Ministry mulls fair value to tax sweat equity

Hindustan Times

NEW DELHI, India

NEW DELHI, India, March 26 -- The finance Ministry is in the process of coming out with detailed guidelines on arriving at the fair market value for employee stock option schemes (ESOPs) for the purpose of calculating the Fringe Benefit Tax (FBT) which was imposed on stock options in the latest Union Budget.

The difference between the fair market value (FMV) of the shares on the date of vesting of an option and the exercise price of the option is likely to be used for calculation of FBT on ESOPs, government sources said. ESOPs are currently taxable at the time of sale of shares in the hands of the employees. There is no perquisite taxation for employees. From the new fiscal year starting next month, this would change as options would be treated as perks.

Finance minister P.Chidambaram has proposed to introduce FBT on stock options as part of Budget 2007-08 even as it triggered howls of protest from the corporate world, particularly the information technology industry that uses the incentive to attract and retain talent. While the method of FMV is yet to be decided, it could be based on a variation of the model similar to the Black and Scholes model. The model involves using information on the underlying asset, price volatility, time to expiry and interest rates.

Typically, ESOPs go through a four stage process: grant of options, vesting of options in the hands of employees, exercise of options ( the stage at which the employees get the option of buying the shares at a discounted price) and sale of these options in the market. Under ESOPs, companies offer the share option to eligible employees at a discount to the fair market value. The company board decides on the discount is plans to offer to its employees under ESOPs.

Usually, the companies first vest the options in the hands of eligible employees and set the excercising option at a later date.

The difference between the FMV of options on the date it is vested to the employees under the ESOP scheme and the price at which the employees can purchase these shares while exercising the option is likely to be used for calculating FBT, the sources said. For instance, if the FMV is calculated at Rs 200 and is offered to employees at Rs 150 under an ESOP scheme, companies would be liable to pay FBT on Rs 50, the difference between the two.

For listed companies, share price movements in the bourses would be the primary variable for determining the FMV. Besides, it would also factor in variables such as market volatility and interest rates to account for external contingencies. For unlisted companies, it is believed that the erstwhile guidelines of the Comptroller of Capital Issues (CCI) may be used as the benchmark to calculate FBT.

The Hindustan Times is provided through HT Syndication, New Delhi.

March 27, 2007