If P Chidambarms fringe benifit tax is to be believed; very soon indian esop holders will have to pay tax on ESOP in advance with every vesting period. So what are tax implications so far till this new proposal gets debated in both houses of parliament & gets Shikka-Mortab'ed in FBT Esop Law.
Mergers, ESOPs and their tax implications
2006-07-17 13:00:05
Gaurav Taneja and Rajesh S, senior tax professionals with Ernst & Young have analysed below some of the important tax issues that are thrown up with respect to employee stock option plans ('ESOP' or "Plan') in the event of merger.
Corporate mergers have long been used globally to create larger businesses, become more competitive or just as a means of survival in today's dynamic environment. Many high profile mergers & acquisitions have grabbed our attentions in the recent past and the trend appears to be catching on. However, like all significant corporate actions, mergers also bring with them a plethora of regulatory requirements and tax implications. What we have analysed below are some of the important tax issues that are thrown up with respect to employee stock option plans ('ESOP' or "Plan') in the event of merger. The analysis presupposes a merger of two companies, each of which, prior to the merger, has ESOPs of their own.
Tax compliant planA conventional ESOP is taxable in the employee's hands at two points. The first point of taxation is when the employee exercises the options i.e. the shares of the company are transferred to him upon payment of the exercise price. The notional gain (quantified as the difference between the exercise price and the market price prevailing on date of exercise) is generally treated as salary income and taxed accordingly. The second point of taxation is when the employee sells the shares. The gains, if any, is taxed as short term or long term capital gains depending on the period for which the shares are held after exercise.
The Indian income tax laws provide concessional tax treatment for plans that are compliant with the specified Central Government Guidelines ('CG Guidelines') and have been filed with the specified income tax authorities. Plans compliant with CG Guidelines allow is subject to a single point taxation at the point when the shares arising from the exercise of options are disposed off by the employee with the full income being taxed as capital gains.
The CG Guidelines stipulate that no changes can be made in the plan after the plan has been filed with the income tax authorities. Interestingly, the CG Guidelines have not specifically indicated as to what constitutes a 'change' in the Plan, whether only material changes are covered and also whether a change would affect the qualification of the Plan only prospectively or even retroactively. In contrast, the Security and Exchange Board of India (SEBI) guidelines on ESOPs permit changes to be made in the plan provided it is not detrimental to the interests of the option holders. No such clarification has been provided in the CG Guidelines.
A merger often necessitates amendments in the existing plan(s). This may cause a hitherto CG Guidelines compliant Plan to become non-compliant with the loss of attendant tax benefits. The CG Guidelines should be amended, preferably with retrospective effect, permitting those changes that are necessitated by corporate actions like mergers or acquisitions or changes that are not detrimental to the existing option holders. This would go a long way in removing the current uncertainty that surrounds the applicability of CG Guidelines.
Exchange of options
Most mergers involve extinguishment of one company's shares and stock options in lieu of the other company's shares and stock options respectively. For the purposes of this article, we have restricted our analysis to tax issues arising in the context of an exchange of one company's stock options ('vested' and 'unvested') with the other company's stock options. In this connection, it is important to understand some of the tax provisions relating to capital gains, which are outlined below-
Capital asset
Under the Indian income tax laws, gains arising on transfer of a capital asset are made liable to capital gains tax. The term 'capital asset' has been defined to include 'property of any kind', subject to certain exceptions (i.e. stock in trade, personal effects excluding jewellery, agricultural bonds and certain bonds). Shares or securities are therefore typically regarded as capital assets. The term 'transfer' has been defined to include 'sale, exchange, relinquishment of the asset or the extinguishment of any rights therein.'
Capital gains exemption
Normally, exchange of capital assets will give rise to capital gains tax in India. However, the tax laws provide a specific exemption from capital gains tax for any transfer of shares by a shareholder of an amalgamating company, in a scheme of amalgamation, in exchange for shares in an Indian amalgamated company. Consequently, exchange of shares under a scheme of merger satisfying this exemption provision will not be liable to tax in India.
