ESOPs (Employee Stock options): More pain than gain for employees? - India - www.moneycontrol.com - June 30, 2008

Isha Dalal, CNBC-TV18

 http://www.moneycontrol.com/india/news/management/esops-more-pain-than-gain-for-employees/14/55/344619

Employees Stock
Option or ESOPs have over the years become the preferred form of
remuneration. They give the employees the opportunity to partake in a
company's fortunes on the stock markets. But where there is a gain
there is inevitably a tax. In 2007, Finance Minster P Chidambaram ruled
that ESOPs were a fringe benefit and hence should be subject to the
Fringe Benefit Tax (FBT). Sure, there was opposition to this move but
not as much against the tax as against the way it was being imposed.
Now in a falling market, FBT threatens to substantially destroy the
remuneration and value of ESOPs.

Honors and rewards
fall to those who show their good qualities in action says Aristotle
and rewarding good employees is exactly why companies around the world
and in India have Employees Stock Option or ESOPs. But starting April 1^st
2007, this reward was not quite easy to come by. That's because ESOPs
became liable to FBT. Which meant that employees to their employers
have to pay a tax of about 34% while exercising their stock options.

Rakesh Dharawat, Partner, PwC said, "Earlier there was a single point taxation for plans which were as per
central government guidelines. So employees would have to pay tax only
on the gains that he made. Under the new FBT regime, the tax will have
to be paid at a vesting value by the employer and then recovered from
the employee regardless of whether the employee has sold the shares or
not."

So
what does this mean? ESOPs are first granted on grant date to the
employee. He then receives the right to apply for shares on a vesting
date and then exercise this option on the exercise date. Under the FBT
scheme implemented from 2007, the employee while exercising his option
pays tax on the benefit that he receives. That's the difference between
the fair market value of the shares as of the vesting date and the
exercise price of the shares."

Not a bad deal when the stock market's rising but what if it isn't?

Dharawat said, "If the employee were to exercise his right to apply for and get the
shares today, he would end up paying FBT or the employer would end up
paying FBT on a January value which is significantly higher than
today's value. Effectively this means that if the stock has fallen down
by 25%, you're effective tax rate of FBT instead of 33% will workout to 55%."

That's
not all. A higher taxation rate means further problems for employers.
FBT is paid as advance tax, which means that the fair market value of
the stock as on the exercise date needs to be estimated by the
employer.

Seshagiri Rao, Director, JSW Steel says, "So far this situation has not arisen in India because when the prices
were going up, you're FBT liability goes on increasing, so whatever you
have paid is fine. In fact situation will undergo a dramatic change
when the financial year changes because whatever advance tax you have
paid, that gets adjusted only in that particular year. So in the
following year when the share price falls, and if one has paid the
advance tax in the last year, then one has to get the refund of that
advance tax in the next year. That will again take a longer time."

So
is there help at hand? Experts say there could be from employers by
bearing some of the tax burden or simply from the government by
amending the law.

Sonu Iyer, Partner, E&Y sais, "What
they could do is either not recover the Fringe Benefit Tax fully from
the employee, take part of the hits in such a situation. They could
reprice their options and this is something in several years ago when
the technology stocks crashed in the US, we saw lot of companies
repricing the options, so that they became more attractive to the
employees. So that's one of the tools open to the employers for making
the Employee Stock Option Plans (ESOPs) more attractive even in a
falling market."

Rao says, "Instead of really worrying about fair valuation on the date of the
Board meeting, whatever market price is there that market price and the
vesting price or exercise price - that difference has to be paid as
Fringe Benefit Tax (FBT); so that the matter ends. In every year during
the vesting period if we have to go on calculating what is the fair
value and then recalculate your FBT liability, I think it is a very
complex situation."

The
Sensex is down about 25% since January making ESOPs not so attractive.
But markets are dynamic they are down today they could be up tomorrow.
So tax authorities will probably use that as an argument to avoid
amending FBT on ESOPs.