ESOPs are a way to reward employees - they incentivize and motivate employees for a long term relationship with the company. However, the purpose of ESOPs can get defeated if they burden the employees.
We would like to see the current law on taxation of ESOPs to be changed because it burden's holders of ESOPs who exercise their options. Lets show you how.
The law states that the difference between the exercise and grant price is taxable as a perk to the employee, at the time of the exercise of the option. The tax on this is withheld by the employer from the salary payments. This often poses cash flow problem for the employee because they might face a cash shortfall.
As a result, in order to meet the cash flow shortfall, the employee might be forced to sell the company's shares, received when the employee exercises the options, in the open market.
In this situation, the employee loses the opportunity of future appreciation and benefiting from the company's progress, which is the objective of granting ESOPs to employees in the first place.
The chart below will help you understand the current taxability provisions.
Ram was granted 1,000 ESOPs in April 2008 at grant prices of Rs 10 per option. These became eligible for exercise on April 2009, at which time the fair market value of the shares is Rs 100. The difference between the grant price (Rs 10) and the fair market value on the exercise date (Rs 100) is a taxable perk and is added to Ram's salary (Rs 90 per share or, Rs 90,000 in total).
This increases the tax burden on Ram because he now has to pay tax out on this. But Ram does not have enough cash to be able to pay out all this money in taxes because he is seeing no additional cash come in, apart from what he gets in his salary.
So, left with no choice, he sells his shares in April 2009 at Rs 100, thereby losing out on potential capital appreciation going forward. Rather than benefiting from long-term capital appreciation, Ram is actually forced to sell his shares to generate cash because of his cashflow issues.
We would like to suggest that the taxable perk should be charged at the time of the sale of the shares, and not at the time of the exercise of the ESOP. This would be more friendly to the employees, without reducing the tax receipts of the government.
By www.iTrust.in - India's leading one-stop financial supermarket for real estate, home loans, investments, taxes and financial planning.
CAclubindia
