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After FBT, are ESOPs attractive?
Nikhil Menon, Outlook Money
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October 31, 2007

Employee stock option plans (Esops) are back in the news. Last month, acknowledging the confusion over calculation of fringe benefit tax (FBT) on stock options, the government pushed ahead the deadline for paying tax from 15 September to 15 December. So, employees are trying to figure out again whether it makes sense to accept Esops after factoring in the FBT.

The confusion: Things were simple earlier. Depending on how long you held your Esops, you had to pay long-term or short-term capital gains tax on the difference between the prices at which you bought and sold them. But from this financial year, companies giving Esops have to pay FBT on them.

Tarun Gulati, vice-president of ESOPDirect, a consultancy company, says: "The amended rule says that the difference between the share's fair market value on the date of vesting (nobody is sure how to calculate that yet) and the exercise price will be liable to FBT at 33.99 per cent."

Exercise price is the price you pay for your shares on the exercise date, on which you decide to buy the shares offered to you. The vesting day is the day you get the shares, which is usually three years after the exercise date.

If you got 100 options for Rs 50 each and their fair market value on the vesting date was Rs 75, your employer will have to pay FBT of about Rs 849 [that is, (75-50)x100x33.99%]. If your company recovers that from you, as many do, your actual buying price is higher than Rs 50. 

The purchase dilemma arises since employees are paying a higher price for the shares (exercise price plus FBT). They fear that if the price falls after the vesting date, they will stand to lose money.

The decision: When the stockmarket is on the upswing, the price on the vesting date is likely to be sufficiently higher than the exercise price. So, you will stand to gain even after taking into account the FBT payout. 

Actually, you could do as well with a cash reward equal to the difference between the exercise price and the price on the vesting day. Sudhir Kapadia, partner of tax consultants BSR & Co., says: "Cash rewards will also attract income tax at similar rates. So, the tax liability remains the same."

But for companies, financially, things will not change after the FBT if they recover it from you. They are charging what they have to for the Esops. The excess FBT amount you are paying is passing through to the taxman. Which is why companies are likely to continue giving Esops rather than cash rewards, which will have to come straight out of their coffers, as opposed to Esops, where you earn from the stockmarket.

So, companies are going ahead with Esops. Recently, two Zee Group companies decided to do so. "I feel that in their current form, Esops will survive in corporate India as both the company and the employee can gain from it," says Amit Mazumdar, vice-president (corporate strategy & finance), Zee-Essel Group.

Esops make sense for the employee. Chances of loss are low if the stocks are held for the long term since the market is showing a secular rising trend. Besides, if you refuse them, don't expect your employer to dig the money out of its coffers to pay you.

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