BUDGET PROVISIONS ON ESOPS WILL OPEN A PANDORA'S BOX
Financial Express Column

HARSHU GHATE
 

Budget presented by the finance minister has significant provisions that affect the employee stock option plans (ESOPs) designed and implemented by companies. Amongst the couple of other provisions relating to ESOPs, one, which has wider implications, is the amendment suggested to proviso to sub-clause (iii) of Section 17(2). The amended clause now provides that unless the issue of options is in accordance with SEBI guidelines the benefit to the employee will be treated as a perquisite.
The suggested change has significant tax implications, especially for companies that have not complied with SEBI guidelines (i.e. unlisted and foreign companies) and listed companies that issued options before SEBI guidelines became effective.

Staying on the right side

While the said proviso to sub-clause (iii) of Section 17(2) even existed earlier, the only (but very significant) addition suggested is that the issue of options has to be in accordance with the SEBI guidelines.

It is well known that the SEBI guidelines are not applicable to the following ESOP schemes :

* ESOPs structured by unlisted companies.

* Shares issued by listed companies to trusts under ESOP prior to June 19, 1999.

* ESOPs by companies not listed in India -

Since the proviso does not make any exemption on the above lines, it is implied that companies falling in the above categories will also have to follow SEBI guidelines to qualify for an exemption as a perquisite.
This proviso is hard on unlisted companies, subsidiaries of foreign companies, and companies listed outside India.

For a scheme to be in accordance with SEBI guidelines, the following provisions have to be compiled with :

* Promoters, directors with more than 10 percent shares, non-permanent employees, employees of group companies will not be   eligible for options.
* Disclosure requirements in terms of the explanatory statement to the resolution to be passed in the general meeting will be   compulsory for an unlisted company.

* Compliance certificate from auditors guidelines will have to be placed at each AGM by the company's board of directors.
* Every company will have to appoint a Compensation Committee of Board of Directors consisting of majority of independent   directors to implement the scheme.
* The major implication for unlisted companies is about complying with the accounting guidelines.


Unlisted Companies' woes

Unlisted companies will have some genuine difficulties in complying with SEBI guidelines. A major difficulty will be in accounting for the ESOP's costs.

The fair value is defined as an option discount (excess of market price on the date of grant of option over the exercise price) or the value of the option using the Black Scholes formula or other similar valuation methods. In case of unlisted companies, calculation based on option discount does not apply, since there is no market price. The other option of using Black Scholes formula has practical limitations. Under the Black Scholes formula one needs to know the market price of the shares as well as the volatility of the shares, which means that one cannot calculate the option value under this method, if the shares are not listed. If the companies follow any similar method it would be like opening a Pandora's box with all differences in perceptions of the company and the accessing officer.

This confusion puts a big question mark on how the unlisted companies should account for the cost of ESOPs. Unless the accounting is done the benefit will be taxed as perquisite.


Prior grants and possibilities

In case of grants made earlier there are two possible scenarios, one where the Options granted have not been exercised, and second, where options have been exercised after April 1.
In the case of unexercised options, it is clear that all those options that have been granted earlier and will be exercised in future, would fall in the tax net as per perquisite.
However, the companies have resource available here. If they comply with the SEBI guidelines, there would be no tax incidence at the time of exercise.

Post-April Scenario

In case of options exercised after April 1, 2000, however, there appears to be very little that can be done to avoid incidence of perquisite tax. In cases where the companies have not issued transferred shares to employees, may be the process can be stalled and deferred till the SEBI compliance is achieved.

Wherever the exercise process is not reversible, it would be the company's responsibility to deduct tax at source on the Perquisite element in this year itself.

There are implications for the Companies and the employees of foreign companies to whom SEBI guidelines do not apply. Most of the Foreign companies would comply with USGAAP on wherever necessary, SEBI guidelines. They are however, not likely to comply with SEBI guidelines.

The unaddressed issues

Year of accounting and incidence of taxation

There is an apparent contradiction in the time gap with respect to the year of accounting and incidence of perquisite.

The guidelines of the market watchdog requires the concerned company to account for employee stock option schemes. There is an apparent contradiction in the time gap with respect to the year of accounting and incidence of perquisite.

SEBI guidelines requires the company to account for the cost of giving employees stock options in the year in which grants are made, whereas the employees are supposed to be taxed in the year of exercise.

In the Indian context, the number of unlisted companies who have implemented ESOP is much larger than the listed companies who have implemented ESOP.

Most of these companies have not complied with the guidelines of market watchdog because they were not supposed to. All such companies now need to have a close look at their schemes and make them compliant with the relevant norms.

Spirit of the suggested provision seems to be that all the companies have to implement ESOPs in an uniform manner by complying with SEBI guidelines. However, the implementation of this proviso would lead to chaos and diversity of practices.

The writer is the Managing Director of ESOP Direct and can be reached at
harshu@esopdirect.com


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