Any information relating to a listed entity which if comes in the market can have a significant effect on its security prices, is treated as unpublished price sensitive information (UPSI). Any person who deals in the securities of any company on the basis of UPSI and makes personal gain by adversely affecting the interest of the general public is guilty of Insider trading. As per the SEBI (Prohibition of Insider Trading) Regulations, 2015, price sensitive information includes:
It is to be noted that possession of UPSI is not an offence but dealing in the securities of the Company on the basis of such UPSI, is.
SEBI also in its SEBI (Prohibition of Insider Trading) Regulations, 2015, has placed restriction on communication on every person who has such UPSI to any other person until and unless such communication is for legitimate purpose, performance of duties or discharge of legal obligations. Similar restriction is also placed on procurement of such information by any person from Insider. Basically, intent of SEBI has always been to prevent misuse of any unpublished price sensitive information by any person for the purpose of making unlawful gain.
Company has to make sure that any information which, if comes in market, may have material effect on the price of securities in the market, must be disseminated by the company to the stock exchanges in a prompt and fair manner. SEBI, on march 28th, 2014, in the matter of MAN Industries (India) Limited, imposed a penalty of Rs. 25,00,000 on the Company and its officials, for the alleged delay in the disclosure of price sensitive information relating to bagging of an order worth Rs. 1340 crore to the stock exchange.
SEBI has always been vigilant in curbing the practice of Insider Trading and in the year 2015 replaced the erstwhile SEBI (Prohibition of Insider Trading), Regulations, 1992 with the new and far more stringent regulations called SEBI (Prohibition of Insider Trading) Regulations, 2015 signifying its zero tolerance approach towards Insider Trading. These regulations under its ambit cover all the employees or directors of the company.. Now it is intended that anyone in possession of or having access to unpublished price sensitive information will be considered as an “insider” regardless of how such person came in possession of the information. The definition of Insider under the current regulations has been widened enough to cover any person whether connected or not, to the company but has or deemed to have access to the unpublished price sensitive information.
In December 2017,SEBI issued directions to AXIS Bankto conduct an internal enquiry and submit report to SEBI within 3 months for alleged leakage of its financial results for the quarter ending June 30,2017 in WhatsApp chat groups. The information related to its quarterly financial results was being circulated in the WhatsAppgroup much before the time it came in public. The proximity of the figures being circulated in the WhatsApp group and the actual figures was a clear indication that such information was being leaked by a person who had access to the unpublished price sensitive information relating to the quarterly financial results of the company. Therefore, it is pertinent to note that if anyone due to his connection with the company or in thecourse of his employment or due to any other reason, has any price sensitive information in his possession or is deemed to have possession of such information, is under an legal obligation, to not, in any way, communicate such information to any other person until it is for any legitimate purpose.
On February 4th, 2016, SEBI in the matter of Palred Technologies Limited, ordered impounding of unlawful gains of over Rs.2 crore from 15 individualswho were allegedly ‘connected entities’ and had traded in the shares of Palred Technologies Ltd (PTL) while possessing price-sensitive information. SEBI also for the very first time in this case held person connected through mutual friend on Facebook as ‘connected persons’.
On March 11, 1998, an order was passed by SEBI in the matter of Hindustan Lever Limited v. SEBI. HLL announced that it was merging with Brooke Bond Lipton Limited (BBLL) and before merger HLL purchased eight lakh shares of BBLL from Unit Trust of India (UTI). In its reply HLL stated that for insider trading it is essential to prove the misuse of fiduciary position and that the transaction was undertaken to make a gain, profit or to avoid a loss. These contentions were denied by SAT and this case was held to be that of insider dealing.
In November, 2017, an order was passed by SEBI in the matter of Bank of Rajasthan Limited against 7noticees who were found guilty of Insider Trading and communication of UPSI to other person and were collectively ordered to disgorge an amount of Rs.95,77,614 in favor of SEBI.
