Tax implication of Employee Compensation Package to the Employer

In today’s changing times, when employees are critical to the growth of an organization, a large number of companies offer stock options to different levels of employees — be it to retain key employees or to attract new talent.

There are different models of employee stock option plans available: Employee Stock Option Plan (ESOP), Employee Share Purchase Plan (ESPP) and Stock Appreciation Rights Plan (SAR).

While ESPP and SAR models are prevalent in the global market, the ESOP model is prevalent in India due to certain legal regulatory framework.

The first event of taxability is triggered on the date of allotment/transfer of the shares. The benefit arising to an employee, being the difference between the Fair Market Value (FMV) on the date on which the option is exercised less the amount actually paid or recovered from the employee, would be subject to tax as part of the salary income.

Accordingly, an employer is required to compute the benefit under the stock options, include the same as part of the salary income and, accordingly, withhold the tax on the same from the employee.

The manner of determining the value of perquisite differs for shares, which are listed on a recognised stock exchange in India vis-à-vis shares not listed on a recognised stock exchange in India (overseas equity shares). In case the shares of a company are listed on a recognised stock exchange in India, the fair market value (FMV) is to be determined as the average of the opening price and the closing price of the share on that date.

In case the shares are not listed, the FMV shall be such value as determined by a merchant banker (registered with the Securities and Exchange Board of India) on the specified date. The term ‘specified date’ means

(i) the date of exercising of the option

(ii) any date earlier than the date of exercising of the option, not being a date that is more than 180 days earlier than the date of exercise.

The next event of taxability under the stock options would arise in the event of sale/transfer of shares. The difference between the sales consideration and the fair market value on the date of exercise would be treated as capital gains and subject to capital gains tax. The capital gains could be long term or short term, depending upon the period of holding of such shares/securities.

There is no clarity on the taxability of benefit arising under Esops in case of globally mobile employees. Also, the rules do not comment on taxability of individuals whose residential status is non-resident/not ordinarily resident in India and who have worked overseas during the period of the Esop.

An analogy on these open issues can only be drawn from clarifications provided by the Central Board of Direct Taxes from time to time.