Fringe Benefit Tax on ESOP'S

INTRODUCTION

The proviso to section 17(2)(iii) has been omitted. So far the value of any benefit provided by the company free of cost or at a concessional rate to its employees by way of allotment of shares, debentures or warrants, directly or indirectly under any Employees Stock Option Plan or Scheme of the Company offered to such Employees was an EXEMPT PERQUISITE. Now it is a Taxable fringe benefit U/S 115WB (1).

SECTION 115WB (1)

Finance Act, 2007 has inserted a new clause (d) in section115WB (1) to provide for levy of FBT on the value of any specified security or Sweat equity shares allotted or transferred ,directly or indirectly ,by the employer free of cost or at concessional rate to his employees, including former employees. The salient features of this provision are:-

1. FBT shall apply in all cases where any specified security or sweat equity shares has been allotted or transferred by the employer to his employees;
2. FBT shall be payable in the previous year in which such allotment or transfer has taken place;
3. The provisions of this new clause shall apply even if the allotment or transfer is made directly or indirectly;
4. The provisions of this new clause shall apply even if the allotment or transfer is free of cost or at concessional rate;
5. The provisions of this new clause shall apply even if the allotment or transfer is to current or former employee or employees;
6. The provisions of this new clause shall apply in cases where the allotment or transfer is on or after 1st April, 2007.

The expressions specified security and sweat equity shares have also been defined. The value of fringe benefit is subjected to FBT at the prevailing rate, which is currently 30% plus surcharge plus education cess.

DEFINITIONS

Specified security: Specified security means securities as defined in section 2(h) of the securities contract (Regulations) Act, 1956 and includes Employees stock option.

Sweat equity shares: Sweat equity shares means equity shares issued by a company to its employees or directors at a discount or for consideration other than cash for providing know how or making available rights in the nature of intellectual property rights or value additions, by whatever name called.

METHOD OF COMPUTATION OF VALUE OF THE FRINGE BENEFIT

A new clause (ba) has been inserted in sub-section (1) of the said section 115WC to provide for computation of fringe benefit related to allotment or transfer of specified security or sweat equity shares by employers to employees.

It has been provided that the value of fringe benefit in such cases shall be determined in accordance with the formula –

A – B

Where,

A = the Fair Market Value (FMV) of the specified security or sweat equity shares on the date of vesting of the option. Such value has to be determined in accordance with the method as may be prescribed by the CBDT; and

B = the amount, if any, actually paid by, or recovered from the employee;

• Option means a right but not an obligation granted to an employee to apply for the specified security or sweat equity shares at a predetermined price.
• The CBDT has, vide notification S.O. number 1805(E) dated 23rd October, 2007, inserted Rule 40C in the Income-tax Rules, which has prescribed the method for determination of fair market value of specified security or sweat equity share, being a share in the company.

RULE 40C – Determination of fair market value:

NOTE:

1. Closing price shall be the sell price of the last settlement
2. Opening price shall be the sell price of the first settlement
3. Specified date means
4. the date of vesting of the option,
5. any date earlier than the date of the vesting of the option, not being a date which is more than 180 days earlier than the date of vesting.

DETERMINATION OF THE COST OF ACQUISITION FOR CAPITAL GAINS PURPOSE:

Consequent to insertion of clause (ba) in sub-section (1) of section 115WC Providing for the valuation of fringe benefits referred to in clause (d) of sub-section (1) of section 115WB, a new sub-section (2AB) has been inserted in section 49.

This new sub-section provides that the cost of acquisition of specified security or sweat equity sharesshall be the fair market value which has been taken into account while computing the value of fringe benefit under the new clause (ba) of sub-section (1) of section 115WC.

DETERMINATION OF PERIOD OF HOLDING:

A new sub-clause (hb) has also been inserted in clause (i) of Explanation 1 to clause (42A) of section 2. This new sub-clause provides that the period of holding in case of such specified security or sweat equity shares, in the hand of the employee, shall be reckoned from the date of allotment or transfer of such security or shares.

RECOVERY OF FBT BY THE EMPLOYER FROM ITS EMPLOYEE:

A new section 115WK has also been inserted enabling the employer to recover the fringe benefit tax from the employee in respect of specified security or sweat equity shares, if such security or shares are transferred or allotted to the employee on or after 1st April, 2007.

It has been prescribed that the employer can vary the agreement or scheme under which such specified security or sweat equity shares has been allotted or transferred. The agreement or scheme can be varied with a purpose to recover from the employee the fringe benefit tax to the extent to which such employer is liable to pay the fringe benefit tax in relation to the allotment or transfer of such specified security or sweat equity shares to such employee.

Illustration

The above amendments are explained with the help of an illustration.

A company X grants option to its employee R on 1st April, 2004 to apply for 100 shares of the company at a pre-determined price of Rs.50 per share with date of vesting of the option being 1st April, 2006 and exercise period being 1st April, 2006 to 31st March, 2010.

Employee R exercises his option on 31st March, 2007 and shares are allotted/transferre d to him on 3rd April, 2007. On 25th October, 2007, these shares are sold for Rs.200/- each. On the date of vesting of the option, fair market value of the share was Rs.80/- per share. The tax implication of above situation will be as under:-

Since shares are allotted or transferred on or after 1st April, 2007, provisions of fringe benefit tax are attracted. Fringe benefit with respect to employee R is (Rs.80 – Rs.50) × 100 = Rs. 3,000.

Company X will pay fringe benefit tax on Rs.3,000.

Cost of acquisition in the hands of employee R = Rs.80 per share

Capital gain = (Rs.200 – Rs.80) × 100 = Rs.12,000

Period of holding = 3rd April, 2007 to 25th October, 2007 i.e., less than 12 months.

Hence, the amount of Rs.12,000 will be charged to tax as short term capital gain.