Taxation of ESOPs/ Sweat Equity - WIRC - Taxation of...Types of ESOPs / sweat equity… • ‘Employee Stock Option Scheme’ ‒The company grants option to its employees to buy

Taxation of ESOPs/ Sweat Equity

Ashesh Safi

5 November 2011

Contents

• Concept

• Objectives

• Types of ESOPs/ sweat equity

• Taxation of ESOPs/ sweat equity

• Taxation of SARs

© 2011 Deloitte Haskins & Sells2

• Taxation of SARs

• Case Studies

Concept

• ESOP/ sweat equity is a –

‒ right given to an employee

‒ to buy specified number of shares of employer company/ group

company

‒on a future date

‒

© 2011 Deloitte Haskins & Sells

‒

‒at a pre-determined price (typically at a price prevailing at the time of

grant)

3

Objectives

• Retain, motivate and reward employees for their performance

• Link the interests of employees with the objectives of the company

• Link the interest of employees with that of the shareholders

• Tool for tax planning

• Non-cash compensation


• Non-cash compensation

4

Types of ESOPs / sweat equity

• ‘Employee Stock Purchase Plan’ or ‘Employee Stock Option Scheme’

‒Employee allows the employer to hold certain portion of his monthly

salary. The amount so accumulated is utilized to acquire shares at a

discounted value or otherwise at a future date.

• ‘Employee Stock Ownership Plan’

‒Employee is given the option to acquire shares of the company at a


‒Employee is given the option to acquire shares of the company at a

pre-determined price after a certain period, directly or indirectly through

a trust.

• ‘Employee Stock Purchase Scheme’

‒The company offers shares to an employee, as part of a public issue or

otherwise at a predetermined price.

5

Types of ESOPs / sweat equity…

• ‘Employee Stock Option Scheme’

‒The company grants option to its employees to buy a specified number

of shares at a specified price during a specified period.

• ‘Stock Appreciation Rights or Plans’

‒Employees are awarded stock equivalents at a pre-determined value.

After the stipulated period, employees are allowed to encash such


‒

After the stipulated period, employees are allowed to encash such

rights. This is also known as Phantom Equity Plan.

• ‘Sweat Equity’

‒Equity shares issued by the company to 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.

6

Events

Grant

• Grant of options under a plan or scheme of the company

Vesting

• The process by which an employee is given a right to apply for shares of the company against the option granted to him

• An application by an employee to the company for issue of shares


Exercise

• An application by an employee to the company for issue of shares against the option vested to him

Date of Allotment

• The date on which the underlying asset being shares are allotted to the employee

Sale

• Sale of shares allotted to the employee

7

Taxation of ESOPs

8

Taxation of ESOPs

• Following aspects need consideration from the perspective of taxation of

ESOPs:

‒Taxation in the hands of employee at the time of exercise and

subsequent sale of shares.

‒Obligations of the employer to withhold tax at source on the benefit

received by employee under ESOP scheme

‒


‒

received by employee under ESOP scheme

‒Deductibility of the perquisite element / cost of ESOP in the hands of

employer.

9

Taxation in the hands of employees

Legislative history:

• Phase I: Prior to 1 April 1999

‒No tax legislative procedures, so covered by general provisions and

considered as a taxable perquisite at the time of grant of options [Abbot

v. Philbin (44 ITR 144)]

‒Later on, CBDT stated that taxability would be in the year in which


‒Later on, CBDT stated that taxability would be in the year in which

option is exercised – four situations were examined [CBDT Circular No.