Bank of Rajasthan and ICICI bank ltd. were in negotiation of merger and information w.r.t. negotiation was already in public domain since May 06, 2010.The Binding implementation agreement of merger got signed on May 18, 2010. One of the noticee who was also the brother of the promoter’s wife purchased shares of the Company during the period from May 17, 2010 to May 18, 2010 and subsequently sold the shares within 8 to 10 days, thereby making illegal gain of Rs. 95,77,614. It was contended by noticee that there was no documentary evidence in the show cause notice that he was in possession of UPSI and the news of merger was already out in the market on May 6, 2010.
It was also contended that he was neither an insider as per the definition of insider nor he was covered in the definition of connected person. A.O. held that combined reading of definition “unpublished” and “Price sensitive information” makes it clear that if the news/information regarding the merger of BOR and ICICI in newspapers/reports are not published by either of the two parties to the merger or their agents, then the same cannot be treated as published. It was further held that the noticee was not covered in the definition of “relative” as per Companies Act, 1956 but is covered in the definition of “insider” since he had access to UPSI.As per the trading pattern of the noticee, it was observed that he was not an active investor in the equity market.
Conclusion:
Developments in Capital markets in the last few years depict that any form of malpractice which adversely affects the faith of bonafide investors in the market will not tolerated by the Market Regulator, SEBI. It’s high time that companies should draw attention towards the trading done by their promoters or employees or any person who is related with the company in its securities and must ensure that such trading is not in any way in violation of any the prevailing SEBI Laws. Companies must adopt appropriate measures that whosoever has or is deemed to have any unpublished price sensitive information shall not communicate such information until it is for any legitimate purpose. To effectively curb insider trading, companies should conduct knowledge seminars or awareness sessions for their Promoters, Directors and employees to make them aware of insider trading and its repercussions. They should also be made aware of the monetary penalties which could be imposed on being found guilty of Insider Trading. Companies should follow and maintain strict procedures and controls to adhere to the applicable laws and to maintain the confidentiality of any price sensitive information.
Fairness is not an attitude. It’s a professional skill that must be developed and exercised
-Brit Hume
Disclaimer: –
The entire contents of this document have been developed on the basis of relevant statutory provisions and the information available at the time of the preparation. Though the author has made utmost efforts to provide authentic information however, assumes no responsibility for any errors which despite all precautions, may be found herein. The material contained in this document does not constitute/substitute professional advice that may be required before acting on any matter. The author and the company expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be done by any such person in reliance upon the contents of this document.
‘INSIDER’ & ‘CONNECTED PERSONS’
“Don’t try to buy at the bottom and sell at the top. It can’t be done except by liars.”
-Bernard Baruch
INTRODUCTION
Capital Markets have always been a major source for the corporate to raise funds in an efficient and speedy manner and for the Investor community, an important avenue to invest their surplus and hard earned monies into the economy. But to efficiently deliver these functions, a fair and stable stock market is a must. Such efficiency and fairness of the market is adversely affected by many prevalent malpractices which not only hinder the growth of stock market but also create a sense of insecurity amongst the general public before investing in the stock market.
One such malpractice is ‘’Insider Trading’’. Insider trading basically means trading in the securities of the Company by the person who have some information which is not available to the general public in the market and thus allowing them to make unlawful gains.
Till about 3 decades ago, this concept was more prevalent in West, but the bug is spreading fast and can now be seen even in this terrain of the world. Over the years, the Government of India has formed various committees to look into the regulatory framework for Insider Trading. In the year, 1989, a committee by the name of Abid Hussain Committee was formulated which recommended that in order to tackle Insider trading effectively, formulation of special legislation by SEBI was required.
Accordingly, in the very 1st year of its formation, SEBI promulgated SEBI (Prohibition of Insider Trading) Regulations, 1992. The motive behind the Regulations was to take care of the interest of innocent and bona-fide investors and at the same time catch hold of persons who are responsible for tampering the market due to possession of inside confidential information. But, with the passage of time and robust growth of the Indian Capital Market, the 1992 Regulations were turning out to be inadequate in curbing the insider trading practices. Therefore, a need was felt to enact more stringent regulations to protect the interest of the bonafide investors. Accordingly, SEBI formed a high Level Sodhi Committee under the chairmanship of Justice N.K. Sodhi to review the Existing regulations. After taking into consideration the recommendations of the Sodhi Committee, SEBI replaced the existing insider trading regulations with a more comprehensive and stringent SEBI (Prohibition of Insider Trading regulations) 2015 w.e.f 15thMay, 2015.The 2015 Regulations have given a very wide definition of the term ‘Insider’.
