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ACCOUNTING
ASPECT OF ESOPS
Meaning
ESOPs refer to various schemes
of offering an equity stake by a Company to its employees. The stake may be
in various forms such as allotment of shares, grant of stock options that
entitle the employee to acquire shares in the future, or simply by way of rewarding
an employee based on the appreciation in the value of the shares
Objectives and
benefits
The objectives may vary from the
circumstances and requirements of each case and may include any of the
following:–
- Incentive to employees to
work for the prosperity and thereby enrich themselves also.
- Incentive to the employee
to continue with the Company for a minimum period of time (thus, ESOPs
are used as "golden handcuffs").
- Reward for past
performance.
- Partial avoidance of
immediate cash outflow for the Company on accounts of salary.
Explanation of some
types of ESOPs
- Under Stock Option
Schemes, the Company grants an option to employees to apply for the
shares of the Company during a specified period of time at a price that
is either pre-determined or is to be determined at an agreed formula.
- Under Share Purchase
Schemes (ESPS), the company offers shares to employees which are
allotted against payment of offer price.
- Under a scheme of Stock
Appreciation Rights, employees are paid the appreciation in the
price or value of the shares from the point of grant to the exercise
date.
There can be numerous other
types of scheme and their variants.
Aspects to be
considered in the process of setting up and implementing an ESOPs scheme
- Ensuring adequate reward
linked with performance.
- Compliance with SEBI
guidelines, where applicable.
- Ensuring optimal tax
treatment for employer and the employee.
- Proper accounting and
disclosure.
Tax aspects
From A. Y. 2001-02
up to A.Y. 2007-08 (see proviso to S. 17(2)(iii), S. 47 (iii) and
fourth proviso to S. 48 of the Income-tax Act, 1961)
- ESOPs are not taxed at the
time of grant or exercise. As per proviso to S. 17(2)(iii), value of
benefit arising out of allotment of shares, warrants or debentures free
of cost or at concessional rate under a scheme of stock options in
accordance with guidelines issued by the Central Govt. is not treated as
perquisite.
- Transfer under a gift or
irrevocable trust of shares, warrants or debentures allotted under a
scheme of stock options would attract capital gains. The market value of
such shares, etc. would be treated as full value of consideration of
such transfer.
From A. Y. 2008-09
up to A.Y. 2009-10, the ESOPs are subjected to FBT:
- ESOPs are subject to Fringe
Benefit Tax (FBT) at the time of allotment or transfer of shares on the
excess of fair value as on the date of vesting and the Exercise Price
[S. 115WB(1)(d), S. 115WC(1)(ba)];
- The value on which the
Employer pays FBT is treated as cost of acquisition in the hands of the
Employee [S. 49(2AB)]; and
- The Employer can recover
FBT from the Employee if scheme is suitably modified and the recovery of
fringe benefit tax is deemed to be the tax paid by such Employee in
relation to value of fringe benefits provided to him. However, the
employee is not be entitled for any refund out of such deemed payment of
tax and is also not be entitled to claim any credit of such deemed
payment of tax against tax liability on other income or against any
other tax liability [S. 115WKA, S. 115WKB].
Further, Rule 40C and Rule 40D
have been prescribed for valuation of specified security being an equity
share and specified security not being an equity share in a company
respectively.
Valuation of shares
of a listed company
- Where the share in the
company is listed on a recognized stock exchange on the date of the
vesting of the option, the fair market value will be the average of the
opening price and closing price of the share on that date on the said
stock exchange.
- Where the share is listed
on more than one recognized stock exchanges on the date of vesting of
the option, the fair market value will be the average of opening price
and closing price of the share on the recognized stock exchange which records
the highest volume of trading in the share.
- In case, on the date of
vesting of the option, there is no trading in the share on any
recognized stock exchange, the fair market value will be the closing
price of the share on any recognized stock exchange on a date closest to
the date of vesting of the option and immediately preceding such date.
Valuation of shares
of an unlisted company or specified security not being an equity share
- Where the share in the
company is not listed on a recognized stock exchange on the date of
vesting of the option, the fair market value will be such value of the
share in the company as determined by a merchant banker on the specified
date. Similarly, the fair market value of a specified security not being
an equity share in a company will be such value of the share in the
company as determined by a merchant banker on the specified date.
Further, the CBDT has issued
explanatory circular on FBT vide Circular No.9/2007 dated 20-12-2007 that
gives following illustration besides providing answers to 25 Frequently Asked
Questions (FAQs):
Illustration: A company X grants
option to its employee R on 1st April, 2004 to apply for 100 shares of the
company at a pre-determined price of Rs. 50/- per share with date of vesting
of the option being 1st April, 2006 and exercise period being 1st April, 2006
to 31st March, 2010.
Employee R exercises his option
on 31st March, 2007 and shares are allotted/transferred to him on 3rd April,
2007. On 25th October, 2007 these shares are sold for Rs. 200 each. On the
date of vesting of the option, fair market value of the share was Rs. 80 per
share. The tax implication of above situation will be as under:-
Since shares are allotted or
transferred on or after 1st April, 2007, provision of fringe benefit tax are
attracted. Fringe benefit with respect to employee R is (Rs. 80 – Rs. 50) x
100 = Rs. 3,000.
Company X will pay fringe
benefit tax on Rs. 3,000.
Cost of acquisition in the hand
of employee R = Rs. 80 per share
Capital gain = (Rs. 200 Rs. 80)
X 100 = Rs. 12,000
Period of holding = 3rd April,
2007 to 25th October, 2007 i.e., less than 12 months. Hence, the amount of
Rs. 12,000 will be charged to short term capital gain.
