ESOPs are usually discussed from the employee’s side, as a perquisite on exercise and capital gains on sale. For the employer, the questions are wider and interconnected: whether, when and how much it can deduct, how the cost is accounted for, how it is borne within a group, including across borders, and how deferred tax follows.
Key Considerations
1. Tax deduction
(a) Allowability: The Income-tax Act has no specific provision for deductibility of the ESOP discount, and the claim rests on the general deduction for business expenditure. The Courts have consistently held that the discount is the cost of securing employee services, not a loss on capital account, and that no cash outflow is needed for it to qualify. The question of principle is now before the Supreme Court.
(b) Timing: The obligation arises at grant, and only its quantum is settled at exercise. The deduction is therefore spread over the vesting period, and is reversed for options that lapse.
(c) True-up: The deduction is computed on the value at grant. Whether it can be adjusted on exercise to the actual discount, upwards or downwards, remains open.
2. Ind AS 102: These decisions arose under the earlier GAAP and SEBI framework, which measured the cost at intrinsic value. Ind AS 102 measures it at the grant-date fair value of the option on a pricing model, without remeasurement. Therefore, claiming the amount charged in the accounts aligns the tax computation with the audited financial statements, and a true-up, if claimed, would sit outside the accounts.
3. Group grants: Where a holding company grants options to employees of its Indian subsidiary, the deduction belongs to the subsidiary, which receives the services.
– If the cost is pushed down as a deemed capital contribution, the subsidiary pays nothing and its claim may be on a weaker footing.
– A recharge at cost, under an agreement, invoiced and settled, places the claim on a stronger footing and attracts neither GST nor withholding; it also moves cash to the parent outside the dividend route, if aligned to the vesting schedule.
4. Indian parent, overseas employees: Where an Indian company grants options to employees of its foreign subsidiary, the services are rendered to the subsidiary, and the cost is not deductible in India. It should be recovered from the subsidiary at arm’s length, failing which a transfer pricing adjustment may follow. Under the FEMA NDI Rules, the issue of options to such employees is permitted.
5. Deferred tax: If the deduction tracks the accounting charge year by year, there is no temporary difference and no deferred tax asset. One arises only if the deduction differs in timing or amount, as on a true-up claim, which is then assessed as an uncertain tax treatment.