In this “INSILYSIS” sseries of ours, we have made an attempt to do a detailed analysis of who is an “insider” and “connected person”.
WHO IS AN INSIDER?
Regulation 2(1)(g) of the SEBI (Prohibition of Insider Trading) Regulations, 2015, defines insider as :
While the definition may sound straightforward, it is sometimes difficult to determine who is actually an insider. The definition of insider prescribes two categories of people:-
1. The first one who has connection with the Company and
2. The other one who are not connected with the Company but are in possession of or having access to unpublished price sensitive information.
SEBI’s Intent behind coining the term insider was just to differentiate the persons who are connected with the Company or have access to unpublished price sensitive information from the ordinary investors who trade in the securities of the Company on the basis of their financial wisdom, in order to create a level playing field and to safeguard investing public against financial misfortunes. The regulations implicate anyone who has or expected to have the possession of the Unpublished Price Sensitive Information (UPSI) by the virtue of his position as an Insider. Unpublished price sensitive information generally relates changes in capital structure, financial results, mergers or demergers or bonus or any other information which may impact the price of the security in the market on becoming generally available in the public.
Another term which holds a great significance and forms a major part of Insider is ‘connected person’. The term connected person is defined in regulation 2(1)(d) of the SEBI (Prohibition of Insider Trading) Regulations, 2015, which includes the following person:
SEBI in the PIT Regulations 2015, has taken a step further and has broadened the scope of definition of connected person to a far extent when compared with the erstwhile regulation, 1992. This can be implied from the fact that under the Regulations 2015, any person who is or has been associated with the Company in any manner, directly or indirectly during the last 6 months will be considered to be an connected person and is reasonably deemed to have access to the unpublished price sensitive information will be treated as a Connected person. Therefore, even a driver or a cleaning staff of the company who has traded on the basis of the unpublished price sensitive information received during the course of his employment will not be out of the purview of the definition. Even the officials of the stock exchange or clearing corporations who receives unpublished price sensitive information in their regular working are also not out of the purview of the definition under the new regulations.
SEBI has also through its informal guidance dated July 25th, 2016 while replying to a query by HDFC Bank ltd., has clarified that portfolio managers while managing their clients investment cannot trade in the securities of the Company of which they have unpublished price sensitive information. If they do so, then it will be assumed that such investment has been made on the basis of the unpublished price sensitive information possessed by them and they will be held guilty for insider trading.
SEBI’s intent behind taking a time period of 6 months for seeing the association of any person with the company is sufficient enough to curb the trading in the securities of the company on the basis of the UPSI as the gravity of any price sensitive information to impact the market can reasonably be lowered down during the period of 6 months.
Various cases have been settled wherein different perspective have been taken for considering a person as an insider, some of which are mentioned below :
INTERNATIONAL FRAMEWORK
Instances related to Insider trading has been found all over the world since last many years and many countries have different laws for it but the basic intention behind all such laws has always been to curb this practice. Heavy penalties are being imposed on person found guilty of Insider Trading worldwide. One such landmark case was when former Goldman Sachs Director Rajat Gupta, was imposed a penalty of $13.9 million by the U.S. District Court and was permanently barred from acting as an officer or director of a public company. When compared with the law in UK, the Indian law on this subject appears to be more stringent. In UK, both the liabilities, civil or criminal are determined by different statues but in India same statue is applied for both the liabilities. Indian law appears to be stricter as there is no defense available to escape the liability as compared to the UK Law where certain defenses are available. But the scope of Indian law can be seen as narrower when compared with the UK law as Indian law is limited to dealing only with listed Companies while no such criteria is mentioned in the latter. It is also to be noted that under the Indian law a person is deemed to be a connected person if he has been connected to the Company during a period of 6 months prior to the insider trading act but no such time period has been prescribed under the UK law.
Also, as per the Criminal justice act of UK, motive that a person knew the information was an inside information at the time of committing such act is required while no such motive is required as per the Indian law.
