorporated therein ( viz. total no. of shares to be
    issued under ESOS, class of employees entitled to
    participate, pricing formulae as basis of allotment of shares
    offered on grant/exercise of options, no. of shares/stock
    equivalent to be issued to employees, period & manner of
    obtaining approval of shareholders)                 contd….
           Guidelines


Salient features of Not. No 323/2001 dt 11th October, 2001
   Indian Co. issuing shares to comply with SEBI regulations in
   this connection
      Guidelines to apply to Co. defined in Sec 17(2) of Act, viz
         (i) listed in a recognised stock exchange in India or a
         exchange outside India; an unlisted domestic co.
         (ii)or subsidiary/holding of such Co.
         & where such Co. carries on business in India
                                                          contd….
       Guidelines

 A promoter employee/director holding > 10% of equity
 shares not allowed to participate in Scheme
 Every Co. to furnish a copy of Plan to jurisdictional CCIT
 within 6 months of effective date of plan
    Guidelines deemed effective from 01.04.2000
…………
Guidelines in “Explanation” defines certain associated
terminologies inter alia Exercise/Grant/Option etc.etc
        Guidelines
Relevant terminologies……

•OPTION – A right but not an obligation granted to employees to
apply for shares at pre determined price

•GRANT-ing – Co. offers ESOS to employees opting for it

• VEST-ing – Post Grant-ing subject to fulfillment of certain
conditions … power vests in employees to subscribe to ESOS

• EXERCISE-ing – Employees exercise right to buy ESOS.
Consequently Co. allots shares to employees
           Changes in relevant provisions of Income Tax
           Act

Income Tax on Fringe Benefit (FBT) introduced by Finance Act
2005 w.e.f 1.4.2006. Chapter XII-H. Secs. 115W to 115L added
Finance Act 2007 inserted Sec 115WB(1)(d) w.e.f 1.4.2008…
          Any specified security/sweat equity allotted/transferred
          by employers to employees free of costs/at concessional
          rate.
          Explanation (a) to this cl. read as
    (i)    Specified securities means securities defined in SCR &
           includes ESOS
                                                   contd….
          Changes in relevant provisions of Income Tax
          Act
Finance Act 2007 also inserted Sec 115WC(1)(ba) w.e.f
1.4.2008…
Value of Fringe Benefits(FB) = Fair Market Value(FMV) of
SSs/Sweat Equities as in SEC 115WB(1)(c) on the date of
vesting with employees as reduced by amount paid for shares
   Explanation to this cl. stated….
   FMV means value determined as per method prescribed by
   Board
    (a)    Option means a right but not an obligation granted to
           employees to apply for specified securities….
                                                      contd….
    Changes in relevant provisions of Income Tax
    Act


Finance Act 2007 deleted provisio to Sec 17(2)(iii) w.e.f
1.4.2008…
Consequently Board’s guidelines in Not. No 323/2001 dt
11th October, 2001 issued under provisio to 17(2)(iii) re
applicability of provisio to shares etc. allotted under ESOS,
became inoperative
   Changes in relevant provisions of Income Tax
   Act


Finance Act 2007 simultaneously inserted sec 115WKA
w.e.f 1.4.2007 ….. providing for recovery of FBT by
employer from employees of FBT paid by employer on
ESOS, in terms of sec 115WC(1)(ba)
   Changes in relevant provisions of Income Tax
   Act


Finance Act 2009 inserted sec115WA(1B) w.r.e.f 1.4.2009
….. providing for processing of FBT returns being
redundant …. FBT thus stood withdrawn
   Changes in relevant provisions of Income Tax
   Act

Post withdrawal of FBT …… Finance Act 2009 inserted sec
17(2)(vi) w.e.f 1.4.2010 providing for…..
…perquisite includes value of SSs (including ESOS) allotted
by employer free of costs/at concessional rate
….value of ESOS = FMV on the date of exercising of option
by assessee - amount paid for shares
…FMV means value determined in accordance with
prescribed methodology
                                            contd…
   Changes in relevant provisions of Income Tax
   Act

Finance Act 2009 inserted sec 49(2AA) w.e.f 1.4.2010
providing for…..
…where capital gains(CG) arises from transfer of specified
securities etc. as referred to in sec 17(2)(vi), cost of
acquisition of such securities = FMV as taken for this
purpose
     Changes in relevant provisions of Income Tax
     Act
Rule 3 (8) & (9) incorporated w.e.f from 01.04.2009 stipulated
….
   for sec 17(2)(vi) of the Act value of SSs/Sweat Equity
   shares( equity share in a Co.) on the date of exercise of
   option to be determined in specified manner as
   follows
   …the FMV of share listed in a recognised stock exchange
   will be average of opening price & closing price on the
   recognised stock exchange on the date of exercise of
   option
   FMV of shares = (Op. price + Cl. Price on day of exercise
   of option) / 2                          contd….
     Changes in relevant provisions of Income Tax
     Act