710 dated 24 July 1995]

• Phase II: Between 1 April 1999 to 31 March 2000

‒Finance Act, 1999 introduced provisions relating to taxation of ESOPs

[section 17(2)(iiia)]

‒Taxable as perquisite at the time of exercise of option

10

Taxation in the hands of employees…

• Phase III: Between 1 April 2000 to 31 March 2006

‒Amendment made vide Finance Act 2000 and 2001

‒Proviso was inserted in section 17(2)(iii) and clause (iiia) omitted

‒Scheme to be in accordance with guidelines issued by the Central

Government

‒


‒

‒Taxability shifted to the year of sale of shares

• Phase IV: 1 April 2006 to 31 March 2009

‒FBT provision introduced by Finance Act 2005

‒Taxable as fringe benefit

‒FBT payable by employer

11

Taxation in the hands of employees…

• Phase IV – Contd…

‒Valuation based on vesting date

‒Detailed Circular No. 9 dated 20 December 2007 issued explaining

provisions

‒Valuation guidelines prescribed in Rule 40C/ 40D


‒

• Phase V: 1 April 2009 onwards

‒FBT provisions omitted vide Finance Act (No. 2) 2009

‒Taxable as perquisite under section 17(2)(vi)

‒Taxable at the time of allotment and transfer of shares

‒Valuation guidelines prescribed in Rule 3(8)

12

Points of taxation for employees

Grant of Options

Vesting


Exercise of Options/ Allotment of shares

Sale of Shares

Taxable as

salary income

Taxable as

capital gain

Gain up to the date of exercise will be taxable as perquisite (on exercise of options). Gain

from the date of exercise till the date of sale will be taxed as capital gains

Taxation as salary income

At the time of exercise of options:

• As per section 17(2)(vi), value of any specified security or sweat equity

shares allotted or transferred free of cost or at concessional rate to the

employee is considered as taxable perquisite

• Securities covered:


Specified Security

• Securities as defined in 2(h) the Securities Contracts (Regulations) Act, 1956

• Securities offered under any ESOP plan or scheme

Sweat Equity Shares

• Shares issued by the employer 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

Taxation as capital gains

At the time of sale of shares:

• Capital gains arising at the time of sale of shares are taxable in the

hands of employees, either as long term or short term capital gains

(depending upon the period of holding of shares from the date of

exercise)

• Capital gains are to be computed as the difference between sale


• Capital gains are to be computed as the difference between sale

proceeds and FMV on the date of exercise of options [Section 49(2AA)]

15

Valuation methodology

• Value of the specified security or sweat equity shall be determined as

follows:

‒Fair Market Value (‘FMV’) on the date of exercise less the amount

actually recovered from the employee

• FMV of the specified security or sweat equity shall be determined in

accordance with Rule 3(8) of the Income-tax Rules:


accordance with Rule 3(8) of the Income-tax Rules:

16

Unlisted shares

(a) Unlisted shares FMV shall be the value as determined by a Category I merchant banker registered with Securities and Exchange Board of India on the exercise date or 180 days prior to such date

Valuation methodology…

Shares listed on a stock exchange in India

(a) Shares traded on the date of exercise

Average of the opening and closing price on the date of exercise of option

(b) Shares not traded on the date of exercise

Closing price on a date closest to the date of exercise of the option and immediately preceding such date

Shares listed on more than one stock exchange


(a) Shares are traded on the date of exercise

Average of the opening and the closing price on the stock exchange, which records the highest volume of trading in shares on the date of exercise of option

(b) Shares are not traded on the date of exercise

Closing price on a date closest to the date of exercise of the option and immediately preceding such date on the stock exchange which records the highest volume of trading in shares

Obligations of the employer

• Employer is obliged to withhold taxes from the amount of perquisite arising to the employees due to exercise of stock options/ sweat equity

Withholding Tax


of stock options/ sweat equity

18

Issues relating to deductibility

Whether discount on market price of shares is deductible for corporate tax purposes?


is deductible for corporate tax purposes?

19

Issues relating to deductibility…

• As per CBDT Circular No. 9/2007 dated 20 December 2007 (during the

FBT regime) clarified the following:

− In case the employer purchases shares and then subsequently

transfers such shares to its employees, expenditure so incurred is

allowable as deduction in computing taxable income of the employer

company.


