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India’s New Budget Proposes Elimination of Fringe Benefit Tax on Employee Stock Options

January 1, 0001

 

On July 6, 2009, India’s Finance Minister presented India’s Union Budget 2009 (Budget), announcing several key policy initiatives of the Government of India. Included in the Budget is a proposed elimination of the Fringe Benefit Tax (FBT) on all benefits, including on employee stock options, and a modification of the Indian Income Tax Law (Tax Law) so that employee stock options would be taxed as perquisites. The proposed changes would in effect shift the burden of the tax on employee stock options from the employer to employees and would help reduce the administrative burden faced by employers under the FBT regime.

As reported in a previous O’Melveny & Myers Client Alert, India’s Fringe Benefit Tax: Common Issues (October 22, 2008), under the current FBT regime, stock options granted to employees are treated as fringe benefits, for which employers are liable to pay tax at the time of transfer or allotment of the shares. Employers have been statutorily provided with the flexibility to recover FBT from their employees. The FBT on employee stock options currently reaches non-Indian companies that have granted employee stock options to employees of an Indian subsidiary and Indian companies (including subsidiaries) granting options to employees in India. In general, under the current FBT scheme, 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 (if the company is not listed on a recognized stock exchange in India, the FMV used to calculate the tax is to be determined by a Securities and Exchange Board of India-registered Category 1 Merchant Banker). Companies which have granted options that are subject to the FBT are required to estimate and pay this tax liability on a quarterly basis.

The proposal contained in the Budget would effectively replace the FBT regime with a tax on stock options as an employee perquisite. The Indian Finance Bill 2009, which is the implementing legislation for many of the tax proposals in the Budget, would add a provision to the Tax Law that makes “specified securities” taxable as perquisites. “Specified securities” is defined to include shares offered under an employee stock option plan or scheme. The amendment further specifies that stock options would become taxable at the time the option is exercised based on the FMV at the time of exercise reduced by the amount paid by the employee to exercise the option. Perquisites are taxed in the hands of employees at the same rate as ordinary income (the maximum marginal rate of tax for individuals is proposed to be reduced from 33.99% to 30.9%). Employers would be required to withhold tax at the time of exercise of stock options by the employees.

The proposal for eliminating FBT should help address the difficulties faced by employers that have granted stock options to employees in India. The process for computing the FBT, including the requirement that the valuation be performed by a merchant banker, is time consuming and potentially expensive. However, for purposes of determining the perquisite tax on the date of exercise of an option, the guidelines for calculating FMV at the time of exercise are still to be introduced by the tax authorities.
The changes in legislation at this stage are proposals, and they still must be approved by India’s legislature. The proposed changes, if approved, would take effect for all stock options exercised by employees in India on or after April 1, 2009. Employers who may have already paid FBT in the first quarter installment on June 15, 2009 may need to apply to the tax authorities for a refund and at the same time withhold tax from any employees who exercise options.

This Client Alert provides a general summary of the proposed changes to the FBT and the taxation of perquisites under Indian law. However, the rules surrounding taxation in India are complex. This summary does not include all of the detailed rules contained in the proposed amendments to the Tax Law. 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 India for review and comment on this Client Alert.