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Friday, July 10, 2009

Example for new Perqusite Tax versus old Fringe Benefit Tax

An example for the previous post "FBT removed in Budget 09-10. Time to rejoice? Think again."

An employee is awarded X shares under an RSU plan, with a vesting date 4 years in the future. The RSUs are awarded at face value, say INR 2.

4 years later, on the vesting date, the stock price is at an all time high of INR 102 i.e. the FMV = INR 102. After the vesting date, irrespective of when the employee exercises his options (i.e. buys the shares from the company), the notional value per RSU is already fixed = INR 100. Even if the employee exercises his options later, he has to pay FBT of about INR 34 per option when he exercises.

Say, after the vesting date, the employee waits for another 6 months or a year before deciding to exercise. Now consider a market crash, as has happened. IT stocks being particularly susceptible, would steeply drop. The stock price drops to INR 32. The RSUs are almost worthless now! The notional capital gain is INR 30 per RSU. While the employee has to pay INR 34 to the government per RSU. Unless one is sure that the stock price will increase drastically in the future, there is no point in exercising the RSU. (And if someone says he is sure about the stock market, he's either stupid or joking.)

With the new taxation rules, the same situation is much better. Say, the employee decides to exercise at INR 32, he will pay a perq tax of about INR 9 (at a marginal tax rate of 30%).

Even without a market crash, one is perhaps better off since the price of stocks varies over a period of time. Perhaps the stock price was at an all time high around the vesting date (as in the example above, at INR 102). A few months later, any number of real or imaginary concerns can bring down the price sharpely. Say the stock price drops to INR 62. Thus the perq tax that needs to be paid is about INR 18. Thats nearly half the previous FBT per RSU.

Finally, after exercise of the stock options, the employee should wait for a year before making a sale, which would be a long term capital gain and hence exempt from tax.

1 comment:

Anonymous said...

why didn’t I come across this article earlier!!! pretty useful!!!