ESOP - Accounting, Tax and Valuation Aspects Finger on ESOP Pulse - PowerPoint PPT Presentation

ESOP - Accounting, Tax and Valuation Aspects “Finger on ESOP Pulse” Accounting Tax 1

Contents Particulars ESOP Overview Planning and Strategy Implementation Financial aspects of ESOP Key Driver of ESOP • Accounting • Tax • Valuation 2

ESOP Overview 3

ESOP  Flexible financial and equity incentive instrument  Compensation tool  Rewarding Existing Employees and attracting new Talent “The flowers of tomorrow are in the today’s seeds” 4

Planning and Strategy

Stages in Deciding ESOP Plan Thinking Like Owners  Valuation of Company  Discount Offered  Tax Implications  Accounting Compensation cost  Regulatory implications viz, Company Law, SEBI regulation, Just FEMA regulations, Income Tax another Investment  Shareholding Dilution Plan  Industry Practice  No. of shares to offer  Administrative aspect 6

Implementation 7

Stages in Implementation of ESOP Plan Commercial Legal Financial Section -45 read Exit Calculation of Lock in Sale with Section – Capital Gain 49(2AA) of Income Period Tax Act, 1961 Section -17 (2)(vi) Perquisite Inflow of Funds Exercise Income Tax Act, Valuation Exercise 1961 read with Period Rule 3(8)(i) of Income Tax Rules Amortization of 1962 Compensation Vesting Cost Vesting Book of Period Generation of Compensation Accounting cost – SEBI Grant Future Cash Valuation Flows (ESOS and ESPS Guidelines), 1999 Formulation of Compliance to Formulation of Incentive Strategy to Companies Act Plan Compensate and SEBI Employees Guidelines 8

Financial Aspects of ESOP Tax Accounting 9

Accounting Perspective 10

Accounting aspect of ESOP in India Stages Tax Treatment Grant of Options  Valuation is required to amortize the Employee Compensation Cost during the vesting period;  Graded Vesting : Each vest consider as a separate grant;  Straight Line Accounting : Amortization of Employee Compensation cost on time proportionate basis  In case of lapse of unvested / Vested option , the accounting to be reversed

ESOP Accounting APPLICABLE LAW International GAAP INDIA: US GAAP IFRS 2: SEBI (ESOS and ESPS) Guidelines, 1999 SFAS 123 (Revised): ICAI Guidance Note Share Based Payment Fair Value Method Intrinsic Value method allowed with Fair Value Method Mandatory disclosure as per Fair Value Method Mandatory To determine the compensation cost which is required to be amortized over the vesting period and detailed disclosure regarding option statistics including disclosure of stock option compensation cost computed by applying Fair value method and impact of non recognition of Fair Value compensation cost on basic and diluted EPS.

Tax Perspective

Tax Implications of ESOP in India Stages Tax Treatment Grant of Options Nil Vesting of Options Nil till Exercised Exercise of Options Taxed as perquisite in the hands of Employees which is computed as the difference between the FMV of the share on the date of exercise and the exercise price. The employer is required to withhold tax at source in respect of such perquisite. Sale of Options The incremental gain (i.e. difference between sale consideration and the FMV on the date of exercise ), on sale of shares is considered a capital gain for the employee. For computing capital gains, the FMV on the date of exercise becomes the cost base. During the period April 2007 to March 2009, employer was required to pay Fringe Benefit Tax (FBT) on benefit derived by employee from ESOPs. The employer was allowed to recover such FBT from the employees. After FBT has been abolished benefits under ESOP taxed as perquisites in the hands of employees

Key Driver of ESOP ESOP Valuation Accounting Tax

ESOP Valuation Valuation Accounting Tax Listed Company on Intrinsic Value Fair Value Recognized Stock Unlisted Company Exchange Average of Opening Market Price and Closing Market No Method has been (-) Option Pricing Model Price prescribed Exercise Price On Exercise Date Shares of foreign companies listed on Intrinsic Value method allowed with foreign stock exchange are regarded as disclosure as per Fair Value Method unlisted shares

