Guest Post — Valuation of Sweat Equity Shares As a Perquisite In the Hands Of the Employee

by Vinaya HS on October 3, 2012

in Finance

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The following is a guest post by Mr. Aashish Ramchand. Aashish is a Chartered Accountant by qualification and the co-founder of makemyreturns.com, an online tax advisory and filing site. He is very passionate about Indian taxes and loves to write articles about the Indian tax system. He has worked with KPMG and JRC advisory both in international and domestic taxation respectively. His cumulative experience in taxation is 5-years. He has also completed Level 1 of CFA (USA) exam. If you need to connect with Aashish you can reach him at aashish@makemyreturns.com. You can also follow him on twitter through the handle @aashishjr.

I’m personally interested in the topic of ESOP (Employee Stock Option Plans) Valuation and Taxation since D has this option at work and we’re actively participating. I’d been meaning to read-up on this topic when luckily for me Aashish was kind enough to write-up a whole guest post on this topic. Aashish has also kindly agreed to answer any questions that you may have through the comments section below. So, feel free to ask your questions, clarifications, and doubts on this topic through the comments section on this post.

Now, over to Aashish.

Sweat Equity SharesProvisions with respect to valuation of sweat equity shares as a perquisite in the hands of an employee.

Sweat equity shares means “equity shares issued by a company to its employees or directors at a discount or for a consideration other than cash for providing know-how or making available rights in the nature of intellectual property rights or value additions by whatever named called. These sweat equity shares must be transferred on or after April 1 2009. If these securities were transferred during April 1 2007 and March 31, 2009, then the employer is liable to pay fringe benefit tax. As mentioned above these shares are allotted directly either or indirectly by the employer to the employee either free of cost or at a concessional rate.

If the above mentioned provisions are satisfied, the perquisite will be chargeable to tax in the hands of the employee in the assessment year relevant to the previous year in which shares or securities are allotted to the employee For the purpose of valuation of the perquisite one has to find out the fair market value of shares. The fair market value of the shares will be calculated on the date on which the employee exercises the option. Amount actually recovered from the employee in respect of the shares shall be deducted.

In case where on the date of exercising the option, the share in the company is listed on a recognized stock exchange in India, the fair market value shall be the average of the opening price and the closing price of the share on that date on the said stock exchange. When however on the date of exercising the option, the share is listed on more than one recognized stock exchange, the fair market value shall be the average of opening price and closing price of the share on the recognized stock exchange which records the highest volume of trading of the shares. Where on the date of exercising the option, there is no trading in the share on any recognized stock exchange in India; the fair market value shall be the closing price of the share on any recognized stock exchange on a date closest to the date of exercise of the option and immediately preceding such date.

In a case where on the date of exercise of option, the share in the company is not listed on a recognized stock exchange in India, the fair market value shall be such value of the share in the company as determined by a merchant banker on the specified date. Specified date means date of exercise of option or any date earlier than the date of exercise of option not being a date which is more than 180 days earlier than the date of exercise of option.

Let me explain the entire concept by means of an illustration (click on the image if you need to see a larger version) —

Image of ESOP grant illustration

In the above illustration, perquisite will be taxable in the hands of Mr. Mark, as shares are allotted on or after April 1, 2009. The value of the perquisite will be Rs. 2, 68, 000 i.e. 400 shares x 670 [700-30(being pre-determined price)]. The cost of acquisition in the hands of Mr. Mark for the purpose of determining capital gain at the time of transfer of these shares will be Rs. 700 per share i.e. the fair market value on the date of exercise of option.

A quick reminder — Aashish has kindly agreed to answer any questions that you may have through the comments section below. So, feel free to ask your questions, clarifications, and doubts on this topic through the comments section on this post.

And to wrap-up, a quick note about Make My Returns

Make My Returns is the brainchild of three entrepreneurs with vast experience in the internet and tax domain specifically in income tax returns and income tax efiling space. We are a team of young, enthusiastic guys who want to make taxes that much easier for everyone else. Our core product offering through Make My Returns is a simple and easy income tax efiling service for online filing of income tax in India. Efiling of income tax returns online has never been more simpler and stress-free. We have different packages to suit your needs like do it yourself, expert help and also a specific online income tax return package for NRIs.




Thanks for reading this article. I'd love to hear your opinion. Please use the comments section below to share your thoughts. I frequently write new articles that also cover several other aspects of personal finance including credit cards, financial goals, health insurance, income tax, life insurance, mutual funds, retirement planning, and much more. You can Subscribe through Email and receive new articles directly in your Inbox or you can Subscribe through the RSS Feed and receive new articles in your feed reader.

{ 6 comments… read them below or add one }

Ravi October 3, 2012 at 12:55 PM

Can you also explain how capital gains are calculated on the same.

Vinaya HS October 3, 2012 at 4:00 PM

@Ravi –

Will forward your query to Aashish.

Sridhar October 8, 2012 at 8:17 PM

I own a few options in a private (unlisted) Silicon Valley startup with office in Bangalore. Because there has been a jump in the FMV of the company, exercising my options would mean paying substantial perquisite tax – many times more than the strike price ! And because it is an unlisted company – I’d be paying tax for an asset whose value can possibly go down all the way to zero !

I read on some website a while ago that perquisite tax doesn’t have to be paid if an employee exercises the options after quitting the company. Other websites don’t say anything of this sort. What is the true picture ? Is there a way to exercise options without paying perquisite tax ?

I don’t mind taxation of actual capital gained – from strike price of option to sell price of shares, but paying lakhs of rupeers of perquisite tax for shares of a company that may not get acquired at all and lose all its value – seems a bit ridiculous.

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