where on the day of exercise of option share listed in
multiple stock exchanges ….
   … FMV of such share = average of op. price & cl. price
on the recognised stock exchange which records highest
volume of trading on the day of exercise of option
                                                   contd…
      Changes in relevant provisions of Income Tax
      Act
where on the day of exercising option by employee there is no
transaction in such shares in any recognised stock exchange
then…..
FMV of such share = cl. price of such share on any recognised
stock exchange on a date closest to exercising of option &
immediately preceding such date
or
cl. price of such share on a recognised stock exchange which
records highest volume of trading if cl. price as on date closest
to date of exercising option & immediately preceding such
date, recorded in multiple recognised stock exchanges
    Changes in relevant provisions of Income Tax
    Act


where on the day of exercise of option such shares are not
listed in any recognised stock exchange then,
   …. FMV of such share = value of shares as determined
by merchant bankers on specified date


Rule 3 also defines inter alia closing price, merchant
bankers, opening price, recognised stock exchange etc.
         Tax implications of Stock Plans

                  Taxability in employee’s hands
             in the hands of EmployeesPlan
  Taxability Qualified Plan
 Event                        Non Qualified
 Grant              No tax                         No tax
Vesting             No tax                         No tax
Exercise            No tax             Benefit liable to be taxed as
                                      perquisite – Employer liable for
                                       WHT[Fair Market Value (FMV)
                                         on exercise date less EP]
  Sale          CG liable to tax              CG liable to tax
                  [ SP - EP]                    [SP - FMV]


  No tax on employer except responsibility of TDS…. Tax levied on
             employee benefit for Non Qualified Plans
        Proposal in FBT regime

 No distinction between Qualified/Non qualified Plans.
  Applicability extended to any Stock Plans whatsoever
 Employer liable for FBT @ 33.99% on
         FMV * on date of exercise minus amount recovered
          from employee, if there be any
          (*) Rules for computing FMV to be adhered

   Employees continue to be liable to CG tax at the time of
    sale (subject to specific exemptions)
            Tax on ESOS in FBT regime

                       Employee
   Event        Qualified/ Non Qualified            Employer
                          Plan
   Grant                No tax                        No tax
  Vesting               No tax                        No tax
 Exercise               No tax                Benefit liable to FBT as
                                             benefit to employees on
                                             which tax to be paid by
                                                   employer **
   Sale                CG tax *                  Not applicable
               [SP-FMV on exercise date]
                                                  Liability
* Subjectto domestic law/ treaty exemption
                                                   shifts
** FBT not tax deductible for employer
    Issues….FBT on ESOS

   Significant additional cost for employers
   Tax on notional benefit !!!!
   Administrative hassles
   Ambiguously worded amendment – several open
    issues
       What is the trigger for FBT – Vesting or Exercise
       If “exercise” – what happens to Share Awards,
        Share Purchase Schemes, Stock Appreciation
        Rights, Restricted Stock Units?
             Example – Options of a listed Co. under a Qualified
             Plan
   ESOP granted/vested – 1000         Exercise – April 15, 2007      Sale - April 16, 2008

   Exercise Price (EP) – Rs. 100      FMV - Rs. 1000                 Sale Price - Rs. 3000

    Incidence On            Event                Pre - Budget            Post – Budget

     Employee       Exercise                                 NIL                        NIL
                    Sale of Shares                       No Tax                     No Tax
                    (LTCG exempt)
                    Total                                    NIL                        NIL
     Employer       Exercise                                  NA           (FBT) 305,910

                    Sale of Shares                            NA                           -
                    Total                                    NIL                   305,910

               Employee remains neutral – Employer suffers a huge cost
             Example – Options of an MNC Sub. Co. under a
             Qualified Plan
   ESOP granted/vested – 1000  Exercise – April 15, 2007      Sale - April 16, 2008

   Exercise Price (EP) – Rs. 100  FMV - Rs. 1000              Sale Price - Rs. 3000


    Impact On             Event              Pre - Budget          Post – Budget

    Employee      Exercise                              NIL                        NIL
                  Sale of Shares                     657,140                  453,200

                  Total                              657,140                  453,200
    Employer      Exercise                               NA           (FBT) 305,910

                  Sale of Shares                         NA                        NA
                  Total                                 NIL                   305,910
Employee saves on CG Tax – Employer suffers a huge cost
     Issues & Concerns
   Grand fathering feasible?
        For options granted but not vested
        For options granted & vested but not exercised
   In case of MNCs/ Indian subs.
        FBT payable by Foreign Co. or Indian Co.?
        Incidence of cross-charge/ expense on Indian Co?
        If employees are expatriates?
   FBT “cost” recoverable from employees? Taxable?
   Possible to mitigate FBT impact by accelerating exercise?
       ESOP allotted to Non Residents /Foreign employees

   Foreign employees may have to pay tax both in India & foreign
    countries (viz UK) , where they work
   Income Tax Act totally silent on computation of perquisite value
    of ESOPs allotted to foreign employees
   In FBT regime .. this issue got clarified in answer to Query No.
    4 of CBDT Circular 9/2007 –
    where employee is based in India only for a part of grant
    period, a proportionate amount of value of fringe benefit will
    attract FBT. Proportionate amount to be determined by
    applying to value of fringe benefit, in proportion which length
    of the period of stay in India by employee during grant period
    bears to length of grant period
       ESOP allotted to Non Residents /Foreign employees