− If the shares are allotted to the employees from the share capital of

the company, no deduction is allowable in computing the taxable

income of the company since no expenditure has been incurred by

it.

20

Relevant case laws

• Mumbai ITAT in the case of VIP Industries Ltd. [2010 ITA No. 7242/

Mum/ 08] held that difference between market price and price at which

shares were allotted to employees could not be considered as a

revenue expenditure allowable under the Act

‒ No expenditure had been incurred by the taxpayer and a mere

receipt of lower amount could not be deemed as an expenditure.

‒


‒

‒ A short receipt of share premium was a notional loss and not actual

loss

‒ SEBI guidelines were not conclusive for allowing an expenditure

under the Act

21

Relevant case laws…

• Delhi ITAT in the case of Ranbaxy Industries [2009 026 TTJ 771] held

that difference between market price and price at which shares were

allotted to employees is non-deductible on account of the following

reasons:

− The difference between market price and grant price represents

share discount

−


− The amount is not an actual expenditure incurred by the tax payer

− SEBI guidelines are not a prerogative for determining allowability or

otherwise of an item for income tax purposes

22

Relevant case laws…

• Chennai ITAT in the case of M/s SSI Limited [I.T.A. NO. 1384/ MDS/

2004] held that difference between market price and price at which

shares were allotted to employees is deductible for tax purposes:

‒ It was a benefit conferred on the employee and a benefit, which could

not be taken back by the company.

‒ So far as the company is concerned, once the option is given and

‒


‒

exercised by the employee, liability in this behalf is ascertained.

‒ It is not the case of contingent liability depending upon various factors

on which the assessee had not control.

‒ Assessee’s claim of deduction was in accordance with the SEBI

guidelines.

‒ Hence, the amount is a deductible expenditure.

23

Taxation of Stock Appreciation Rights

(SARs)(SARs)

24

Taxation of SARs

• SARs differ from stock options

• In case of SARs, the employee does not have to pay for acquiring an

underlying security under the SARs scheme. The employee only receives

appreciation in the value of an underlying security.

• Upon exercise SARs provide only for cash payment and not for the issue

of shares.


• The exact quantum of benefit or reward is ascertained at the point of time

when SARs are redeemed. Whereas in the case of a stock option, the

benefit can be ascertained when shares are actually sold.

• SARs result in receipt of a reward, though measurable in terms of money

by which the share price has gone up. While ESOPs result in acquisition

of an asset at a concessional price by the beneficiary.

• Amount received on redemption of SARs is a revenue receipt, liable to

tax as income under the head ‘salaries’.

25

Taxation of SARs…

• Reference is made to the decision of Mumbai ITAT in the case of Sumit

Bhattacharya v. ACIT (2008) 300 ITR 347 wherein it was held that

redemption of SARs is quite different in scope and application as

compared to ESOPs. Further, the amount received on redemption of

SARs is a revenue receipt in the employee’s hands, liable to be taxed as

‘income from salaries’ even if received from ultimate parent company of

the employer.


Recent Judicial Precedents

27

Abhiram Seth v. JCIT (Delhi ITAT)

• Facts of the case

‒Assessee, an employee of M/s Pepsico India Holdings (P) Ltd. was

granted valuable rights in shares of Pepsico Inc. on various dates from

1995 to 2000

‒ESOP stocks were held with Barry Group of Merrill Lynch (Trust), USA

‒Assessee exercised and sold the shares on 25-02-2004 and offered the


‒

‒Assessee exercised and sold the shares on 25-02-2004 and offered the

gains to tax as long term capital gains

‒The relevant assessment year is 2004-05 (prior to FBT regime)

‒Assessee was required to pay purchase price at the time of sale of

shares. Therefore, the assessee actually received the differential

amount between gross sale consideration and cost price.

28

Abhiram Seth v. JCIT (Delhi ITAT)…

‒AO observed that as shares were allotted and sold by the assessee on

the same day, the profit arising should be taxable as short term capital

gain.

