The Hindu Business Line : ESOPs — no more a benefit at the fringe

While presenting the 2007-08 Budget, the Finance Minister, Mr P. Chidambaram, proposed that perquisites to employees through Employee Stock Option Scheme (ESOPs) be taxed as fringe benefits in the hands of employers.

The scheme, as then proposed, was to free employees from tax on ESOPs, whose value was taxed as perquisite in their hands. The Finance Bill proposal was to tax as fringe benefit (taxable in the hands of the employers) the difference between the fair market price of the shares and the amount actually paid by the employees.

Basic issue remains

Obviously, there was considerable opposition to this on the ground that the value of such shares could not be taxed in the hands of the employers, as the beneficiaries were the employees. Responding to the protests, Mr Chidambaram seems to have taken a softer stance but the relief given still does not address the basic issue.

While recommending the passing of the Finance Act in the Lok Sabha on May 3, the Minister said: "FBT on ESOPs will stay. This is a worldwide practice. However, we are introducing some changes. The fair market value will now be determined at the time of vesting of ESOPs." He also promised to issue guidelines on how to arrive at the value of ESOPs.

Thus, the scheme of taxation of ESOPs is still incomplete.

The change announced, which now stands approved by Parliament, is that the fair market value of shares would now be determined for levy of FBT on the date of vesting of options — not when the options are exercised.

The Minister has said that the FBT payable by the employers would be passed on to the employees. Thus, the benefit employees were to get by ESOPs ceasing to be perquisite is taken away and ESOPs will bear tax both in the hands of employers and employees.

The following objections still persist in the matter of taxation of ESOPs:

While presenting the Budget, introducing the FBT, the Finance Minister justified this tax saying "... I now propose that where the benefits are usually enjoyed collectively by the employees and cannot be attributed to individual employees, they shall be taxed in the hands of the employer."

Certainly, this is not the situation in the case of ESOPs. Their values are attributable employee-wise. Thus, in taxing ESOPs as a Fringe Benefit, Mr Chidambaram is going back on the declaration he made before Parliament while presenting the 2005-06 Budget.How far this going back is fair and justified can be best judged by Parliament.

ESOPs are employees' perks and should be taxed only in their hands. Employers, at best, could be required to deduct tax at the determined difference in price from the employees on the vesting dates.

The scheme makes the position worse as it makes employers conduits for tax to be paid by employees to whom they would naturally pass the burden. That being so, why not continue the present scheme of taxing ESOPs as perks in the hands of the employees only?

`Off-the-cuff' changes

The Minister has mentioned "worldwide practice" but not the countries he has in mind. According to my information, perhaps nowhere in the world are employers taxed on the value of ESOPs. In developed countries such as the UK, the US, Australia and Singapore, ESOPs are taxed as perquisites in employees' hands, and not subjected to FBT. Hence, the justification on the ground of worldwide practices does not seem correct.

Further, it does not seem fair for the Minister to mention `worldwide practices' that are against the taxpayers' interest — not those that are in their favour, and adopt the same. Uncharitable indeed.

With such off-the-cuff changes, the IT Act is made complicated and also fairness in taxation gets distorted.

(The author is a former Chairman of CBDT.)