Employee stock awards – Tax
issues
October 20, 2010
Contents
•
Introduction
•
Things to know
•
How stock awards operate
•
Accounting overview
•
Taxation issues
•
2
•
Corporate taxation
•
Employee taxation
Issues around mobile employees
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Introduction
•
An employee incentive programme widely used by corporates
•
Right to buy certain assets at a designated price during or end of a period
•
Tool for attracting and retaining skilled employees
•
Create a sense of entrepreneurship for the employee
•
Align the interest of employees with those of shareholders
•
Hedge companies from hostile takeovers by spreading ownership
•
Opportunity for the employees of group company to participate in stock award
programmes
3
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Things to know
•
Grant
An offer by the company to the employees to participate in its
stock award programme
•
Vesting
The process by which the offer accrues to the employee for
acceptance
•
Exercise
An act by which the employee accepts the offer
•
Allotment
The stage where employee becomes the owner of the award
•
Offer price
Price payable by the employee upon exercise
4
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Things to know
•
In the money
Market value is higher than the exercise price
•
Out of the money
Market value is less than the exercise price
•
Dilutive schemes
Whereby the employees subscribe to the unissued
shares
•
Non-dilutive schemes Whereby existing shares are purchased and allotted to
the employees.
5
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
How stock awards operate
x
x
x
Grant
Vesting
Exercise
x
Allotment
x
Sale
•
Options granted to employees to buy specified number of shares
•
Vesting could be all at once or schemes may have varying vesting schedules
•
•
Price pre-determined at the time of grant is payable on exercise
•
•
6
40% in year 2, 30% in year 3 and 20% in year 4
In certain cases prices would be recovered from the monthly salary
Presence of lock-in period for transfer of shares after allotment.
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
How stock awards operate
Stock Appreciation Rights
•
•
•
Linked to the financial performance of the Company
No allotment of shares
On exercise, the employee is paid cash
Governing regulations
• Companies Act, 1956
• Securities Exchange Board of India Guidelines
• Foreign Exchange Management Act 1999
Compliance
• Accounting – guidance note on stock awards by ICAI
• Income-tax Act,1961
7
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Accounting overview
Accounting overview
•
Accounting for stock awards is governed by ICAI guidance note
•
Excess of fair market value (FMV) on grant date over exercise price to be
recognized as expense
•
The amount is to be expensed during the vesting period
•
FMV to be determined based on valuation techniques if market price on grant
date is not available
9
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Accounting overview
Number of Options
100
Date of grant
November 1, 2008
Vesting period
12 months
Exercise period
1 month
Allotment
Immediately on exercise
FMV of shares on the date of grant
`150
Exercise Price
0
Employer to expense
`15,000 over vesting period
Employer to expense during 08-09
Employer to expense during 09-10
`6,250
`8,750
10
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Tax issues – Corporate taxation
Corporate taxation
SSI Ltd. v. DCIT 2005 (85 TTJ 1049) (Chennai Tribunal)
•
SSI Ltd issued stock options to its employees
•
Difference of FMV on grant date and exercise price paid is deferred over vesting
period
•
Costs debited to profit & loss income and claimed as deduction
•
CIT directed under section 263 to disallow stock options costs by holding it as
contingent and notional in nature
•
SSI Ltd contended that charge to P&L is per SEBI guidelines and in line with
guidance note
•
Tribunal held in favor of SSI Ltd that the expenditure is not contingent in nature and
allowed deduction
12
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Corporate tax
Ranbaxy Laboratories Ltd v. DCIT 2009 (124 TTJ 771) (Delhi Tribunal)
•
The assessee charged the difference between the market price and the
issue price to the financial statements
•
The charge to its financial statements was deferred over the vesting period
(5 years)
•
Tribunal held that the charge to the financials is a notional expenditure
•
Tribunal distinguished the SSI Ltd decision on facts
•
Tribunal also held that Chennai tribunal deliberated whether the charge is
contingent or otherwise and not whether it is notional.
