Advertisment

The twist in ESOP opera

author-image
CIOL Bureau
New Update

Pratima Harigunani

Advertisment

PUNE: Some quarters in the IT industry may wiggle like a fish out of water.

With the Budget’07 out, the reach of the Fringe Benefit Tax (FBT) net has been proposed to stretch further and Employee Stock Option Plans (ESOPs) would now fall under its ambit.

The industry, which was expecting the finance minister to ease some FBT burden announced last time, has been taken aback with an additional baggage to prepare for.

Advertisment

On the fringe

To put the FBT perspective crisply, the move will now make companies amenable to tax payments on ESOPs, which till now was only taxable at the point of sale at the hands of employees. The erstwhile tax ranged from 20-33 per cent depending on the period when it was exercised and thus incurred short term or long-term respectively. The tax liability with the new FBT move would now fall upon the company.

Exclusive Cybercast: Karnik on budget

And as Sharad Joshi, a chartered accountant, pegs the net effect, this could be to the tune of 46 per cent, significantly higher than the current net 30 per cent tax outgo. “It’s a back door entry to mop up more money and the government would definitely rake in a good amount, especially from the IT coffers.”

Advertisment

The moot point is whether an ESOP qualifies as a fringe benefit. Typically, the maturity period for ESOPs is three to five years with a lock-in tenure. Is it not a part of the long-term compensation package?

The industry feels that it’s a wrong categorization. CP Gurnani, president, international operations, Tech Mahindra, says that even if a slot change is happening, it should be under a new scheme. “The move is quite abrupt. ESOPs have been there for around five years. It would be a confusing and time-consuming affair for reworking the Maths.”

Looking back, the Union Budget in 1999 contended that stock options would be taxed as a perquisite at the time of exercise of the option and subsequently as capital gains at the time of the sale of security.

Advertisment

Interestingly, some time back, two senior employees of Zee Telefilms moved court against the Central Board of Direct Taxes contending that ESOPs are perquisites, being given in lieu of actual compensation and, thus, cannot be taxed at the time of exercising the option.

Sharad Joshi, feels, “ESOPs are a mechanism of inculcating loyalty and vested interest on the employee side. I don’t know what fringe benefit can it pass on to him? FBT, per se, was an unwarranted tax. It might not affect those who are making profit but others have a reason to bother.”

Advertisment

The employee angle

HR hoopla

While the bean counters have already started their back-of-the-envelope scribbles, the announcement poses significant tension signals for the HR community too. ESOPs after all, owe their popularity in India as an adept HR maneuver to motivate, retain and reward employees.

First pioneered by Infosys under the aegis of its then CFO TV Mohandas Pai, ESOP is touted to be a philosophy of sharing wealth with the employees by spurring ownership, fealty and performance motivation among employees. This announcement is particularly grave for the industry where ESOPs are quite rampant given the fact that attrition has always been at the top of an HR manager's pecking order.

As Rahul Mulay, general manager, Operations and HR head at Harbinger says, “ESOPs have so far performed well as a motivation tool in the IT industry. This move is not a very good idea. It might be detrimental as companies would mull looking at other alternatives.”

Advertisment

For Deepak Nathani, COO, CFO at Cybage the inclusion of ESOP is a cause of concern. “We are planning for an IPO and ESOPs were integral to our strategy. This new ambit would unarguably increase the net outgo for an employer.”

There are possibilities that the Budget impact would force the HR departments to reshuffle their motivation toolkit.

Everyone, of course, is waiting for the fine print to arrive. But the long-term HR impact of the ESOP proposal cannot be shrugged off, as Natnani avers.

Advertisment

While, India has so far only seen ESOPs functioning as an HR tool, internationally they often result in employees buying over a company when the original promoter relinquishes charge or doubling a corporate finance avenue viz. funding expansions, acquisitions or spinning off a division.

The Budget 2007 move can thus tweak an HR manager's toolkit besides leading to some more hemorrhage for the finance honchos.

The employee angle

While the move might be a crackdown for blue chips, it might not be very stoic for the blue-eyed boy too. Yeah, we are hinting at the software professionals, who have been enjoying the fruits of their reward, and many have turned overnight Richie-richs too with ESOPs. The FBT effect would also lessen the final amount that an employee can pocket.

Initially, for the employee, an ESOP was not taxable when he got the shares. He was taxed, when he sold them on the profit made during the sale. He could also use the option of gifting the shares or transferring them to another person under an irrevocable deed and thus pay no tax. Capital gains tax was however applicable based on the difference between the sale price and the issue price (the price at which shares were offered initially).

Now, things would change if the FBT move comes into effect. The company might be the upfront victim; the burden in all possibilities can be gradually passed on the geek in the cubicle. As Joshi explains, “Companies would factor in this effect in the cost-to-the-company statements. Percentage of ESOPs in the total package may thus be reduced.”

Not to forget, long-term tapering down of the salary peaks, that would come in gradually. Joshi estimates ESOP and FBT to a factor here to the tune of 10 to 20 per cent. “This would happen in the next two to three years.”

Joshi also cautions the possibility of black money be accelerated as many would try to skirt accounting for expenses like travel and other such so-called fringe benefits.

Taxing times

Despite vocal industry demand, last year, Union finance minister too, made very few changes to the FBT (barring certain changes in chapter XII-H of Income Tax Act).

The FBT was introduced in 2005 and had in its perimeter tour and travel, hospitality and hotel boarding and lodging, contribution by an employer to an approved superannuation fund etc. The industry has been incessantly imploring for reduction of FBT rates and simplification of the assessment procedure. Little could it have known that there's more on the way.

So would the industry keep its hopes and ears open for a rollback? Or would it steer away to other alternatives to ESOPs like employee stock options or profit sharing mechanisms, which are usually prohibited from investing primarily in employer securities. The fine print is yet to arrive and the industry is solicitously waiting for that.

But then, does it have any other option?

© CyberMedia News

More stories on budget

tech-news