Has 409A gone global? The FBT has expanded.

Recently we became aware of an issue in India that makes us think 409A is potentially going global. The Fringe Benefit Tax, or FBT has recently been expanded to include a provision for equity compensation, and it looks somewhat familiar.

It is our understanding that any company with employees in India compensated with stock options must report quarterly and pay a tax on the intrinsic value of an option as it vests. In addition, the valuation must now be performed by a Category 1 Merchant Banker registered with the Security and Exchange Board of India.

Two "relevant" valuation methodologies used in the FBT are the NAV and PECV methodologies. Briefly, the NAV (Net Asset Value) method is almost purely a measurement of net assets, which is obviously a poor measure for any growth stage company, particularly a venture-backed one. The Profit-Earning Capacity Value (PECV) method is equally mis-fit for a growth-stage company in that it extrapolates from after-tax earnings over the past three to five years. Clearly a non-starter for companies that do not have positive earnings in the first place.

With all this taken into consideration, we believe that the Category 1 merchant banks of India will be falling back on the widely accepted Fair Value standard, and others like it, for companies that are more difficult to value, such as venture backed startups and other growth-oriented companies. In fact, we have received such an indication already from at least one of our US-domiciled clients that has operations in India.

We are continuing our research on this issue, and will update this article as we learn more.

Please see the attached PDFs for more.