Sucheta Dalal :Centre should ponder over the irksome FBT
Sucheta Dalal

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Centre should ponder over the irksome FBT  

Mar 26, 2007

On the 10th anniversary of what was billed the dream budget, the devil in the details continue to confound different sections of industry, not merely steel and cement manufacturers. Meanwhile, the middle class is fuming at rising local and central taxes, levies, tariffs as well as lack of infrastructure (read sadak, bijli and paani); the poor (read aam admi) are battling inflation for two square meals and suicidal farmers are either fighting off the debt trap or struggling to keep their land safe from various state governments who want to give it away to rich industrialists for their Special Economic Zones (SEZ).

In this environment of discontent, one believed that the thriving, well-paid and completely tax-free Information Technology (IT) sector has less to complain about, even though companies will have to pay the hated Fringe Benefit Tax (FBT) on Employee Stock Options (ESOP) at the time they are exercised. Apparently, the IT sector is also desperately harried. The head of a recently listed company told me, “If all my employees decided to exercise their ESOPs (Employee Stock Option Plans) around the same time, my entire profit will be wiped out in paying FBT. The industry has already made a representation to the finance minister for reconsideration of the tax.

Essentially, the government has decided to apply FBT to the spread on stock options at the date of exercise. As Sridar Iyengar, former chairman of KPMG India and now independent venture capitalist has argued in a column, “No one seriously believes, even in Silicon Valley, that stock options are NOT for services and therefore prima facie they are a component of overall compensation. So, yes, some form of taxation is appropriate. But what should be the amount of the attributed income, who is the taxpayer, what tax regime it falls under — income, capital gain — its timing, calculation and amount should all be carefully considered before proposing the tax”. But the government has gone ahead and proposed the tax and kept the industry on tenterhooks while it figures out the rules, their consequences and application.

What is evident on the face of it, is that IT companies may even end up paying FBT on account of employees who are no longer in their employment, because the tax becomes payable only when the stock option is exercised. Also, ESOPs are given in lieu of wages, but they are not tax deductible although wages are. Worse, since companies have no way of predicting how their share price will perform, they have no way of planning for the incidence of tax when the ESOPs are exercised. These are just a few of the serious flaws in the application FBT to ESOPs.

Curiously, however, unlike cement and steel company stocks, IT shares have not been rocked in the post-budget market turbulence, with every new interpretation of the implication of the tax on ESOPs. Maybe investors have not quite understood the tax implications or believe that the industry will be able to persuade the FM to change the rules.

It could well be a false hope. After all, the FM has persisted with the draconian and illogical FBT, which is really an expenditure tax in the garb of an income tax. The government is hell bent on gouging this ‘tax’, whether or not a company has earned a profit. In fact, even a year after it was introduced, the finance minister has neither sympathy nor understanding for the problems of smaller companies as regards the FBT.

Meanwhile, the growing liquidity squeeze has dealt them a further blow in the form of rising interest rates. In comparison, the IT industry has been having such an easy ride in relation to taxation, that it is seriously irking a host of other businesses who believe that their contribution to the nation is no less significant that the software sector. So, no matter how valid its arguments, it is difficult to predict that the IT industry has a better chance of convincing the FM to rollback his proposals. Logic dictates that employees, who benefit from ESOPs and choose when to cash them in, would be willing to pay a reasonable tax on their gains.

But as we pointed out, logic is hardly the basis of introducing FBT in a fast growing economy that is starved of employable people. The domestic venture capital (VC) industry is another that is seriously upset at the budget. In a representation to the government they have pleaded against the amendment to restrict the pass-through benefit to Indian venture capital companies only to income received from a specified list of industries. The change virtually cripples the domestic VC industry because those wishing to invest outside the specified list will not be able to raise funds. At the same time the exchequer will earn very little revenue because foreign funds, which account for 90 per cent of the investments, are unaffected by the budget provisions. It means that the government has chosen to hurt the growth and development of the domestic VC industry, without even the justification of collecting significant tax revenue.

This, as they point out, is especially unfair because the mutual funds enjoy blanket pass through, although they risk retail investors’ money and have a much shorter investment horizon. So, in the end, astounding as it may seem, a supposed progressive and liberal FM has hit at the most enterprising and wealth-creating parts of the economy, whether in the manufacturing sector that is coming out of deep recession or in services which is India’s growth engine. And all this while proclaiming that there are hardly any change in taxes in this budget.

-- Sucheta Dalal