Under the US Law, an insider, affiliate or control person is defined as an officer, director or owner of more than 10% of the voting stock in a company, or the immediate family of any of these persons. No such criteria of holding any percentage of voting stock has been prescribed under the Indian law, even a person who is not holding a single share in the Company can be treated as Insider, thus the scope of insider can be said to be wider when compare to the US Law.
CONCLUSION
From the above discussion and analysis, it is amply clear that that the term “Insider” has a very wide connotation. It not only is a person in direct employment of the company but also covers their immediate relatives, any person who have been connect in past also, the intermediaries, any person having fiduciary relation with the company etc. The conclusive reading of various judgments established under the SEBI (Prohibition of Insider Trading) Regulations, including the cases that were settled under the erstwhile 1992 Regulations, establishes that SEBI has adopted a zero tolerance approach for cases relating to trading by insiders on the basis of the unpublished price sensitive information. Heavy penalties are being imposed by SEBI on the persons found guilty of Insider trading such as in the case of Sigrun Holdings Ltd. ,SEBI through its Order dated June 17 ,2016 , imposed a monetary penalty of Rs. Six crores and Eighteen Lakhs in total on the Managing director of the Company for violating the Insider trading regulations. Various orders are being also made like declaring the transaction void, prohibiting the person from dealing or investing in securities or returning the securities so purchased or sold or directing the person who has dealt in securities in violation of these Regulations to transfer an amount or proceeds equivalent to the cost price or market price of securities.
Disclaimer: –
The entire contents of this document have been developed on the basis of relevant statutory provisions and the information available at the time of the preparation. Though the author has made utmost efforts to provide authentic information however, assumes no responsibility for any errors which despite all precautions, may be found herein. The material contained in this document does not constitute/substitute professional advice that may be required before acting on any matter. The author and the company expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be done by any such person in reliance upon the contents of this document.
The Finance Minister, Mr. Arun Jaitley, announced the Budget for 2017-18 on 1st of February, 2017. Under the Annexure III to Part B of Budget Speech, certain Additional Revenue Mobilisation (ARM) and Anti-abuse Measures in the area of Direct Taxes were announced. This included the proposal to restrict the exemption from long term capital gains in case of transfer of listed shares by providing that the exemption, subject to notification of certain exceptions, shall be available if security transaction tax has been paid at the time of acquisition of such shares where they have been acquired after 1st October, 2004.
The present provision in this regard is, Section 10(38) of the Income Tax Act exempts the long term capital gains arising in case of transfer of equity shares on or after 01-10-2004, where such transaction is chargeable to securities transaction tax (STT). However this provision has been modified in the latest budget and it is now proposed to levy tax on transfer of listed shares if the STT is not paid at the time of acquisition of such shares.
While certain allotments like IPOs, FPOs, Bonus or Rights Issues, acquisition by Non-Resident under FDI Policy etc. have been clearly excluded from applicability of the aforesaid provision on the grounds that in these cases STT cannot be paid at the time of acquisition of shares. However there are many more types of allotments of equity shares where the payment of STT cannot be made at the time of acquisition of shares. These include Private Placements, Employee Stock Options, conversion of convertible securities etc. Taking the example of ESOPs, wherein Employees are given a right to obtain the equity shares of the company at a pre-determined price and the employees can acquire shares of the company either by way of fresh allotment or through transfer of shares from the Trust. In case of fresh allotment, there is no question of paying STT upon acquisition. Even in cases where the Trust route is opted by the listed company and the trust acquires shares of the company from secondary market, the STT will be paid when the Trust will acquire shares. However the transfer of shares from Trust to employee will be an off-market transaction. In this manner, employee can never pay STT at the time of acquisition of ESOP Shares-neither in case of fresh acquisition nor in case of Trust route. Accordingly, the benefit of holding ESOPs for long term will not be available anymore.
By the announcement of this Budget, ESOPs and Private Placements have been put under grey area as there is no explicit clarity over the exemption from long term capital gains arising upon transfer of these shares by the holder of such shares. This will lead to dilution of the basic idea of wealth creation and retention of employees by granting ESOPs to them. They will not get any benefit by opting and holding ESOPs for a longer period.