Intrinsic Value Intrinsic Value” is the excess of the market price of the share under ESOP over the exercise price of the Option (including upfront payment, if any) Suppose : Current Market Price is Rs 100 Exercise price is Rs 70 Then Intrinsic Value is Rs 30 However if the CMP was Rs.50 instead, there would be no intrinsic value of the option since the exercise price is more than CMP and in this case options could not be exercised and instead stand lapsed

Fair Value Method – Black Scholes Method Under this methodology we shall be calculating the call price of options and this basically calculates the compensation cost. The benefit of this model is takes into consideration the factors like volatility, dividend yield ,Risk free rate and expected life of options. Suppose : Exercise price is Rs 100 Fair Value per share Rs 200 Volatility 10% Dividend yield zero Risk Free rate 8.76 % Expected life of option 3 Years Differential value or value of perquisite is = Rs 200- 100 = Rs 100 in normal parlance. However when we use the black scholes calculator the value that shall be coming to Rs 123 which is the compensation cost or loss to a company which it shall be booked on a notional basis in its books of account.

ESOP Tax APPLICABLE LAW: Income Tax Act – 1961 and Notification no. 94/2009 dated 18.12.2009 issued by CBDT To determine the value of perquisite taxable in hands of employees Particulars Listed on Recognized Stock Exchange Unlisted Company Situation Market Price on Exercise Market Price on Exercise Date is available Date is Not available Method of Average of Opening and Latest Closing Price of the No Method has been Valuation Closing Price of the share on share immediately Prescribed the Exercise Date preceding the Exercise Date SEBI Registered Category – I Valuer Merchant Banker 19

Valuation guidelines under erstwhile FBT regime  Shares of foreign companies listed on foreign stock exchange are regarded as unlisted shares  Foreign company shares to be valued by SEBI registered Category I Merchant Banker (“MB”)  Listed price of foreign company may be considered by MB as one of the basis for valuation  MB to determine the value on the basis of alternative methods and recommend the most appropriate value  Shares with multi-vesting dates allotted at one shot, with total shares allotted are less than the shares vested - Follow FIFO method  Valuation may be carried out anytime as long as specified security is valued on the specified date  Valuation by more than one MBs - the value on the date closest to the vesting date to be considered *  Valuation by a MB on different occasions - the value on the date closest to the vesting date to be considered *  No FBT if value on the date of vesting is less than the exercise price *  Assessing Officer is bound by valuation unless the valuation is perverse *(at the time of FBT vesting date was relevant)

Grey Area ESOP cost is tax deductible for company ?? Recently in July 2013, the Special Bench of the Bangalore Income High Court of Madras Tax Tribunal in the case of Biocon (HC) in the case of PVP Ventures Limited held that discount on Ltd. (Taxpayer) [TC(A) No. 1023 of issue of ESOP is deductible 2005] held that there was no error business expenditure. in Tribunal’s ruling which held that ESOP cost was allowable as expenditure as the Taxpayer had debited ESOP cost to profit and loss account (P&L) as per the directions of Securities and Exchange Board of India (SEBI).

ESOP Valuation Vs Equity Valuation 22

Discounts in ESOP Valuation Discounts & Premiums come into picture when there exist difference between the subject being valued and the Methodologies applied. As this can translate control value to non-control and vise versa , so these should be judiciously applied. – Impact on entity as a whole • Discount for Entity Level  Key Person Discount Global Studies over the years on diversified  Discount for Contingent Liability companies and holding companies has shown  Discount for diversified company that companies trade at a discount in the range  Discount for Holding Company of 20%. to 40% each.  Tax Payout • Discount for Shareholders Level – Impact on specific ownership interest  Discount Lack of Control (DLOC)  Discount Lack of Marketability (DLOM) • % stake & special rights DLOM: As per CCI Guidelines, 15% • Size of distribution or dividends discount has been prescribed; however • Dispute practically DLOM and DLOC depends upon • Revenue / Earning – Growth / Stability following factors: • Private Company • Shareholders Agreement caveats

Tricky Issues