Budget 2020: Despite ‘Fixing’, ESOP Remains A Much-Abused Acronym

Budget 2020: Despite Sitharaman’s correction, ESOP continues to be a much-abused acronym, argues Raghav Bahl.

Photo: The Quint

The Quint’s Editor-in-Chief Raghav Bahl analyses ESOP in Budget 2020.

Cameraperson: Sumit Badola
Video Editor: Vivek Gupta and Mohd Ibrahim
Video Producer: Hera Khan

India taxes ESOPs, ie employees stock options, harshly, very harshly. Let me give you a quick history lesson.

When I founded TV18 in the early 90s, we had given generous stock options to our critical team members. In that sense, we belonged to a clutch of ESOP pioneers in India. And since we were leaders in business news, we also drilled hard into issues around entrepreneurship, taxation and union budgets.

Click on the player below for the podcast.

Now cut to that fateful Union Budget of 2007. The aggressive Mr Chidambaram had unveiled a shocking model of ESOP-taxation. Let me explain with a simple example:

Chidambaram's Model of ESOP-Taxation in Budget 2007

Imagine a stock/share whose Fair Market Value is Rs 100. To incentivise a key employee, assume she is given a Grant of 1 Mn options at Rs 10, thereby giving her a potential income of Rs 90 Mn - it’s a potential, and not real/realised, income because no actual shares have come into her possession yet.

Now assume further that she has two years to tell the company whether she is accepting the Grant or not. This is called the Exercise Period. The minute she says “Yes, I want the Grant”, she has Exercised it.

But note that it could take several more weeks, even months, of regulatory steps for her to actually own these shares after she has said “yes”.

This is where the trouble started. Mr Chidambaram said she should pay the tax immediately upon the Exercise.

But there’s a problem, right? She has yet to get the shares; all the “gains” are notional, on paper. So how and why should she pay a tax on an illusory income?

Worse, imagine that she gets the shares in 3 months, but some adverse event had occurred in that hiatus, and the value of each stock had dropped to Rs 5 from Rs 90.

Now see the ridiculous situation that she finds herself in: she would have paid tax on an “income” of Rs 90 mn, even though she has made a loss of Rs 5 mn.

So the budget’s logic was clearly absurd. It flew in the face of every canon of taxation, ie paying a tax on notional income, even losses.

It happened only in India!

Sitharaman Tried to Heal the Tax Wound

But in this year’s budget, Finance Minister Nirmala Sitharaman said she had fixed the long-festering ESOP tax wound

“During their formative years, start-ups generally use Employee Stock Option Plan (ESOP) to attract and retain highly talented employees. ESOP is a significant component of compensation for these employees. Currently, ESOPs are taxable as perquisites at the time of exercise. This leads to cash-flow problem for the employees who do not sell the shares immediately and continue to hold the same for the long-term. In order to give a boost to the start-up ecosystem, I propose to ease the burden of taxation on the employees by deferring the tax payment by five years or till they leave the company or when they sell their shares, whichever is earliest.”

Nirmala Sitharaman, Finance Minister (Budget Speech 2020)

Delayed Correction or 'Reform'?

Indian start-ups erupted in cheers. Frankly, we are a strange country, which applauds when a mistake, that should not have happened in the first place, is corrected after a dozen years of exploitative, vicious implementation. Because in India, an excruciatingly delayed correction is called a “reform”!

Wait...There's a Catch

Anyway, the real drama and tragedy, à la a Garam Dharam Bollywood potboiler, lay coiled in the fine print. As usual, unwaveringly, with deadly precision, India’s bureaucrats struck to neuter even this tiny “reform”. Just see what they did.

It’s not a general policy applicable to all 20,000 odd start-ups.

No sir, it’s restricted to only about 250 of the “few chosen” by a committee of government secretaries who have ordained, with divine conviction, that “come hither, you innovative newbies, enjoy these ESOP tax concessions”. There is a sharper sting in the tail – the perverse tax is not abolished, only deferred by five years; and if you leave the company, you lose the concession, with one stroke creating a rigid, inflexible market for hiring talent.

So there they go again, micro-managing and tinkering with the free market of mobile talent!

ESOP - The Much Abused Acronym!

And finally, why is this concession not given to any ESOP holder? Is the engineer who made Facebook apps work on Jio feature phones any less talented and creative? Why is he denied this concession just because he works in a large company? Is talent the determinant or the size of the employer’s balance sheet?

What can I say in the end? I truly believe that Ms Sitharaman’s quest was honest. She wanted to correct an injustice. But her bureaucrats simply torpedoed her noble intention.

Alas, ESOP continues to be a much-abused acronym. As it stands today, it expands to an Egregious State Oppressing Performers!