New valuation rules for taxation of perquisites

On 18 December 2009 the Central Board of Direct Taxes (CBDT) issued its long-awaited rules for the valuation of perquisites, which will take effect on 1 April 2010. In accordance with the amendment made by the Finance (No. 2) Act, 2009, to section 17(2) of the Income Tax Act, 1961, shares acquired by employees under employee stock ownership plans (ESOPs) are now regarded as salary income for the employee. An employer is required to withhold tax on the difference between the fair market value of the shares (on the date of the employee’s exercise of option) and the price paid by the employee. Until now the method for calculating the fair market value of shares for this purpose was uncertain. The government’s valuation rules for perquisites are intended to remove this ambiguity.

The valuation rules for calculating the fair market value of shares allotted to employees is substantially comparable to those used under the fringe benefit tax (FBT) regime. For example, in both cases employers have to obtain a valuation from a merchant banker to determine the fair market value of the shares for unlisted companies. This requirement may prove to be particularly cumbersome and expensive for smaller, unlisted companies, as they are more likely to be obliged to to engage merchant bankers (depending on the exercise schedule under the ESOP). However, as under the FBT regime, listed foreign companies would also be required to obtain a valuation certificate from a merchant banker, despite the companies’ stock prices being readily available.

Notably, the valuation method to be used by the merchant bankers has not been specified in the rules, in effect allowing them to use any method they choose. Nor has the CBDT clarified whether FBT already paid by employers with respect to stock options exercised after 1 April 2009 will be adjusted in relation to future tax liabilities, or whether a refund will be available. Another issue which remains unclear is whether the government will provide a waiver of the interest levy on late payments of advance tax, given that the valuation rules for ESOPs were released only in December 2009.

The legislative and regulatory update is compiled by Nishith Desai Associates, a Mumbai-based law firm. The authors can be contacted at nishith@nishithdesai.com. Readers should not act on the basis of this information without seeking professional legal advice.