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November 28, 1997


Taxing options

Is the employees stock option scheme taxable? Yes, says
the I-T Department. No, says Infosys Technologies.

The employees stock option plan of Infosys Technologies Limited has raised fresh doubts about the taxability of such schemes.

The Income-Tax Department, Karnataka and Goa circle, has now sought clarifications from the Central Board of Direct Taxes.

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The issue gains significance because Indian software majors have just begun to use stock options to retain valuable programming talent.

The Infosys stock option plan gives its employees a right to subscribe to its shares. The Income-Tax Department claims these are taxable. Infosys maintains they are not.

The points of dispute between the I-T Department and the company relate to:

  • Whether the employees stock option plan is taxable;
  • If it is taxable; at what point;
  • What is the value that is taxable;
  • And under which section of the I-T Act is it taxable.
Infosys is basing its argument with the I-T Department on a CBDT circular concerning taxability of perquisite on shares issued to employees at less than market price.

The relevant CBDT notification was made vide circular 'no 710' on July 24, 1995. It says that where shares have been offered only to employees, the value of perquisite will be the difference between the market price of the shares on the date of acceptance of the offer by the employees and the price at which the shares have been offered.

The circular says such a benefit amounts to a perquisite within the meaning of Section 17(2)(iii) of the I-T Act, 1961.

Infosys, under its stock option plan, issues warrants to employees deemed eligible by the advisory board constituted for the purpose.

As of date, 349,000 warrants have been issued by the company to Infosys Technologies Limited Employees Welfare Trust. These are to be held in trust and transferred to selected employees.

The warrants, issued at Re 1 each, entitle the holders to apply for and be issued one share of the company at a price of Rs 100 during a period of five years from the date of issue.

However, the warrants and the shares to be issued thereon are subject to a lock-in period of five years from the date of the warrants' issue.

According to Infosys, the warrant gives only an uncertain and conditional right and the conditions may, or may not, be fulfilled. Even if the warrants get converted into shares, the uncertainty remains. Hence, the warrant or the share cannot be treated as an amenity.

Further, the company has pointed out to the I-T Department that there is no direct employer-employee relationship in this case as the stock option plan is administered through a trust.

Incidentally, it may be noted that the trust is yet to be granted registration from the I-T Department. Its application for registration of the trust is pending before the department.

Citing that as per Section 17(2)(iii) of the I-T Act, perquisite is something given by an employer to an employee, Infosys has argued that the warrants are transferred by the employees trust which is not the "employer''.

Further, the company points out that the warrants/shares are not transferable and the employee does not have physical custody as on the date of offer.

The employee becomes fully entitled to it only upon the happening of "future uncertain conditions''. In such a circumstance, the market value is the value at which the trust can buy back the share as per the scheme.

Hence, there is no question of any difference between the offer price and the market price.

The company has contended that Section 17(2)(iii) of the I-T Act states that a perquisite is something given by an employer to an employee. In the case of Infosys, the warrants are transferred by the employees' trust, which is not the employer.

Moreover, the words "whether directly or through a fund'', appearing in Section 17(2), are conspicuous by their absence in Section 17(2)(iii). Thus, an amenity to an employee through a fund would be outside the ambit of Section 17(2)(iii).

However, as per the I-T Department, the value of the share at the time of conversion of warrants into shares by an employee should be treated as the market value for the purpose of calculating tax.

Further, the I-T Department argues that "but for the lock-in period, the employee enjoys all other benefits and rights of a shareholder''.

The department is now alleging that the trust has been formed with the sole purpose of avoiding the employer-employee relationship between Infosys and those coming under its stock option plan so that the scheme falls outside the ambit of Section 17(2)(iii).

- Compiled from the Indian media

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