Unvested options
Unvested options are those that are not yet eligible for exercise. The capital gains exemption indicated above covers only exchange of shares and not options. An option remains unvested till such time the employee fulfils all the conditions necessary to become eligible to exercise the option. Hence, there is an element of contingency attached with the acquisition of the underlying asset (i.e. shares) in the case of unvested option. For example, if the employee quits the organization then he may not be eligible to exercise the options and convert them into shares. Moreover, the options, and specially unvested options, are generally neither transferable nor tradable and hence cannot be converted into money or money's worth. Consequently, it may be possible to argue that the unvested options will not qualify as 'capital asset' for the purposes of capital gains transaction and as such, there is no tax liability on exchange of one company's unvested options with the other company's unvested options, regardless of the ratio in which such exchanges are made.
Vested options
In the case of vested options, the employee is eligible to exercise the options and convert them into shares by tendering the exercise price. Since the employee has an almost assured right to the underlying shares, while it can be argued that vested options are not 'capital assets', exchange of vested options could be construed as 'transfer' of asset and may attract capital gains tax liability. However, the valuation of a vested option in terms of its cost of acquisition and sale consideration will present lot of practical difficulties. The other question that arises in relation to vested option is the period of holding to determine whether it qualifies as a long term or short-term asset. Share held for a period of more than 1 year will qualify as a long-term capital asset and subject to a concessional capital gains tax treatment. But, in the absence of a specific provision, it is not clear whether the same holding period (i.e. 1 year) can be extended to vested options though the underlying assets are shares of the company.
In the absence of clarity on these issues, it would be simpler and more tax efficient for the employee to exercise his vested options (if the terms of the Plan permit) on the eve of the merger and then receive shares in lieu thereof from the amalgamated entity. This could be a tax-free transaction, is specific circumstances as cited above.
The CG Guidelines were formulated to benefit employees by not taxing them on the notional gains at the time of exercise. Exchange of vested options with another set of vested options may, at best, provide gains which are again, purely notional. Hence, it would be unfair to tax a mere exchange of vested options and it would benefit the tax-payers if a suitable clarification to this effect was issued by the tax authorities.
Merger of foreign companies
It is also important to examine the tax position of ESOPs in case of merger of two foreign companies as many individuals who are working in Indian subsidiaries of foreign multinational companies are holding parent foreign company's shares by virtue of ESOPs. The exemption provided under Indian tax laws for exchange of assets in the event of merger is not available for shares held in such foreign companies. Consequently, in addition to the tax exposure on exchange of vested/unvested options, it appears that employees could be held liable for exchange of shares between foreign companies. This creates an inequitable situation between employees holding shares of an Indian company vis-à-vis employees holding shares of a foreign company and appropriate remedy should be framed under the tax laws to remove this disparity.
OECD guidelines
Mergers, being a global phenomenon, bring about cross border taxation issues, namely double taxation issues, with respect to ESOP. It is interesting to note that the Organisation for Economic Co-operation and Development (OECD) has commented on the issue of double taxation on account of alienation of stock options as a result of a merger or acquisition in case of mobile employees (i.e. employees who are residents in one country but working in various other countries). Since the point of taxation and characterization of income could differ in each country it has suggested that there should be proper mechanism to provide foreign tax credit in such a scenario.
In conclusion...
Considering the above, it would seem that there are still a lot of grey areas regarding tax implications of ESOPs on account of mergers. As can be discerned, there are many issues, which are left open to interpretation and would require a critical analysis of the facts and circumstances to arrive at an appropriate conclusion. Though the law cannot provide regulations for each and every aspect, considering that mergers and ESOPs are truly the flavour of the day, it would be appropriate if the tax laws and double taxation av oidance agreements become better equipped to deal with these issues.
