Budget 07 and ESOPs taxability

The Finance Minister has made only a few changes. But those impact the existing individual tax regime in this Budget.

There is no change to the individual tax rates. But the maximum effective tax rate on the highest tax slab of Rs 10,00,000 has increased to 33.99% from the existing 33.66%.

This increase is due to the Secondary and Higher Education Cess of 1 per cent over and above the existing 2 per cent edu cess. This is partially offset by the token increase of Rs 10,000 in the basic exemption limits for all individuals.

Consequently, where senior citizens and others could save Rs 2,000 and Rs 1,000 respectively in taxes, the Secondary and Higher Education Cess on income tax could neutralise such benefits.

This may consequentially adversely impact an individual's take-home salary with a taxable income over Rs 510,000 (assuming he is only claiming a deduction for savings specified under Section 80C).

One important change in this Budget is the taxability of Employee Stock Options (ESOPs). Till now, ESOPs were taxable at the time of sale of shares in the hands of the employees. There was no perquisite taxation for employees.

With the recent increasing trends of multinationals granting huge amount of incentive compensation to attract and retain talent in the form of ESOPs, the value of the ESOP benefit will fall under the Fringe Benefit Taxation (FBT) regime.

The FBT would be leviable at 33.99% on the difference between the fair market value on the date of exercise of ESOPs and the exercise price. This would entail a significant outflow of taxes for the employer. 

For plans not compliant with the Central Government Guidelines, there is no perquisite taxation. But the employer would be subject to FBT on similar basis. Such expenditure would not be tax deductible for the employer. 

On the sale of shares, the difference between the sales consideration and the fair market value on date of exercise will be subject to Capital Gains Tax.

Stock options issued to globally mobile employees may, under this new amendment, suffer double taxation without corresponding tax credits due to differential tax treatments in India and overseas jurisdictions.

Investment in art is gaining popularity. Such investors could be making substantial gains without payment of any taxes currently on the basis that such art is a personal effect.

Budget 2007 decrees that art collections (drawings, paintings, sculptures or any work of art), would not be considered personal effects and will be subjected to capital gains tax on transfer.

Capital gains arising out of transfer of Long Term Capital Assets is generally taxable at 20% (plus applicable surcharge and education cess). Such gains, when invested in bonds of National Highways Authority of India and Rural Electrification Corporation Limited (or other notified assets), are exempted from tax.

Last year by virtue of a notification, such investments were restricted to Rs 50,000,00 per taxpayer. This ceiling is now incorporated in the statute itself.  

The deduction for contributions to notified pension schemes has now been extended to employees of other employers as well. It was limited only to employees of the Central Government earlier.

This opens up avenues for future notifications of pension schemes which will open doors for non government employers to contribute to such schemes as may be notified in future.

Currently, deduction on interest paid on loan taken from any financial institution or approved charitable institution to pursue higher education is not allowed to parents, only to the student when s/he starts repaying the amount. 

Now, the spouse/ children of the individual can claim deduction of interest on loan taken for higher education.

The existing limit of Rs 10,000/ Rs 15,000 for deduction for medical premiums for regular/ senior citizen assessees has been increased to Rs 15,000/ Rs 20,000 respectively.

The Banking Cash Transaction Tax will be applicable to individuals and Hindu Undivided Families (HUFs), on cash withdrawals above Rs 50,000 (the earlier limit was Rs 25,000) on any single day from an account (other than a savings bank account).

Obtaining and quoting the Permanent Account Number (PAN) would be the sole identification number for all participants in the securities market.

The author, Nikhil Bhatia, is a partner at BSR & Co.