   On withdrawal of FBT, CBDT Circular on this issue becomes
    redundant, though it may have persuasive value to indicate
    Govt’s intention on this issue

   In absence of specific guidelines from tax authorities, a
    position that only proportionate income which relates to
    services rendered in India during vesting period ought to be
    taxable in India, and income which relates to services
    rendered outside India during vesting period, ought not to be
    taxable in India, defendable

    Based on the above………………..
    ESOP allotted to Non Residents /Foreign employees

   For employees(NR & RNOR)in year of exercise, taxable
    value of the perquisite can be prorated based on length
    of services rendered in India during grant/vesting
    period vis-à-vis length of grant/vesting period

   For employees(ROR)in year of exercise, 100% of
    perquisite value to be considered(i.e., without any
    apportionment)for TDS u/s 192. Employees may, in
    their individual tax proceedings, consider claiming
    foreign tax credit (FTC) of taxes suffered in India based
    on prov. of tax treaty applicable
        Example – Expatriate employees double whammy!!

   Representation to the Authorities - reconsideration

   Detailed review of existing Stock Plans
      Assess impact on “as is” basis

      Analyse exposure of overseas parent Co.


   Explore alternatives to forestall or at least mitigate FBT

   In case of recovery from employee, factor in tax impact,
    accounting & exchange control implications (if any)

   Review of “internal systems” - data capturing to compute FBT

   Rethink compensation strategy
        * Assumed ESOPs are taxable on exercise in home country
            Example – Options of an MNC Sub. Co. under a
            Qualified Plan
Rethink recovery mechanism
    Example
   X Ltd. providing BPO services in India to a foreign co ‘F Co’
   X Ltd. bills F Co on cost plus mark up @ 10%
   FBT* payable for the FY 2007-08                                        Rs. 10,000
   Recovery towards FBT from F Co incl. mark up                           Rs. 11,000
   Tax on recovery @ 33.99%                                               Rs. 3,700
   Net outflow on account of FBT                                          Rs. 2,700

    * FBT treated as a part of employee cost   * FBT not allowed as a deduction
    Computation of Capital Gains

•Mr. A buys 100 shares of Co. X on 01.01.2009 for Rs.
10/- per share

•He pays Rs. 1,000/- as share price incl. taxes

•Brokerage charge Rs. 5/- as STT

•Overall, pays Rs. 1,005/- for 100 shares to Broker


Cost for computation of capital gains would be only
Rs. 1,000/-. STT to be excluded.
    Illustration 1

•Mr. A sells 25 shares of X Co. on 30.11.2009 for Rs. 20/-
per share
•Brokerage charge Rs. 5/- as STT
•Broker issues a cheque of Rs. 495
       [25 shares x Rs. 20/- per share less Rs. 5/-]

•Shares sold within 12 months. Hence, STCG.
•Cost = (1000/100) * 25 = 250
•Sales value = Rs. 500 i.e. gross of STT
•Gains = 500 – 250 i.e. 250
    Illustration 2

•Mr. A sells 25 shares of X Co. on 30.11.2009 for Rs. 5/- per
share
•Brokerage charge Rs. 5/- as STT
•Broker issues cheque of Rs. 120
       [25 shares x Rs. 5/- per share less Rs. 5/-]
•Shares sold within 12 months. Hence, STCG.
•Cost = (1000/100) * 25 = 250
•Sales value = Rs. 125 i.e. gross of STT
•Loss = 250 – 125 i.e. 125
     Illustration 3


•Mr. A sells 25 shares of X Co. on 31.01.2010 for Rs. 20/-
per share
•Brokerage charge Rs. 5/- as STT
•Broker issues cheque for Rs. 495
       [25 shares x Rs. 20/- per share less Rs. 5/-]

•Shares sold after 12 months. Hence, LTCG.
•No tax as LTCG on such transactions is exempt
     Illustration 4

•Mr. A sells 25 shares of X Co. on 31.01.2010 for Rs. 5/- per
share
•Brokerage charge Rs. 5/- as STT
•Broker issues cheque for Rs. 120
       [25 shares x Rs. 5/- per share less Rs. 5/-]
•Shares sold after 12 months. Hence, LTCG.
•Since, LTCG on such transactions is exempt, there is no
benefit for loss incurred
    Set-off and carry forward of Capital Losses


•STCL adjustable against both STCG & LTCG on any capital
asset

•LTCL Loss can be adjusted against only LTCG

•If no gains available for adjustment, Loss can be c/fd upto
8 years & adjusted as above

•After 8 years, loss lapses
     Tax on Short-Term Capital Gains


•Net off the STCG with STCL, if there be any

•No benefit under Chapter VI-A allowable (i.e. Section 80s)
Tax Rate is 15%

•Education Cess @ 3% on Tax and Surcharge
Thank You

								
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