From A. Y. 2010-11
onwards, the ESOPs are again subject to tax in the hands of the employee as
perquisite:
- Section 17(2)(vi) provides
that the value of any specified security including ESOP or Sweat equity
shares allotted or transferred, directly or indirectly, by the employer
or former employer, free of cost or at concessional rate will be taxed
as perquisites in the hands of the employee receiving such benefit.
- Explanation (c) to Section
17(2)(vi) provides that the perquisite value of specified security
including ESOP or Sweat equity shares shall be the fair market value on
the date on which the option is exercised by the employee as reduced by
the amount actually paid by, or recovered from such employee.
- Explanation (d) to Section
17(2)(vi) provides that the fair market value to mean the value to be
determined in accordance the method as may be prescribed.
Further, as per Income-Tax
(Thirteenth Amendment) Rules, 2009 notified vide Notification No.
94/2009 dated December 18, 2009, rule 3(8) prescribes the following to
determine fair market value of specified security or sweat equity share:
- In a case where, on the
date of the exercising of the option, the share in the company is listed
on a recognized stock exchange, the fair market value shall be the
average of the opening price and closing price of the share on that date
on the said stock exchange
- Where, on the date of
exercising of the option, the share is listed on more than one
recognized stock exchanges, the fair market value shall be the average
of opening price and closing price of the share on the recognised stock
exchange which records the highest volume of trading in the share
- Where, on the date of
exercising of the option, there is no trading in the share on any
recognized stock exchange, the fair market value shall be—
a. the closing price of the share on any recognised
stock exchange on a date closest to the date of exercising of the option and
immediately preceding such date; or
b. the closing price of the share on a recognised
stock exchange, which records the highest volume of trading in such share, if
the closing price, as on the date closest to the date of exercising of the
option and immediately preceding such date, is recorded on more than one
recognized stock exchange.
- Where, on the date of exercising
of the option, the share in the company is not listed on a recognised
stock exchange, the fair market value shall be such value of the share
in the company as determined by a merchant banker on the specified date.
Accounting
treatment
a. For ESOPs
The SEBI guidelines require
accounting treatment for ESOPs in accordance with the following illustration
:
Suppose a company grants 500
options on 1-4-1999 at Rs. 40 when the market price is Rs. 160, the vesting
period is two and a half years, the maximum exercise period is one year. Also
suppose that 150 unvested options lapse on 1-5-2001, 300 options are
exercised on 30-6-2002 and 50 vested options lapse at the end of the exercise
period. The accounting value of the option being :
500 x (160-40) = 500 x 120 =
60,000
The accounting entries would be
as follows :
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1-4-1999
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Deferred Employee Compensation Expense Employee Stock
Options Outstanding (Grant of 500 options at a discount of Rs. 120 each)
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60,000
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60,000
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31-3-2000
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Employee Compensation Expense Deferred Employee
Compensation Expense (Amortisation of the deferred compensation over two
and a half years on straight-line basis)
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24,000
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24,000
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31-3-2001
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Employee Compensation Expense Deferred Employee
Compensation Expense (Amortisation of the deferred compensation over two
and a half years on straight-line basis)
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24,000
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24,000
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1-5-2001
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Employee Stock Options Outstanding Employee
Compensation Expense Deferred Employee Compensation Expense
(Reversal of compensation accounting on lapse of 150 unvested options)
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18,000
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14,400
3,600
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31-3-2002
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Employee Compensation Expense Deferred Employee
Compensation Expense (Amortisation of the deferred compensation over
two and a half years on straight-line basis)
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8,400
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8,400
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30-6-2002
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Cash Employee Stock Options Outstanding Paid-up Equity
Capital Share Premium Account (Exercise of 300 options at an exercise price
of Rs. 40 each and an accounting value of Rs. 120 each)
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12,000
36,000
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3,000 45,000
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1-10-2002
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Employee Stock Options Outstanding Employee
Compensation Expense (Reversal of compensation accounting on lapse of 50
vested options at the end of exercise period)
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6,000
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6,000
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The T-Accounts for Employee
Stock Option Outstanding and Deferred Employee Compensation Expense would be
as follows:
Employee Stock
Options Outstanding Accounts
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1/5/2001
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Employee/
Compensation Deferred Compensation
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18,000
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1-4-1999
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Deferred Compensation
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60,000
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30-6-2002
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Paid-up Capital/Share Premium
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36,000
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1/10/2002
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Employee Compensation
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6,000
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60,000
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60,000
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Deferred Employee
Compensation Expense Account
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1/4/1999
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ESOS Outstanding
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60,000
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31-3-2000
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Employee Compensation
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24,000
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31-3-2001
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Employee Compensation
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24,000
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1/5/2001
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ESOS Outstanding
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3,600
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31-3-2002
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Employee Compensation
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8,400
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60,000
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60,000
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Employee Stock Option
Outstanding will appear in the Balance Sheet as part of Net worth or
Shareholders, Equity.
Deferred Employee Compensation
will appear in the Balance Sheet as a negative item as part of Net worth or
Shareholders’ Equity.
b. For ESPS
Accounting treatment for
Employee Stock Purchase Scheme (ESPS) is explained in the SEBI guidelines
with the following illustration.
Suppose a company issues 500
shares on 1-4-1999 under an ESPS at Rs. 40 when the market price is Rs. 160.
The accounting value of the shares being :
500 x (160-40) = 500 x 120 =
60,000
The accounting entry would be as
follows :
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Rs.
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Rs.
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1/4/1999
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Cash
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20000
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Employee Compensation Expense
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60000
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Paid-up Equity Capital
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5000
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Share Premium Account (Issue of 500 shares under
ESPS
at price of Rs. 40 each when market price is Rs. 160).
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75000
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