INDIA BUSINESS WORLD - FEBRUARY 2007
The Month that was ...

FBT ON ESOPS TO HIT WHERE IT HURTS MOST

This Year, The FM May not have done justice to his reformist image. But he hasn't missed out on the chance to garner Rs 3,000 crore for the exchequer. At a time when corporate tax collections are on a roll Rs 13,487 crore more than the budgeted amount there are many who would question the need for imposing a higher tax burden. Consider the evidence: if you exclude all the exemptions, the tax rate for corporates, inclusive of all taxes, works out to 44%, far higher than the Asean levels. The government's contention is that the effective tax rate is just 19% against the statutory rate of 33.99%.

The FM has chosen to go soft on knocking off exemptions, perhaps to avoid upsetting any constituency. Instead, he has decided to bring the untaxed into the tax net the $30-b IT-ITeS industry, and export oriented units have to now pay a minimum alternate tax (MAT) on 10% of their book profits. The idea is to bring a sector nurtured with fiscal sops for a long time, into the tax net. However, small and medium IT companies will feel the pinch more.

"The move shows that the government is not in a mood to extend the tax holiday for companies housed in software technology parks beyond 2009," according to Sunil Kapadia, tax partner, E&Y.

The other big blow is that all companies will have to cough up a 30% fringe benefit tax (FBT) on the gains accruing on Esops. So Esops as a perk to retain talent may lose sheen.

The existing tax regime has turned grimmer with the proposed hike in dividend distribution tax from 12.5% to 15%.

"The increase in dividend distribution tax could have been moderated. Bringing Esops under the FBT ambit is retrograde as it was a major employee attraction and retention tool. Taxation brings in a degree of complexity. MAT on companies enjoying a tax holiday under sections 10A/10B of the Income-Tax Act is an unpleasant surprise. It reduces confidence in the regulatory regime while taking investment decisions. The Budget is negative for the IT industry," says V Balakrishnan, CFO, Infosys.

In fact, India Inc expected the 10% surcharge to go. Instead, only 12 lakh firms with a taxable income of up to Rs 1 crore have been spared from the surcharge. Not to mention the the extra 1% cess to fund secondary and higher education.

Perhaps, the FM is playing a waiting game. He has in fact extended deadlines for major exemptions and introduced new ones as well. Corporate tax exemptions will cost the government Rs 50,075 crore in 2006-07. If tax collections continue to remain buoyant, he might have headroom to trim tax rates next time around.

IT COMPANIES will find it hard to retain talent now. That is, whenever the Employee Stock Options (Esops) issued by them are converted into shares, they will have to pay a fringe benefit tax (FBT) on it. Knowledge industries such as IT, biotech and pharmaceuticals will be the worst-hit. Gains from Esops will be taxed at 33.99%. So when Infosys issues an option at Rs 10 to an employee and a year later he converts it into a share at Rs 200, then Infosys will have to pay a tax of 33.99% of Rs 190, which is the gain in the Esop.

Esops have emerged as a critical retention tool for companies in a market where nothing money, job profiles, brand name seems to be working. According to estimates, over 90% of IT companies make use of the tool. But nobody expects Esops to lose appeal. "It's just that the returns employees expect from Esops will rise.

The FBT will be imposed on employers, but most companies said the clauses in the contract will allow them to pass it on to employees. Most executives called it a retrograde step.