Presently these are the specimen provisions and the actual exemptions are yet to come. Regulators need to consider to exempt ESOPs as well as Private Placements from the levy of long term capital gain tax upon non-payment of securities transaction tax at the time of acquisition.
Motivating the Employees inspite of Demonetisation blues
The preceding year 2016 has given few gigantic reforms which are going to lay an impact worldwide. PM Modi’s surprise in the form of Note Ban in India is one of a major reform and whether this will prove to be a boon or a bane is still to be seen..!
A very bold move was taken by Shri Narendra Modi, our Prime Minister, on November 8th, 2016, when he announced that all 500 and 1000 rupee notes cannot be used anymore thereby giving a jolt to the country. This move is backed by his idea to curb black money circulation in India and thereby making it a corruption free place. But it is still to be concluded that how far this course of action will prove to be justified for the entire nation?
The major hit is been faced by the salaried class people of the country. The sudden invalidation of 500 and 1000 rupee notes which accounted upto 85% of the cash circulation in the country represented a significant monetary shock. Research have also shown that this black money accounted for a significant portion of India’s GDP. By putting this currency out of circulation, the overall GDP is also expected to low down in the short run. The brunt is being felt by all across industries, be it FMCG, Pharma, Manufacturing, Telecom, Infrastructure, BFSI etc.
However, the proverb “No gain without pain” holds true here as well. The ultimate idea is to seek a better future and fiscal growth of the country resulting out of a corruption free India. In the longer run, tax and interest rates on loans are expected to come down as higher income tax collections arising from better compliance would offer scope to reduce rates over the long term. The cash crunch has drawn all the attention and the industrialists are now focusing just to save the potential losses and to overcome the downfall faced by them.
Jobs & Appraisals
Nevertheless the above, the pain becomes more painful when it starts to pinch the general masses. In such critical time, it is important to hold on to the key builders of businesses i.e. the employees to support the businesses to revive back. . The cash crunch has put the employees and workers out of the annual appraisal limelight. While, it can be expected that appraisals are going to be minimal in the year 2017, job change is also not left as an option to the employees to get better hikes. The “startup industry” is on the verge of shutting down due to this cash crunch.
Even if the revenues are on a slight downfall for the time being, this does not in any way mean that no other appraisal tools are available! Companies should aim to find ways to engage the employees with them rather than focusing only on paying them off. It will result in more loyal, harder working employees. Making Employees a stakeholder in the Company’s growth will also motivate the Employees to work effectively and efficiently in order to enhance the profitability of the business.
Go Cashless with ESOPs
When the entire country is getting cashless, why to stay behind for appraisals!! Effective appraisal tools in the form of Equity Incentives are very much prevalent across industry. Employee Stock Option Plans, popularly known as ESOPs wherein the equity of the company is shared with the employees is gaining acceptance as well as attention in the market as an alternate to cash compensation. Over the years, ESOP has gained worldwide recognition and is now a most attractive tool for employee reward and retention.
Companies are keen to adopt this strategy over vanilla increments. While cash has always been a short term motivator, ESOPs are a dual benefit strategy for both employees as well as the owners. Equity-based incentive plans create a sense of belongingness among Employees as they get directly linked with the growth of the Organization. It makes the Employees think and work as an intra-preneur & motivate them to work effectively and efficiently in order to enhance the profitability of the business.
Equity linked incentives gain all the more significance in the present cash crunched country. Under the present scenario, ESOPs can be prove to be real savior and can rescue both for the corporates who are cash-short and for their staff who is expecting the usual annual appraisals. Stock Option Plans are cashless compensation strategies which act as catalyst for employee behavior, thereby creating successful teams through shared goals. Sharing in equity will not only save the cash outflow from the company but at the same time add value to it by aligning the interests of the employees to the interest of the business and the company. In fact, employees will be paying cash to the company in order to acquire shares under ESOPs thereby generating funds for the company. Companies are extensively focusing on providing various kinds of benefits to their employees over and above the fixed salary. In such a scenario, ESOP can prove to be a carrot, which can be diligently used to reward the employees without cash outflow, and make them a partner in Companys’ growth.