Source : Moneycontrol.com
-------------------------------------------------------------------------------------
Tax implications of ESOPs
T. Banusekar | Wednesday, 12 September , 2007, 15:43
I work in a multinational company in India. The parent company of my employer is in the US and the shares of the said company are listed in the New York stock exchange. The parent company has allotted shares to me under a stock option scheme in February 2005. I paid no money for the options. The options were sold and the difference between the sale price and the grant price was paid to me in rupees. What is my tax liability in respect of the same? - S. Murugan
Section 17(2) as it stood at the relevant point in time provided that employees stock option shall not be regarded as a perquisite and taxed in the hands of the employees if the scheme or plan was in accordance with the guidelines issued in this behalf by the Central Government.
Given that the stock options were given to you by the US parent company, it is very unlikely that the same is in accordance with the guidelines issued by the Central Government.
Therefore, the difference between the market value as on the date of exercise of the option and the price at which the shares were allotted to you will be treated as a perquisite and would be taxable under the head salary in your hands at the normal rate of tax. The difference between the selling price and the market price as on the date of exercise of option (duly indexed if the gain is long-term) will be taxed as capital gains in your hands.
I was allotted 1,875 shares of my employer company under an Employees Stock Option Scheme. The shares are listed on Nasdaq. The shares have vested with me from May 2004 on the basis of 52.083 shares per month. In May 2007, my employer company was acquired by an European company. Since then, no shares have been vested with me under the scheme, as a result of a fresh understanding with the employer. What are the fringe benefit tax implications of the stock options that I hold so far? - Jatin Kikani
The Finance Act 2007 has amended the provisions relating to fringe benefit tax to provide that employees stock option and sweat equity will be subject to fringe benefit tax.
Section 115WB (1)(d) provides for the same to be subject to fringe benefit tax at the time of allotment or transfer.
The value of the same is to be taken on the basis of the fair market value on the date on which the option vests with the employee as reduced by the amount actually paid or recovered from the employee in respect of the same.
The fair market value is to be determined in accordance with the method that may be prescribed by the board. It may be noted that the charge arises on allotment or transfer of the said shares to the employees. It may also be noted that these provisions are applicable from April 1, 2007.
Therefore, fringe benefit tax will be payable in respect of the employees stock options.
Fringe benefit tax is normally payable by the employer but it may also be seen that
Section 115WKA provides that it will be legal for an employer to recover the fringe benefit tax from an employee even where the agreement or scheme was made prior to April 1, 2007.
I presently reside at New Delhi where I am employed. I have taken a housing loan to purchase a house in Kolkata. I stay in a rented house in New Delhi. Will it be possible for me to claim the exemption in respect of HRA that I receive from my employer? - Ranjan Bhattacharya
Section 10(13A) allows an exemption in respect of HRA provided the employee is in receipt of HRA and where he is actually paying rent for an accommodation occupied by him.
In your case there should therefore be no difficulty in the claim of exemption u/s10(13A).
The fact that you own a house in Kolkata will in no way affect your claim for exemption u/s.10(13A).
I am running a training institute in India and I provide training services to consultants in the US. This training is provided to them Online. The payments are made to me into my bank account in India. Are the sums I receive for such training provided taxable in India and if so at what rate is it taxable?- Kali
The sums received by you for providing training online to consultants in the US and credited into your bank account in India will be taxable in India.
This income will be taxable at the normal rates of tax applicable to an individual.
When my wife was employed she took a housing loan from her employer to purchase a house in her name. The tax benefits in respect of the repayment of the loan and the interest thereon were claimed by her as a deduction. After my wife resigned her job, the housing loan was transferred to a bank where both my wife and I jointly obtained the loan. Since then I have been paying the EMI out of my salary. Can I claim the tax benefits in respect of the EMI paid by me? - Anand Bhat
Apparently the fact that your wife has claimed the tax benefits on the repayment of the earlier loan taken from her employer and the interest thereon coupled with the fact that the house was registered in her name go to show that she is the real owner of the house.
Hence it will not be possible for you to claim the tax benefits in respect of the EMI paid by you, merely because of the fact that the same is paid out of your income.
