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FBT, equity plunge ends Esop fable

Posted on 21 October 2008,    
 5688    Share  Report

Sub Heading : Double whammy for staff exercising rights and those who held on to their shares

Author : Priyanka Golikeri & Vivek Kaul. Mumbai/DNA

Content : Employee stock option plans (Esops) have been a big motivator for employees particularly in the banking and the information technology sectors.
Not anymore.
Fringe benefit tax (FBT), introduced a couple of years back, has killed the Esop party.
The market crash has added to the troubles.
Employees who had exercised stock options and held on to the shares, have been hit by a double whammy.
First, they are sitting on losses as the price of shares they had got after exercising the options, are quoting at levels much below the price at which they had exercised those options.
Harshu Ghate, managingdirector of Esop Direct, the Pune-based stock options consultant, said the stock market crash has meant things are under water.
"And I don't see the markets going up rapidly in the near future," he said, hinting at the piquant situation for holders.
The second and major point of discontent is that employees have already paid FBT at the time of exercising these options.
FBT was introduced bythe government a couple of years back and is supposed to bepaid by the company on any "fringe benefits" it offers to its employees.
Though the employer or organisation is supposed to pay the FBT, in reality it is passed on to the employee.
"In most cases, FBT is borne by the employee," said K Sudarshan, global vice-president, marketing and communications, EMA Partners International, the global executive search firm.
"As FBT is borne by employees, those who have exercised their options are in a quandary," said New Delhi-based human resources consultant Yogesh Saigal.
The following example shows how employees who have exercised their options and converted them into shares are sitting on huge losses.
Let us say a company issued an option to an employee at Rs 400 per share.
The employee decides to exercise the option when the market price of the share is Rs 600. On exercising the option the employee first pays Rs 400 per share to the company.
At that point in time, the company will have to pay a fringe benefit tax of 33.99% on the fringe benefit value.

The fringe benefit value is calculated as the difference between the market price of the share at the time of exercising the option and the price at which the option has been exercised.
Hence, in this example, the fringe benefit value works out to Rs 200 per share (Rs 600 minus 400).
And so the company will have to pay a FBT of around Rs 68 (33.99% of the fringe benefit value of Rs 200).
Now this doesn't sound a huge number in case of one share. However, imagine if the employee has exercised 1,000 shares. Then the company has to pay an FBT of Rs 68,000 (Rs 68 x 1,000 shares) to the government.
Even though the company pays FBT to the government, in most cases it passes it onto the employee, by getting the employee to pay the amount of FBT upfront at the time of exercising the option.
Agrees a human resource official from a top IT company based out of Bangalore, "FBT is passed on to the employees." The employee can, of course, hope to recover this cost and make much more money by hoping that the market price of the stock rises and he recovers the FBT he has paid and makes more money. But with the stock prices falling since the beginning of the year that is clearly not happening.
Let us suppose in the example taken, the market price of the share has fallen by 40% since the option has been exercised and is currently quoting at Rs 360 (Rs 600 - 40% of Rs 600).
So the employee has lost Rs 40 per share (Rs 360-400) and is sitting on losses worth Rs 40,000 (Rs 40 x 1,000 shares) because the market price of the share has fallen since the time he exercised the option. Add to this, Rs 68,000 he has paid for FBT he is sitting on total losses worth Rs 1.08 lakh.
With the stock market falling employees have been thinking whether Esop continues to be an effective tool of motivating and holding onto people.
"Many stocks have fallen by 70%. In these times, Esops are not an effective tool," says Sudarshan of EMA Partners.
Ghate of EsopDirect feels the options issued at higher prices and not yet exercised will be cancelled and new options will be issued keeping in mind the current prevailing market prices.
"If cancellation seems problematic, then companies could continue with existing options, but simultaneously grant more options taking into account the current market price," he adds.



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