David Makarechian,
Jeffrey Walbridge
In April 2007, the Indian government imposed a fringe benefit tax (FBT) on the allotment or transfer of shares by a company to its employees under an employee stock option plan. In October 2007, the Central Board of Direct Taxes (CBDT) issued rules prescribing the method of valuing stock options subject to the tax. This Client Alert is a reminder about the previously approved tax law changes and the fact that employers in India generally must accrue and remit the taxes once the options begin vesting (even though they may not be exercised until some later date).
In general, under the FBT scheme as enacted, a tax of 33.99% is levied on the spread, if any, between the exercise price and the fair market value (FMV) of the shares subject to a stock option on the date the option vests. (The FMV used to calculate the tax is to be determined by a Category 1 merchant banker in India.) Companies which have granted options that are subject to the FBT are required to estimate and pay this accrued tax liability on a quarterly basis.
Although the FBT is calculated as of the vesting date of the options and the company is required to estimate and pay the liability on a quarterly basis, the FBT with respect to a particular option is payable only upon exercise of the option. Upon exercise, an employer is allowed to recover the pro rata FBT paid or payable by the company with respect to the option from the employee exercising the option. It is advisable for stock option agreements and stock option plans covering employees in India to include a specific clause permitting this recovery of the tax. Many companies that have implemented new stock option plans since the rules were enacted have added such provisions to their plans and may be recovering the tax from employees who exercise options. Under applicable Indian law, companies are generally permitted to amend or revise existing option agreements to permit recovery of the FBT. However, there may be circumstances where the consent of the option holders would be required for these changes (for example, in certain plans governed by the laws of a country other than India which may not permit a unilateral amendment by the employer).
Several questions have arisen over the last few months regarding the FBT rules as applied to employee stock options. The CBDT addressed some of these questions in Circular No 9/2007 (Circular), which is available
here. Companies are directed to the Circular for a further understanding and explanation of the rules. We have addressed some of the most frequently asked questions here:
1. If employees of an Indian subsidiary are granted options in shares of a foreign holding company, is FBT applicable and which company must pay the tax?
In general, the employer is liable to pay the FBT for fringe benefits provided to its employees. As interpreted by the Circular, the Indian subsidiary would be responsible for the FBT resulting from a stock option granted by a foreign parent to an employee of the subsidiary.[1]
2. If an employee is granted a stock option by a non-Indian parent company, and the employee is a Non-Resident Indian (e.g., living in the U.S.), is the option subject to FBT?
Generally, no. Collection of the FBT is the responsibility of the Indian employer for stock options granted to its employees. The tax would not extend to stock options granted by a foreign holding company for optionees residing outside of India, even if the optionees are Indian citizens.
3. Will a stock option grant be subject to the FBT if the option is granted by a non-Indian parent company to an employee of an Indian subsidiary, but the grant occurs while the employee is outside of India (for example, while providing services to a U.S. parent company in the U.S.)?
Yes. If the employee is based in India but providing services outside of India on a temporary basis, the option would still be subject to the FBT if the employee was based in India at any time beginning with the date of grant and ending on the vesting date of the option (this period of time is referred to as the "grant period"). The amount of tax payable would be pro rated for the portion of the grant period that the employee was in India.
4. If a non-Indian parent company grants a stock option to an employee of the non-Indian parent, but the grant occurs while the employee is working in India, is FBT payable and if so by which entity?
In this case, the non-Indian parent company would be responsible for paying the FBT on the stock option granted to its employee. As in the case immediately above, the amount of the tax would be pro rated based on the portion of the grant period that the employee was based in India.
This summary provides a general overview of some of the frequent issues that arise in connection with the FBT. However, the rules surrounding the FBT are complex. This summary does not include all of the detailed rules contained in the FBT. Companies should consult their Indian counsel concerning the application of the rules to any particular set of circumstances.
O’Melveny & Myers LLP is not licensed to practice law in India, and this Client Alert should not be construed as providing advice concerning the laws of India or of any other country or jurisdiction. Readers are encouraged to consult with counsel in India in the event of questions concerning the matters addressed herein. The authors are grateful to Vikram Shroff and Parul Jain of Nishith Desai Associates in Mumbai for review and comment on this Client Alert.