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Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Corporate tax
Circular No.9/2007 dated 20 December 2007 clarifies:
•
In case employer purchases shares and transfers to employees, the
expenditure is allowable as deduction
•
If the shares are allotted from the share capital of the company, no
deduction for expenditure is allowable
Stock awards resulting in payments by the
Company may not trigger deductibility issues
14
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Corporate tax
Transfer pricing
•
Stock awards costs recharge from/on group companies is an international
transaction
•
Recharge of costs to be reported in form 3CEB
•
Basis of costs allocation to be documented
•
Companies operating on “Cost plus mark up” to include stock awards costs
recharge
15
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Tax issues – employee taxation
Tax on stock awards – the law so far
•
Tax treatment of stock awards has undergone significant changes since its
introduction in 1999
Period
Scheme of taxation
1999-2000
Introduction of stock awards
Employees are taxed on exercise
April 1, 2000 – March 31,
2007
Stock awards classified into:
• Specified awards – i.e. awards filed with the CIT
• Other awards
Tax levied on the employee
April 1, 2007 - March 31, Fringe Benefit Tax (FBT) payable by employer
2009
April 1, 2009 onwards
17
Employee stock awards – Tax issues
Employee to pay tax in the year of allotment
©2010 Deloitte Haskins & Sells
Tax on stock awards – the law so far
x
x
x
Grant
Vesting
Exercise
•
•
18
x
Allotment
x
Sale
During 1999-2000 stock awards are taxed as perquisite in the hands of employee on
the date of exercise
‒
Exercise price minus FMV is taxable as salary in the year of exercise
‒
Sale price minus perquisites value is taxable as capital gains in the year of
transfer
W.e.f. April 1, 2000, incidence of taxation is deferred till sale for stock awards
covered by specific guidelines
‒
Where the scheme is filed with the Chief Commissioner of Income tax
‒
Capital gain taxes were payable only in the year of transfer
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Tax on stock awards – the law so far
Taxation during 1st April 2007 to March 31, 2009
•
Employer to pay fringe benefit tax (FBT) on allotment of stock awards
•
Stock awards which does not result in allotment such as stock appreciation
rights continued to be taxed as salary income
•
Circular clarified the methodology for determining FMV on the date of
vesting
•
Specific guidelines/provisions were in vogue on the following:
•
•
•
•
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Determination of FBT liability in case of mobile employees
Costs recharged on employees participating in group company stock awards
Allowing recovery of FBT from the employee
Employees reimbursing FBT liability to become eligible for foreign tax credits
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Stock awards taxation – scenario from 1st April 2009
•
Stock awards are considered as perquisites and taxable as a part of salary
income
•
Taxes are payable in the year in which shares are allotted to the employees
•
Difference between the FMV on date of exercise and exercise price is
considered as perquisites
•
Income tax rule 3 prescribe the procedure for determination of FMV:
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Listed securities
FMV determined by
Traded on one Indian stock exchange
Average of the opening and closing
price
Traded on more than one Indian stock
exchange
Average of the opening and closing
price on the stock exchange that
recorded highest trading
Not traded on date of exercise
Closing price of the share on a closest
date preceding the date of exercise
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Stock awards taxation – scenario from 1st April 2009
•
Securities not listed on Indian stock exchange or listed outside India
category-I merchant banker to determine FMV:
‒
‒
On date of exercise or
Any date not more than 180 days preceding the date of exercise
•
Onus is on employer to deduct tax in the year in which stocks are allotted
to the employees
•
Capital gains tax is payable by the employee at the time of sale
•
FMV will be considered as the cost of acquisition for computing capital gain
The existing system of taxation create cash crunch for employees as the
awards are taxable before the realization of benefits
21
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Stock awards taxation – scenario from 1st April 2009
S. No
22
Particulars
Remarks
1
Date of Grant
December 1, 2008
2
Date of Vesting
February 28, 2009
3
Date on which Employee exercises
March 1, 2009
4
Allotment of Shares (100 shares)
April 1, 2009
5
FMV on the date of exercise (`150)
`15,000
6
Exercise Price
Nil
7
Salary Income taxable for the year 20092010
