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
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
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
* 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.
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
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