• Ruling of the ITAT

‒ ITAT held that when the assessee is given an option under the ESOP

scheme not to pay the purchase price of shares at the time of allotment,


‒

scheme not to pay the purchase price of shares at the time of allotment,

but the same is to be deducted at the time of sale of shares, the period

of holding of shares should be determined from the date of allotment of

shares. Just for the reason that purchase price is known on the date of

sale, gain arising from sale of shares cannot be held as short term

capital gain.

29

Case Studies

30

Case Study - 1

5 Options per employee 500 shares per option @ Rs. 10 per share

Date of grant of option 1 April 2006

Grant period 1 April 2006 to 31 March 2010

Date of vesting of option 1 April 2010

FMV on the date of vesting Rs. 25 per share

Date of exercise of option 30 March 2010

FMV on the date of exercise Rs. 22 per share


Issues:

‒ What are the taxing events?

‒ In which year will taxability arise?

‒ What would be the perquisite value in the hands of employee?

‒ What would be the taxable value?

‒ Whether gain will be short term or long term?

Date of allotment of shares 5 April 2010

FMV on the date of allotment Rs. 30 per share

Date of selling shares 1 January 2011

Selling price per share Rs. 50 per share

Case Study - 2

• Facts:

‒During FY 2007-08, Foreign Parent Company (F Co.) granted ESOPs

to an employee of Indian Company (I Co.)

‒The employee was seconded to F Co. w.e.f. 1 December 2007 for 3

years

‒The employee exercised ESOPs on 1 January 2008 (or 1 July 2009)

‒


‒

‒The employee became non-resident in India during FY 2008-09

‒The cost of ESOPs is not recharged to I Co.

• Issues:

‒Taxability of ESOPs in the hands of the employee in India

‒Whether full value or value in proportion to the period of service

rendered in India shall be taxable in India?

32

Case Study - 3

• Facts:

‒X is an employee of Foreign Company (F Co.)

‒At the time of grant of options, X is in employment of F.Co. outside India

‒Options to vest after 3 years

‒X is seconded to Indian group company for a period of 2 years, after 2

years of the grant of option

‒


‒

years of the grant of option

‒Option has to be exercised within 2 years from the date of vesting

‒At the time of vesting, X is in India

‒X exercises the option after completion of secondment in India

• Issues:

‒Taxability of ESOPs in the hands of X in India

33

Case Study – 4 (SARs)

• Facts:

‒X worked as an employee (Director) in an Indian Company (I Co.),

during the period November 2008 to November 2010.

‒Since December 2010, he is working with the Foreign Parent Company

(F Co.) of I Co.

‒During his employment in India, in November 2010, he was granted


‒During his employment in India, in November 2010, he was granted

800 SARs with vesting period up to September 2013, under a Stock

Option Plan of F Co.

‒SARs were granted for the period FY 2009-10 and related to the

services rendered by X in India.

‒Since the payment for SARs granted to X relates to services rendered

in India, the said cost will recharged to I Co.

34

Case Study – 4 (SARs)

‒X exercised the SARs in August 2011 i.e. during his employment with F

Co.

• Issues:

‒Whether payment received by X on exercise of SARs will be taxable in

India?

‒Withholding tax obligation on I Co. or F Co.?

‒



‒Deductibility of cost recharged in the hands of I Co.

35

Case Study – 5

• Facts:

‒ Parent Indian company (I Co.) has

many foreign subsidiaries (F Co.)

‒ I Co. has employees posted

outside India

‒ Such employees remain on the

payroll of I Co.

‒ I Co. awards ESOPs to its

F Co. F Co.

F Co.F Co.

Posted in

F Co.


‒

‒ I Co. awards ESOPs to its

employees including those posted

outside India

‒ Cost incurred by I Co. on award of

ESOPs to employees posted

outside India, is borne by F Co. i.e.

recharge of cost by I Co. on F Co.