`15,000
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Stock awards taxation – scenario from 1st April 2009
•
Addresses concerns on double taxation as mobile employees can now
access treaty benefits without ambiguity
•
No specific guidelines/clarifications in respect of mobile employees
•
Withholding tax compliance for employees participating in group company
stock awards poses a challenge to their employers
•
For computing capital gains FMV to be considered as cost of acquisition
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Particulars
Amount in `
FMV on exercise
90
Exercise price paid
120
Salary income
0
Sale price
200
Cost of acquisition
90 (though employee paid 120)
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Issues around mobile employees
Salary taxation of stock options for mobile employees
Country*
Event of taxation
Australia
Tax on grant – Standard scheme
Exercise – concessionary scheme
Austria
Exercise
Canada
On disposal of shares
Germany
Exercise
Italy
Tax on grant – standard scheme
Tax on sale – concessionary
Non-qualified stock options – exercise
US
Incentive stock options – on disposal
* Source: OECD report on tax policy studies – The taxation of
employee stock options
25
Employee stock awards – Tax issues
©2010 Deloitte Touche Tohmatsu India Private Limited
Taxation of stock options for mobile employees
•
The following issues are likely to arise:
• Timing mismatch in stock award income taxation
• Income mismatch i.e. whether salary or capital gains
• Difficult in determining to which services the stock awards relates
26
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Timing mismatch
•
Mr A, resident of country X, worked seven months in country Y.
•
Part of income of Mr A from Y includes stock awards which were granted on
March 31, 2006
•
Mr A exercised stock awards and was allotted shares during 2009-10 financial
year (FY)
•
X country taxes stock awards in the year of allotment
•
Y country taxes stock awards in the year of grant
•
Mr A to pay tax on stock income in country X during 2009-10 and Y during
2005-06
27
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Timing mismatch
•
Timing of taxation of stock awards may vary between resident country and
source country
‒
For example – resident country may tax on exercise whereas source
country may tax at a different time
•
Model tax conventions and tax treaties require resident country to grant
relief/exemption for taxes paid in source country
•
Per article 23A/23B of OECD, relief to be granted regardless of when the tax is
levied by the source country
•
If X-Y tax treaty is per OECD, then, country X to grant relief for taxes paid in Y
•
Some of the Indian treaties are not in line with OECD on Article 23A/23B
‒
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Employee to approach competent authorities for a resolution
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Issues in income classification – salary vis-à-vis capital gain
•
Double taxation or non-taxation can arise when a country treats stock awards
as capital gain
•
Income from date of grant to date of vest be regarded as salary income
•
OECD advocates income from date of grant to date of exercise as salary
income
‒
Section 17 is in line with the above.
•
Gains that arise after exercise till sale are capital gains
•
In case of levered awards, gains till the end of leverage is to be regarded as
salary income
29
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Attributing option income to services rendered
•
Mr A an employee of X Ltd. A and X Ltd are residents of Country X
•
On 1st April 2007, X Ltd granted stock options to A
•
Option to vest in 3 years
•
Mr A was deputed for 8 months from 1st November 2007 to work in Country Y
•
For 3 months 1st August 2008 he was deputed to Country Z
•
Mr A returned to country X on November 1, 2008 and continued with X Ltd till
March 31, 2010
•
X Ltd has Permanent Establishments in Country Y and Country Z
•
What is the income that is taxable in each of these countries?
30
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Attributing option income to services rendered
•
Country X will tax the entire salary income of Mr. A
•
In terms of OECD salary income for services rendered in in country Y and
Country Z are taxable therein.
•
India in line with OECD
•
If India is the source country, the above is adhered by section 9(1)(ii)
31
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
Take away
•
Terminology used by companies to describe their stock awards may not reflect
how it operates
‒
•
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For taxation how it operates is important
Always remember the basics – Residential status & scope of taxation
Employee stock awards – Tax issues
©2010 Deloitte Haskins & Sells
33
© 2010 Deloitte Haskins & Sells