Conclusion
Although the demonetisation policy is facing a lot of criticism however soon we are going to experience much positive effects of this program. It is going to improvise India’s economic and fiscal conditions in the long run. In the meantime we have in place appropriate tools that enable corporates to plan the annual appraisals for their employees by means of offering them equity based incentives i.e. ESOPs. Corporate houses that are implementing or propose to implement ESOPs in this demonetisation period includes names like Reliance Jio, Rolta India, Oracle Financial Service Software Ltd., Carborundum Universal Ltd. etc. The long-term growth potential of a business is directly proportional as to how well it is able to maintain a balance between satisfaction of its employees and preservation of its assets and financial resources. Shared values leads to Shared Success……
Wishing our readers a highly motivated, blissful and prosperous 2017!!
The term ESOP i.e. Employee Stock Option Plans is prevalent worldwide. The concept is no more restricted to a particular country or continent. It originated way back in 1956 in the USA. The first step was taken by the pioneer of ESOP, Mr. Louis Orth Kelso and from that time till now the 50-plus years since then, ESOPs have become a popular alternative to empower employees, a sale or merger as a tool of business succession, and there are now more employee owned companies.
ESOPs started in Singapore in 1975 when Singapore Airlines adopted it. This was followed by Straits Steamship Limited in 1977. Although ESOPs are popular among MNCs, they were not widely received by the local listed companies until the late 1980s.
There are three employee share incentive plans commonly put in place by companies in Singapore, namely:
Like in India, in Singapore also the concept of ESOP is regulated by multiple Statues out there which includes the Singapore Companies Act, Listing manual of Stock Exchanges of Singapore, taxation laws of Singapore etc. Companies are required to obtain approval of Shareholders in a general meeting before adopting ESOPs. There is a requirement of obtaining shareholders’ approval in the general shareholder meeting before any company can adopt ESOPs. Under an ESOP, the options have a minimum vesting period of one-year and a maximum of five years to expiration.
There are certain restrictions with regard to ESOPs in Singapore for e.g.: employees who are substantial shareholders (with more than 5 percent share ownership of the company) are not allowed to participate in the plan. The number of shares that can be issued under each plan must not exceed five percent of the total issued share capital for mainboard-listed companies and must not exceed 15 percent for the smaller firms listed on the SES Dealing and Automated Quotation (SESDAQ) system. The number of shares issued to directors, chief executive officers, general managers, and officers of equivalent rank is restricted to 50 percent of the total number of available shares under the plan. The maximum entitlement of each participant is 25 percent of the total number of shares available in the ESOP.
However, all these restrictions, regulations and statutory obligation are associated with the ESOP plans that involves the equity shares of the company and not in case of cash-based incentive plans. As explained above, the name given to these kind of plans is Phantom Share/Stock Option Plans. Since there is no direct involvement or dealing in shares of the company, therefore these are not governed by the laws and rules.
We at esop online.in are into catering all ESOP related needs covering the Legal, Taxation, Regulatory & Management support, thereby building & supporting the corporates with the right amount of remuneration for their employees.
Disclaimer: The data produced in this article has been fetched from publically available information & resources.
Employee Stock Option Plans, as a tool to reward & retain key human talent has gained enormous acceptance and adoption worldwide. Enterprises are more than ever interested in adopting non-traditional methods for making payments to their Employees. Hence ESOPs have become the most popular and accepted form of Employee Compensation.
Emergence of share-based payment as an important means of employee compensation has also generated heated debate on the manner of accounting for such payments. Accordingly the lawmakers have chalked down provisions dealing the same primarily under Guidance Note 18- issued by ICAI on Accounting for Employee Share-Based Payments, supported by relevant Sections under Income-tax Act, 1961. Certain judgments have also been given with regard of allowance of ESOP expenses.
COMPENSATION COST: MEANING
In more concrete terms, ESOP expense is known as Compensation Cost. This is because, employee share-based payments generally involve grant of shares or stock options to the employees at a concessional price or a future cash payment based on the increase in the price of the shares from a specified level. The basic objective of such payments is to compensate employees for their services and/or to provide an incentive to the employees for remaining in the employment of the enterprise and for enhanced performance. Compensation Cost is the difference between the value of Company’s Share at the time of Grant and the price at which the Company has offered the Options to the Employee. This difference becomes the Cost to the Company.
