TAX NEWS - January 2010

India: The Central Board of Direct Taxes has released income tax (13th amendment) rules 2009 under the Finance Act 2009

Background

The new regulations of The Finance Act 2009 (Act) are effective retroactively to April 1, 2009, and prescribe the valuation methodology applicable to share-settled equity awards. They abolished the Fringe Benefit Tax (FBT) which was previously payable on share-settled equity awards. Consequently, share-settled equity awards in India are now treated as "perquisites" and subject to income taxation under a system similar to that in place prior to the adoption of FBT. The Act confirms that all income realized in India from equity awards (cash-settled and share-settled) is subject to Indian income tax withholding.

While the Act had imposed a withholding obligation on employers, noticeably absent was any guidance on the valuation methodology employers should utilize to determine the value of shares underlying share-settled awards and, in turn, their withholding obligation. To address this issue, on December 18, 2009, the Central Board of Direct Taxes (CBDT) issued new regulations regarding the methodology to be applied in computing the Fair Market Value (FMV) of the shares underlying share-settled awards at the point of taxation (e.g. exercise for options and vesting for restricted stock/restricted stock units).


Methodology for determining the FMV of shares underlying a share-settled award

Shares listed on a recognized stock exchange in India on the date of taxation – Where the stock of the company granting the equity award at issue is traded on a recognized Indian stock exchange, the FMV of the shares underlying an award is equal to the average of the opening price and closing price of the employer's stock, as quoted on the recognized exchange at the point of taxation.

There are several recognized stock exchanges in India, including the Bombay Stock Exchange, National Stock Exchange, Ahmadabad Stock Exchange and Bangalore Stock Exchange.

Share not listed on a recognized stock exchange in India at the point of taxation – Where the stock of the company granting the equity award at issue is not traded on a recognized Indian stock exchange, the FMV of the shares underlying an award is equal to the value of the company's stock on the "specified date" as determined by a Category I Merchant Banker who is registered with the Securities and Exchange Board of India (SEBI). The "specified date" is the date on which the tax liability arises or any earlier date which is not more than 180 days prior to the point of taxation. In other words, once a company which is not listed on a recognized Indian stock exchange obtains a Category I Merchant Banker valuation with respect to its stock, this valuation may be utilized to calculate the income tax and withholding liability with respect to all awards whose point of taxation arises within the next 180 days of this valuation.

While the new regulations explicitly require a Category I Merchant Banker valuation with respect to shares not listed on a recognized Indian exchange, if a company's shares are listed on a foreign exchange (e.g. NYSE, NASDAQ), the Merchant Banker, at the point of taxation, will generally use the closing price of the company's shares on that exchange. With respect to unlisted shares, the Merchant Banker may use one of a number of valuation methodologies.


Action

- Where employers have operated income tax withholding on share-settled equity awards after April 1, 2009, these companies must use the new regulations to ensure that the proper amount of tax had previously been withheld.

Where too little withholding has been effectuated, employers will likely be able to operate additional withholding on any employee payments remaining in the tax year without incurring any interest or penalties. Conversely, if too much withholding has been effectuated, "over-withheld" amounts likely may be applied against any employee payments remaining in the tax year which related to employment income (e.g. salary, perquisites) without incurring any penalties.

- Employers who have refrained from operating Indian income tax withholding pending the release of valuation guidance must begin to operate withholding in accordance with the new regulations.

- Those companies granting share-settled awards to employees in India, and are not listed on an Indian stock exchange, should utilize the services of a Category I Merchant Banker to determine the FMV of the shares underlying these awards.