Ex­ecs in a Fix Over Stock Op­tions

To avoid high taxes, many look to get pack­ages tweaked when they join cos, while some are giv­ing up Esops when they exit

The Economic Times - - Companies: Pursuit Of Profit -

Sachin Dave & Sreer­adha D Basu

Mum­bai: As if hold­ing on to em­ployee stock op­tions (Esops) worth lit­tle wasn’t bad enough, hold­ers face a tax li­a­bil­ity on those that have been ex­er­cised. Many did so when the op­tions got vested in the ex­pec­ta­tion that the stock would ap­pre­ci­ate.

Many em­ploy­ees of a high-pro­file, food-or­der­ing startup had vested their op­tions, which cre­ated a tax li­a­bil­ity on the mar­gin, the dif­fer­ence be­tween pur­chase price and mar­ket value. In mid-2016, the startup closed, leav­ing sev­eral em­ploy­ees who had ei­ther paid tax or had a tax li­a­bil­ity high and dry. “It is a very com­mon oc­cur­rence where peo­ple have had to pay taxes without any pay­offs. I per­son­ally know more than 30 se­nior ex­ec­u­tives from di­verse busi­nesses and ma­tu­rity stages of their em­ploy­ers who had to,” said VikramBhard­waj, CEO of Redileon Part­ners.

In sev­eral cases, the tax li­a­bil­ity ran into crores of ru­pees.

The prob­lem is not limited to star­tups. At a Mum­bai-based BSE-listed com­pany that was re­cently re­ferred to cor­po­rate debt re­struc­tur­ing, the top lead­er­ship team had to pay sub­stan­tial tax while the stock lan­guished at less than ₹ 2 per share. The em­ploy­ees, who were given stock op­tions by the chair­man, had de­cided to ex­er­cise these when the com­pany got listed.

“Once the vest­ing is done, which is tax free, there would be a tax li­a­bil­ity when an em­ployee ex­er­cises his op­tions but many em­ploy­ees time this to par­tial or full-exit and­hence de­fer­ring their tax li­a­bil­ity to the year in which they ac­tu­ally cash out,” said Amit Ma­hesh­wari, part­ner, Ashok Ma­hesh­wary and As­so­ci­ates LLP. “They take an exit when an in­vestor picks stake in a startup or a com­pany.”

Many se­nior ex­ec­u­tives are try­ing to work around this, es­pe­cially while join­ing com­pa­nies or star­tups where they are get­ting Esops, by get­ting their pack­ages tweaked to in­clude a higher cash com­po­nent or in­clud­ing clauses in the em­ployee con­tract safe­guard­ing them from the tax outgo.

“Em­ploy­ees are all try­ing to avoid the un­cer­tainty around the fi­nal tax bur­den on them ver­sus the up­side from sell­ing their shares,” sa-

id Bhardwaj.

Ex­perts said in many star­tups, ex­piry of the Esop is linked to the em­ployee’s exit. When an em­ployee leaves the or­gan­i­sa­tion, he/she will have to buy the stock if it has vested, oth­er­wise the op­tions ex­pire.

“There­fore, the em­ployee in­curs a tax li­a­bil­ity on the dif­fer­ence bet- ween the no­tional value and the price at which it was is­sued. This is where the chal­lenge oc­curs: a lot of peo­ple re­alise the im­pli­ca­tions of this only while go­ing through the exit for­mal­i­ties,” said Anuj Roy, part­ner — dig­i­tal prac­tice at ex­ec­u­tive search firm Transearch. “Some at this point, are even let­ting go of their Esops. That is why, in ac­tu­al­ity, real wealth cre­ation in star­tups hap­pens in very few cases. In­creas­ingly, that is why peo­ple aren’t re­ally buy­ing into the Esop story any­more.”

In­dus­try track­ers said the tax li­a­bil­i­ties are a down­side of the sys­tem.

“When em­ploy­ees ex­er­cise their op­tions and de­cide to buy shares of the com­pany, they are ac­cept­ing to take mar­ket risk at that time,” said Harshu Ghate, manag­ing di­rec­tor of Esop Di­rect. “Most of the em­ploy­ees do not fac­tor this risk when they de­cide to ex­er­cise and hold their shares. It is ideal for em­ploy­ees, es­pe­cially of un­listed com­pa­nies to de­fer their ex­er­cise closer to liq­uid­ity event.”

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