COMPENSATION COST = FAIR MARKET VALUE ON GRANT – EXERCISE PRICE
BOOKING OF COMPENSATION COST
Equity-settled Schemes:
In case of Schemes in which the Employee gets the Equity Shares of the Company against Exercise of Options, Compensation Cost is recognised by the Employer on a straight-line basis over the vesting period of the options. The entire expense is calculated at the time of Grant of Options and it is equally divided over a period within which the options will vest with the Employees, as the case may be.
Cash-settled Schemes:
In case of Schemes, where the Employee gets the incremental value of Company’s Shares over a period of time, the Employer has to make a provision equivalent to the amount to be paid to the Employees in the year in which the payment is to be made.
ALLOWANCE OF COMPENSATION COST
TAX TREATMENT
Compensation Cost is an allowable expense under Section 37 of the Income-tax Act, 1961. This is booked as an expense in the Profit & Loss account of the Company and is allowed as a deduction over the period of vesting of options on a straight-line basis.
In case of cash-settled schemes, the expense incurred upon payment of appreciation is booked as a provision in the books of accounts of the company in the year in which payment is to be made.
Let us understand the above-stated concepts with the help of an illustration:
|
||||
| Compensation Cost = Rs. 20/- per option | ||||
| Vesting Period | Options Vested | Compensation Cost (in Rs.) | ||
| 100% at the end of 1st year from the date of grant | 1000 options | 1,000*(30-10) = 20,000 | ||
Therefore, the total compensation cost of Rs. 20,000/- (1000*(30-10)), has to be booked in the year of vesting, by the company in its P&L A/c of the company.
|
|||||
| Vesting Period | Options Vested | FMV on Redemption | Provision to be made* (in Rs.) | ||
| 100% options at the end of 1st year from the date of grant | 1000 options | Rs. 50/- | 1000*(50-30) = 20,000 | ||
* It is presumed that the payment of appreciation is being made in year of vesting.
RELATED JUDGEMENTS
In case of CIT vs. LEMON TREE HOTELS LTD, following the Madras High Court in CIT vs. PVP VENTURES LTD (TC(A) No. 1023 of 2005), it was held by Delhi High Court on 4th August, 2015, that expense incurred by the assessee on account of ESOPs is an allowable expense and hence this could be debited to the profit & loss account of the Assessee i.e. the Employer Company.
Also in another case of CIT(A) vs. PEOPLE INTERACTIVE INDIA PRIVATE LTD dated 21st October, 2015, the special bench has held that the discount under ESOP is in the nature of employee cost and hence is deductible during the vesting period w.r.t. to the market price of shares at the time of grant of options to the Employees. The amount of discount claimed as deduction during the vesting period is required to be reversed in relation to the unvested /lapsed options at the appropriate time. However, an adjustment to the income is called for at the time of exercise of option by the amount of difference in the amount of discount calculated with reference the market price at the time of grant of option and the market price at the time of exercise of option.
The Capital Market Regulator, SEBI, has cleared the air around certain grey areas that persisted under the SEBI (Share Based Employee Benefit) Regulations, 2014, which got notified on 28th October, 2014. SEBI, on 21st October, 2015, had issued a FAQ paper which clarified the ambiguities prevailing on part of Regulation 3(12) of the SBEB Regulations, i.e. with regard to appropriation of un-appropriated inventory under an Employee Benefit Scheme. Further, on 20th November, 2015, SEBI issued another FAQ document on the Regulations, thereby clarifying that Independent Directors can exercise the options granted to them before promulgation of these Regulations.
A gist of both the FAQs is given herein below:
SEBI ENLIGHTED THE GREY AREAS UNDER SEBI (SBEB) REGULATIONS, 2014
Clarification w.r.t to Appropriation of Inventory held by the Trust as on the date of the Notification of the Regulations in the year 2014.