‒ Cost consists of cost of shares and

other administration cost

36

I Co.

SubsidiariesRecharge of

ESOP Cost

Grant of

ESOPs

Employment

contract

Case Study – 5 (contd.)

• Issues:

‒ Taxability of ESOPs in the hands of employees working in F Co.

‒ Taxability of ESOPs in the hands of employees working in India

‒ Deductibility of cost of ESOPs in the hands of I Co.

‒ Taxability of recovery of cost in the hands of I Co.

‒


‒


‒ Deductibility of cost recharged in the hands of F Co.

37

Case Study – 6

• Facts:

‒ Parent Indian company (I Co.) has

many foreign subsidiaries (F Co.)

‒ I Co. awards ESOPs to employees of

F Co.


F Co.

SubsidiarieRecharge

of ESOP

F Co.

F Co.F Co.

Grant of

Employee



ESOPs is borne by F Co. i.e.

recharge of cost by I Co. on F Co.



38

I Co.

Subsidiarie

sof ESOP

Cost

Grant of

ESOPs


• Issues:

‒ Taxability of ESOPs in the hands of employees of F Co.

‒ Deductibility of cost of ESOPs in the hands of I Co.




‒


39

Case Study – 7

• Facts:

‒ Parent Foreign Company (F Co.) has

subsidiary Company in India (I Co.)

‒ F Co. has employees posted in India

‒ Such employees remain on the

payroll of F Co.

‒ F Co. awards ESOPs to its

employees including those posted in

‒

F Co.

Recharge

Employment

contract


‒

employees including those posted in

India

‒ Cost incurred by F Co. on giving

ESOPs to employees working in

India is borne by I Co. i.e. recharge

of cost by F Co. on I Co.



40

I Co.

SubsidiaryRecharge

of ESOP

CostGrant of

ESOPs

Posted in

I Co.

Employee


• Issues:

‒ Taxability of ESOPs in the hands of employees deputed to I Co.


‒ Deductibility of cost of ESOPs in the hands of F Co.

‒ Taxability of recovery of cost in the hands of F Co.

‒


‒

‒ Deductibility of cost recharged in the hands of I Co.

‒Withholding tax liability on cost recharged by I Co. to F Co.

41

Case Study – 8

• Facts:

‒ Parent Foreign Company (F Co.) has

subsidiary Indian Company (I Co.)

‒ ESOP scheme under which option is

granted to employee A in 2008

‒ Employee A is seconded to India for

a period of 2 years beginning

November 2010

‒

F Co.

Grant of

ESOPs


‒

November 2010

‒ Employee A exercises the option in

March 2011

‒ Cost incurred by F Co. on award of

ESOP is borne by I Co. i.e. recharge

of cost by F Co. on I Co.



42

I Co.

Subsidiary Recharge

of ESOP

Cost

Employment

contract with I Co.

Employee


• Issues:

‒ Taxability of ESOP in the hands of employee A

‒ Deductibility of cost of ESOP in the hands of I Co.

‒ Taxability of recovery of cost in the hands of F Co.

‒Withholding tax liability on I Co. to F Co.


‒

‒Withholding tax liability on I Co. to F Co.

43

Case Study – 9

• Facts

‒ Employee A is exercises options granted to him, in November 2010

‒ Cost of shares recovered from him is Rs. 10

‒ FMV on the date of exercise as per Merchant Banker Report is Rs. 20

‒ Valuation of shares under the provisions of section 56(2)(vii) is Rs. 25


‒

‒ Valuation of shares under the provisions of section 56(2)(vii) is Rs. 25

• Issues:

‒What will be the taxable value in the hands of employee A?

44

Questions


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Documents

Taxation of ESOPs/ Sweat Equity - WIRC - Taxation of...Types of ESOPs / sweat equity… • ‘Employee Stock Option Scheme’ ‒The company grants option to its employees to buy