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ESOP FBT: An Open Letter to the FM

Dear Mr. Chidambaram,

I must request you, sir, to relook at your proposal for Fringe Benefit Tax (FBT) on Employee Stock Options (ESOPs).

I have watched you mention, in a number of television interviews, that no one has yet asserted that ESOPs are NOT a fringe benefit. Perhaps the interviewers have missed this, but I would like to say this: ESOPs are a benefit, but they are NOT a fringe benefit.

Not that you need to be reminded, but let me ask you, sir, to look back at the time you introduced FBT. The idea was to tax the company as a whole, what you could not attribute to individual employees; that employees benefited from certain expenses like employee welfare expenditure, conference travel, telephone reimbursements, gifts etc. – and such expenses could NOT be attributed to individual employees (or it was too cumbersome to split the official expense from the personal one). You therefore said that a flat tax would apply to a percentage of such expenses assuming that the personal benefit was that fraction of the expense.

Yet, the underlying theme was that you could not attribute these expenses to the employee directly, and therefore could not tax the employee on this benefit. Unlike, I presume, monies paid directly to the employee such as salary, bonus etc. which are taxed in the hands of the employee since it is well known that the employee has received this amount as a benefit.

Now let me ask you sir, to look at employee stock options. Are they a benefit? Yes, if the stock price of the company is higher than the price the option is offered at.

But are ESOPS a “fringe” benefit? No, sir, they are not. There is no “official” and “personal” benefit differences in this regard, and the employee is fully and completely benefited from the gain in price. The gain can be fully attributed to the employee and there is no confusion about whether the ESOP is partly an official benefit and partly personal. If you want to tax this benefit, sir, you must tax it in the employee’s hands, not in the company’s.

The employee currently pays no tax (if STT has been paid) and a lower capital gains tax if STT has not. But that is on a capital investment – ESOPs are not capital investments, they are options! Only when exercised are they an investment (i.e. money is paid to purchase).

Therefore if we only apply capital gains tax to the difference in the exercise price and the market price at sale, and instead taxed in the employee’s hands the difference between the grant price and that at exercise, it would be more equitable.

Sir, there is another reason I ask you not to tax companies this tax. Imagine that an entrepreneur starts a company today and grants all his employees stock options. In a few years, this company goes public; but the options are not exercised (or not even vested yet). Let us say the stock market likes this company and the share prices double, triple or even quadruple.

At this point sir, please do look at how the company must report its results. At every increase in stock price (which as you know, companies have little control over, and do not benefit from, once listed) there needs to be a provision made for the potential gains their employees will make through their stock options, and the FBT thereof! A company’s stock may increase in price for reasons uncontrollable by the company, and the company does not benefit at all from such a price rise; yet, your new tax now penalises a company for this rise (through the FBT provision). Which means sir, that companies do not benefit from a rise, but have to pay tax on it.

Who does benefit? The employee. Why then should the company be bothered with this benefit? When the employee exercises the option, the company ensures that the taxes are paid – should that not be all the company is required to do?

Now should the pay tax on this gain? That is a matter of conjecture as you reward other people for long term capital gains – but if you feel that the “option” is not really a long term investment, please tax the difference between the option grant price and that at the time of exercise. But please do so in the employee’s hands, not in the company’s.

I understand that the laws have not been framed yet, but please consider my argument as a humble citizen before you do frame them. Please help our small entrepreneurs by allowing them to issue stock in lieu of salaries, and let this benefit be taxed in exactly the same way you tax salaries.

Yours sincerely,
Deepak Shenoy

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