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Tuesday, July 07, 2009

FBT removed in Budget 09-10. Time to rejoice? Think again.

In yesterday's Indian Union Budget 2009-10, the Fringe Benefit Tax (FBT) has been proposed to be abolished. The FBT has been a pain for ESOP holders, ever since ESOPs were brought under FBT in 2007. Since then, Employee Stock Option Plans (ESOPs) have had to pay the FBT on the notional value of the ESOPs. The notional value of the ESOPS = Fair Market Value on vesting date - exercise price. And the FBT rate was a huge 30% per cent plus applicable surcharge plus education cess. Note that the FBT was actually an employer tax which was happily being passed by most employers to the employee. Nothing like being an employer in India, right?

Anyway, since then, companies (esp in the IT sector) have been trying to get the FBT removed. And it seems that their efforts have borne fruit. And everyone is rejoicing. For instance see article: Goodbye FBT… ESOPs just got better again! in India Infoline, FBT abolition should help attract talent in the Deccan Herald, Budget is clicking the right buttons to improve IT infrastructure in The Financial Express. But these articles are almost certainly mis-educating the general public.

Contrary to what you might think, removal of FBT does not mean that taxation of ESOPs will stop. All that has happened is that the taxation in the hands of the employer has been shifted to the employee. So ESOPs, among other items will be treated as perquisite in the hands of the employee and taxed at the prevalent slab rates. Which for most of us will change nothing at all.

The only silver lining that I can see is in the calculation of the notional value of the ESOPs. Previously, the employee had no say in the matter, the notional value was the difference between the Fair Market Value on vesting date - exercise price. Now it will be Fair Market Value on exercise date - exercise price. The vesting date is not under the employee's control, but the exercise date is. Prices of stocks fluctuate... by waiting for an opportune time, one could decide the exercise date at a point where the stock price is agreeably low, and hence reduce the FMV. A long term sale subsequently will reduce the capital gains to 0, hence one can profit from a low FMV.

Example for new Perqusite Tax versus old Fringe Benefit Tax.

4 comments:

rohit said...

It will be great if you can explain with example

Anonymous said...

How is FMV for a start ups calculated?

ZeHawk said...

@anon: Not sure what your Q has to do with my post ;) but heres a couple of good reads: http://www.firstascentventures.com/blog/?p=35 and http://www.firstascentventures.com/blog/?p=17

Bella Holmes said...

I feel sad for this "FBT was actually an employer tax which was happily being passed by most employers to the employee". I am hoping that not all employers are thinking for themselves but they also need to think for their employees too.

IRS Tax Attorney