As per Regulation 3(12) of the SEBI (SBEB) Regulations, 2014, ‘The un-appropriated inventory of shares which are not backed by grants, acquired through secondary acquisition by the trust under Part A, Part B or Part C of Chapter III of these regulations, shall be appropriated within a reasonable period which shall not extend beyond the end of the subsequent financial year:
Provided that if such trust(s) existing as on the date of notification of these regulations are not able to appropriate the un-appropriated inventory within one year of such notification, the same shall be disclosed to the stock exchange(s) at the end of such period and then the same shall be sold on the recognized stock exchange(s) where shares of the company are listed, within a period of five years from the date of notification of these regulations.
Prior to the clarification issued by SEBI, the prima-facie interpretation of this Regulation suggested that the appropriation of un-appropriated inventory can be done only by way of sale of that inventory on the Recognised Stock Exchange. But now, SEBI has clarified that, the Company may either appropriate the inventory by selling it on the Stock Exchanges or towards individual employees by way of an ESPS/ESOP/SAR/GEBS/RBS, provided that such Plan is framed by the Company on or before 27th October, 2015. This would suffice the requirement of Regulation 3(12), and would be deemed as a compliance with proviso to Regulation 3(12).
In case, such appropriation is not done till 27th October, 2015, then the un-appropriated inventory has to be sold on the Stock Exchanges in the next four years.
Exercise of Options granted to Independent Directors before the promulgation of the Regulations
Initially, upon enactment of the Companies Act, 2013, the Independent Directors, were restricted from participating in any Employee Stock Option Plan. Subsequently, the same also got prohibited under Clause 49 of the Listing Agreement and then under the new SEBI (SBEB) Regulations, 2014. This resulted into a lot of chaos as to what shall be the treatment of grants which have already been made to the Independent Directors. The Regulator has now clarified that in case of listed entities, this restriction applies only to the fresh grants being made after the notification of SEBI (SBEB) Regulations, 2014. Accordingly, any amount of benefit granted to an Independent Director before enforcement of new norms under Companies Act, 2013 is valid and hence, it will vest and can be exercised as per the terms and conditions of the grant.
However, no fresh ESOPs shall be granted to the Independent Directors under the Plans framed after the SBEB Regulations came into picture.
SEBI ENLIGHTED THE GREY AREAS UNDER SEBI (SBEB) REGULATIONS, 2014
Conclusion: CP Viewpoint
Every new enactment brings along both, the solutions and some new questions. The aforesaid two FAQs issued by SEBI are of huge significance for companies having Trusts, along with those who have already granted benefits to their Independent Directors and also a clarification for those who propose to come up with similar kind of Employee Benefit Plans.
The promulgation of new Insider Trading norms, which came into effect from May this year, created an air around the Employee Stock Option Plans. With regard to ESOPs, under the new Norms, there were a lot of restrictions, in terms of exercising/ selling/ contra trades/ pre clearance etc. Unlike the PIT Regulations, 1992, ESOPs were not exempted from the purview of the new Insider Trading norms. Accordingly multiple restrictions on trading of shares and all inclusive definitions of term “trading” dragged ESOPs into the wheel.
The norms prohibited employees from entering into contra trades i.e. entering into an opposite transaction within a period of six months of exercise of options or likewise to exercise the options, if there has been and sale transaction during preceding six months. Furthermore even exercise was subject to pre-clearance. The rigidity of the new norms was leading to curb the concept of ESOPs and in fact conventional ESOPs were getting vanished from the scene, with SARs and Phantoms taking the place.
Ever since then, the ESOP ISSUE & THEIR EXERCISE have been a hot topic of discussion amongst the Corporate circles. Various market intermediaries and corporates thus kept approaching SEBI for clarification on applicability and coverage of Insider Trading norms on ESOPs. Consequent to these representations, SEBI took the matter into consideration and gave clarifications on the subject in its meeting held on 24th August, 2015.
Clarifications and Amendments:
It further clarifies that a Spouse, even if financially independent, is presumed to be an “immediate relative”, unless rebutted so.
Amendments in Share Based Employee Benefit Regulation, 2014
Fill out the form below and our team will get back to you shortly
Book a Demo
Fill out the form below and our team will get back to you shortly
