Applicability of ST on ESOP

Employee Stock Option Plan (“ESOP”) taxation has always been a topic of debate and demand in Income Tax.  However, with the incept of Negative list under Service Tax, certain aspects of this subject requires examination from the perspective of their eligibility under Service Tax.

Before we discuss the exigibility under Service Tax, we need to understand the benefit of ESOPs.  The value of perquisite is defined as the difference between the fair market value of ESOP on the date on which the option is exercised by the employee less the amount actually paid by the employee viz. exercise price.  The said understanding is illustrated as under:

Date of vesting                                                               April 1, 2014

Date of exercise                                                             August 1, 2014

Date of allotment                                                            August 15, 2014

Exercise rate per share                                                  Rs 125

Fair market value on the date of vesting               Rs 200

Fair Market value of the date of exercise              Rs 215


Benefit accrued on ESOP  =       (215 – 125)       =          Rs 90

ESOP thus, is an option available with beneficiary to  purchase stocks of a company at reduced rates and difference between the rate on which such shares are exercised and they actually are purchased by the beneficiary is the benefit for such shares.  Although such benefit is a deemed cost to the company, such availability is available as actual financial benefit to the beneficiary of such ESOPs.  Deemed cost in the hands is in the manner that such securities could have fetched money to the Company from open market. Thus loss of such deemed profit is recorded as costs to reflect true value of sale of shares.  Such ESOPs are made available to employees, employees of group companies, directors and other key management personnel.

At the outset, we shall first understand the nature of ESOPs and its exigibility to Service Tax.  ESOPs basically is a gap in the actual value of stocks and the price at which they are made available.  Thus, such difference forms deemed consideration for person who is benefitted from such ESOPs.  Thus, ESOPs per se shall not constitute service, since they are making available a financial instrument at lower price and such price difference is profit obtained by selling such stock in market at theor current value.  Thus, what is important is to examine as to against what such ESOPs were given to the beneficiary.  Thus, if such ESOPs are given to person providing a taxable services then the deemed consideration (available as explained above) shall consititute consideration for such services.  It is important to note that since the Service Tax is not charged separately in ESOP transaction, the benefit shall be treated as cum tax.  We shall now examine the various situations and where ESOPs shall form consideration as exigible to Service Tax.

  1. ESOP to own employees:

ESOPs when made to employee are part of cost to company and as a part of benefits accruing from provision of services as an employee.  It is an incentive for them to remain in employment with the Company. Services of an employee have been excluded from the very definition of Service and thus, any consideration for an activity which is not service shall not be exigible to Service Tax.

  1. ESOP to Directors (including independent directors):

Directors can render their services to the Company in two capacities – One as member of Board of Directors which govern the overall policy, strategy and functioning of a company and secondly under a place of profit as an employee of the company like whole time directors, Chairman and managing director etc.

While the former activities are not conversed under any exclusion or exemption, such services provided by directors are eligible to Service Tax and thus, the benefit as accruing to directors from such ESOPs shall constitute consideration for taxable services.

In their capacity as employee managing day to day functioning of the Company, they would be in a position equivalent to an employee and such provision in such capacity would be not exigble to Service Tax as explained above.

  1. ESOPs to employees of a group company:


ESOPs in the hands of the employee would be not taxable as explained above.  However the question which remains to be examined is the levy of the Service Tax on cross charge between the two group companies.  In this context it is pertinent to mention that cross charge inter se group companies for provision of services or making available facilities is exigible to Service Tax.  Parallely, any cross charge for making available goods would be exigible to VAT.  This cross charge in case of ESOP would be for making available securities of the parent company to subsidiary etc.  Thus, the consideration in terms of cross charge is for making available the stocks of parent company and thus, in other words it can be said that such value is for purchase of stocks from parent company.  Thus, since purchase of stocks is sconsidered as purchase of goods, such transaction has been kept outside the purview of Service Tax.  Thus, such cross charge, to my mind, is not exigible to Service Tax.

ESOPs are one of the many avenues which have been examined in terms of their exposure to Service Tax post negative list.  ESOPs and similar transaction remind us of the limitless possibilities of Service Tax regime which has expanded scope post July 1, 2012.  We trust that such issues would reach settlement before the advent of Goods and Services Tax.