Budget 2018: The expectations from union budget 2018 will be the highest this time, as the year 2018 is very crucial for the Modi government. This budget comes after the implementation of the much talked about tax reform, Goods and Services Tax of GST. So when finance minister Arun Jaitley open his iconic briefcase on February 1 and present one of the most important budgets during his tenure, all eyes will be set on him. But many are requesting the Modi government make adjustments to bring relief for the employees. And in order to make employees benefit from the budget, Modi government should pull off these steps.
While employees are expected to take ownership of their work, stock awards allow them to share the ownership in their employer’s capital too. Stock awards can be seen in the form of Employee Stock Option Plan (ESOP), Employee Stock Purchase Plan (ESPP), Restricted Stock Unit (RSU), Stock Appreciation Rights (SAR), etc. Stock awards could be used either to reward past performance or to retain talent in the future. Hence as a deferred compensation plan, benefits of stock awards can be two-fold: it ensures that those employees who contribute to the profits of the company are recognized and rewarded; for the employer, it is an attractive tool for retention.
Most ESOP schemes follow the grant-vest-exercise-allotment process whereby the reward is deferred until a date in the future (usually 2 to 3 years from the date of grant). ESOPs are taxed on two instances in the hands of employees – firstly at the time of allotment as salary and later on disposal of shares as capital gains1.
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Share-based incentives can also be designed in a way to reward the employees in the form of cash, rather than shares. In such schemes, benefits are settled by the employer in cash based on the underlying share/security. Cash-based schemes such as Stock Appreciation Rights are taxed at the time of payment as there is no concept of disposal at a later stage. As companies make use of ESOP as a means to share their profits with their employees, the tax regime could accommodate a few changes in order to extend certain tax benefits to the employees:
Shifting the tax trigger
Some ESOP schemes impose a mandatory lock-in period (say 1 to 5 years) from the date of allotment. Until the expiry of the lock-in period, the employees are not permitted to sell or mortgage such shares. As the rules currently require tax withholding by employer at the time of allotment, the employee is required to pay tax before earning the benefits of absolute ownership. In view of this, the initial trigger for taxation could be after the expiry of lock-in period or sale, coinciding the taxation with the time when the employee can fully reap the benefits of the scheme.
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Exempt dividends and capital gains from ESOP
Currently, the Income-tax Act, 1961 allows exemption for dividends from domestic companies to the maximum extent of INR 10,00,000. This limit could also be extended to cover the dividends paid by foreign companies on shares acquired under ESOP schemes.
This move would help better distribution of capital and wealth between companies and its employees.
Tax exemption on death or permanent incapacitation
Benefit/payout from ESOPs provided on permanent incapacitation or death of the employee could be exempted similar to death-cum-retirement gratuity.
Clarification for taxability of ESOP where services were rendered outside India during the vesting period
The Central Board of Direct Taxes (CBDT) had issued a circular (No. 8/2005 dt. 29.8.2005) in respect of the Fringe Benefit Tax (FBT) liability of Indian employers in case of internationally mobile employees. The circular clarified that in case of stock awards granted to non-residents or not-ordinary residents, FBT on such benefit was to be computed proportionate to the number of days spent in India by such employees during the grant-to-vesting period. Since the abolition of FBT effective assessment year 2010-11, stock awards have become a perquisite taxable in the hands of the employees. Hence, a clarification for perquisite taxation on similar lines would bring clarity and certainty to the tax payers.
ESOP drives a sense of ownership and growth in the minds of the employees, thereby motivating them for innovation and value creation, which in turn boosts the corporate health. Tax sops would help achieve not only economic growth but also widespread dispersion of capital among employees.
Written by Sudhakar Sethuraman and Vijayalakshmi Kartik. Sudhakar Sethuraman is Partner and Vijayalakshmi Kartik is Deputy Manager with Deloitte Haskins and Sells LLP.