India: Fringe benefit tax of stock awards replaced by income tax

India’s lower house of Parliament recently passed a finance bill which would abolish fringe benefit tax treatment of certain stock awards in favor of income tax treatment.

If these changes are implemented, the tax treatment of stock awards offered in India would change and the corresponding tax burden would shift from the employer back to the employee.

The enactment of the finance bill is expected to pass the upper house of Parliament and be signed into law by the president later this month. A brief summary of the details of the bill in its current form follows.

Taxation of Stock Options

Prior to April 1, 2009: Fringe Benefit Tax

Stock options exercised prior to April 1, 2009 were subject to fringe benefit taxes payable by the employer upon exercise.

The fringe benefit taxes were calculated based on the difference between the fair value of the underlying shares on the date of vesting and the grant price.

The cost basis for capital gains, due upon sale of the shares, was the fair market value of the underlying shares on the date of vesting.

From April 1, 2009: Income Tax

Stock options exercised on or after April 1, 2009 are subject to “perquisite” tax (i.e., treated as salary income) payable upon exercise by the employee.

The taxes are calculated based on the difference between the fair market value of the underlying shares on the date of exercise and the grant price.

The Indian employer is required to withhold and remit applicable taxes to the tax authorities within seven days from the date of salary payment in the month the exercise occurred.

No social insurances apply to the taxable amounts.

The cost basis for capital gains, due upon sale of the shares, is the fair market value of the underlying shares on the date of exercise.

Method for Determining Fair Market Value Remains Unclear

Under fringe benefit tax treatment, an India-licensed Category I merchant was required to determine the “fair market value” of shares of private companies or companies listed outside India.

However, under the new income tax treatment of stock awards, it remains unclear how the fair market value of shares of private companies or companies listed outside India will be determined. Further clarification on this point is eagerly anticipated.

We have prepared a series of Global Equity Desk Reference Guides designed to help multinational companies implement their equity compensation programs.

*Dean Fealk is chair of DLA Piper’s Global Equity and Human Capital group, based in San Francisco. Sang Kim  is a partner in DLA Piper’s International Tax practice, based in Silicon Valley.  S. R. Gopalan is a financial advisor at Dawn Consulting, based in Bangalore, India.