Key Highlights
Facts of the case
The taxpayer was an employee of an Indian company (ICo).
ICo was a step-down subsidiary of a foreign company (FCo).
During the course of employment, the taxpayer was granted options under the stock option scheme of FCo. In FY 2019-20, a portion of these stock options was repurchased by FCo and the consideration received was offered to tax as capital gains by the taxpayer.
The Indian Income Tax Department (the “Revenue”) reopened the assessment under the Income-tax Act, 1961 (the “1961 Act”)2 on the ground that the amount should have been taxed as salary/perquisite under section 17(2)(vi) of the 1961 Act and not as capital gains.
The Revenue, after considering the submissions of the taxpayer, passed an order that the consideration received towards repurchase of the options was taxable as salary income and could not be treated as capital gains (taxable at the lower rate of 20 percent).
Provisions applied by Revenue
Section 17(2)(vi) includes within the definition of a "perquisite" the value of any specified security or sweat equity shares that are allotted or transferred by an employer (or former employer) to an employee, either free of cost or at a concessional rate.
Explanation (c) to Section 17(2)(vi) provides the method for calculating the taxable perquisite value of the security/share on the date of exercise as reduced by the amount actually paid by, or recovered from, the employee.
Revenue’s contentions
The Revenue argued that the stock options were issued on account of the taxpayer’s employment with ICo. Accordingly, the benefit had a direct nexus with employment and constituted an employment-related benefit.
The Revenue relied on Form 16 issued by ICo, which reflected the amount received on repurchase of stock options as a taxable perquisite under section 17(2) of the 1961 Act. Tax was withheld, treating it as salary income.
The Revenue referred to the "Letters of Offer for Repurchase of Vested Options" issued by FCo. These documents indicated that amounts received pursuant to the repurchase were taxable under the heading “salaries.”
Tribunal’s decision
The Bangalore Tribunal ruled in favour of the taxpayer and held that the repurchase of vested options constituted transfer of a capital asset, resulting in “capital gains,” and not a “perquisite” chargeable to tax under the heading “salaries.”
Key observations of the Bangalore Tribunal included:
Taxability under section 17(2)(vi) arises only upon exercise of stock options
A reading of section 17(2)(vi), particularly Explanation (c) to the section, makes it clear that valuation of the perquisite is linked to the date on which the option is exercised. Therefore, the charging mechanism itself contemplates a situation in which the shares are allotted or transferred upon exercise of options. Accordingly, until the exercise occurs, an employee merely holds an option or right to acquire shares and not the underlying “specified security” itself.
No taxable perquisite without exercise of the stock options
Because the stock options were only granted and vested in the taxpayer, but never exercised by him, no shares were allotted and no “specified security” came into existence. Consequently, the pre-conditions for taxation under section 17(2)(vi) were not satisfied.
Reliance on the Supreme Court ruling in B.C. Srinivasa Setty
- The tribunal relied on the principle laid down by the Supreme Court in B.C. Srinivasa Setty,3 namely that the charging provisions and computation provisions of a tax statute constitute an integrated code. If the computation mechanism fails, the charging provision itself cannot operate.
- Applying this principle, the tribunal observed that section 17(2)(vi) contains a specific computation mechanism based on the fair market value of the security on the date of exercise. In the absence of exercise, no specified security came into existence, and no valuation mechanism could operate. Therefore, the charging provisions relating to perquisites also failed.
Vested stock options constitute capital assets
The tribunal relied on Dhun Dadabhoy Kapadia4 and Chittharanjan A. Dasannacharya5 rulings wherein it was held that a right to subscribe for shares is a capital asset. A vested stock option is a right to acquire shares in the future and therefore qualifies as a capital asset under the 1961 Act.6
Repurchase qualifies as a “transfer”
The repurchase of the vested options by FCo resulted in a “transfer” under the 1961 Act.7
Form 16 and TDS cannot determine taxability
The Revenue's reliance on the tax disclosure in the repurchase offer letters and the reporting in Form 16/Form 26AS was misplaced. The tribunal observed that taxability is required to be determined in accordance with the law and not by the payer’s characterisation of payment. Tax deducted at source (TDS) deduction and reporting are merely tax collection mechanisms and do not conclusively determine the recipient's tax liability.
Distinguished Madras High Court ruling
The Bangalore Tribunal distinguished the single-judge decision of the Madras High Court in the case of Nishithkumar Mukeshkumar Mehta,8 inter alia, on the grounds that in that case the employee continued to retain all stock options even after the receipt of compensation. However, in the case of Pramod Kumar Jain, some stock options were repurchased by FCo on payment of consideration.
