The Bangalore Bench of the ITAT has delivered an important ruling clarifying the tax treatment of consideration received on repurchase of vested but unexercised employee stock options (ESOPs). The Tribunal held that such consideration is taxable as capital gains and not as salary since the options were never exercised and no shares were allotted.
Background of the Case
The Assessee was employed with Flipkart Internet Private Limited (‘FIPL’), an Indian company and a step-down subsidiary of Flipkart Private Limited, Singapore (‘FKS’). During the course of his employment, the Assessee was granted 40,536 stock options under the Flipkart Stock Option Plan, 2012 (‘FSOP2012’) by FKS.
During FY 2019-20, FKS offered to repurchase certain vested stock options. Pursuant thereto, the Assessee surrendered 2,653 vested stock options for a consideration of approximately INR 2.34 Crore. Notably, the stock options were never exercised and no underlying shares were allotted to the Assessee.
Tax Treatment of ESOPs
While filing his return of income, the Assessee offered the gains arising from such repurchase to tax under the head “Capital Gains”. However, the Assessing Officer (‘AO’) held that the consideration represented a perquisite arising from employment and was taxable under the head “Salaries” under section 17(2)(vi) of the Income-tax Act, 1961 (‘the Act’).
The Commissioner of Income-tax (Appeals) [‘CIT(A)’] upheld the AO’s findings. Aggrieved by the order of the CIT(A), the Assessee preferred an appeal before the Bangalore Bench of the Income Tax Appellate Tribunal(‘ITAT’)
The Assessee contended that the stock options granted under the FSOP 2012 were never exercised and no underlying shares were ever allotted. Since section 17(2)(vi) of the Act taxes the value of a “specified security” on the date of exercise of the option, the necessary condition for taxation as a perquisite was never satisfied.
Related: LinkSquares Rebuilds Smart OCR Engine for Contract Intelligence
ITAT Ruling
The ITAT analysed the lifecycle of an ESOP and observed that it comprises five distinct stages, namely issuance of option, vesting, exercise of option, allotment of shares and sale of shares. In the present case, only the first two stages had occurred, since the vested stock options were never exercised and no underlying shares were ever allotted to the Assessee.
The ITAT observed that section 17(2)(vi) of the Act taxes the value of a “specified security” allotted or transferred by the employer to an employee. The Tribunal noted that the mechanism prescribed under Explanation (c) to section 17(2)(vi) determines the value of such specified security with reference to the fair market value on the date the option is exercised.
The Tribunal held that a vested stock option merely represents a right to subscribe to shares at a future date and constitutes a capital asset under section 2(14) of the Act. Accordingly, the repurchase of such vested stock options amounted to a transfer of a capital asset within the meaning of section 2(47), and the gains arising therefrom were chargeable to tax under the head “Capital Gains”.
This ruling may have significant effects on how companies structure their employee stock option plans, particularly in cases where vested but unexercised options are repurchased. This could lead to a re-evaluation of the tax implications of such plans and potentially impact the way they are administered.
The ITAT also rejected the Revenue’s reliance on Form 16, the deduction of tax at source under section 192 and the indicative tax treatment contained in the repurchase documentation, holding that the correct head of income must be determined in accordance with the provisions of the Act and cannot be governed by the characterization adopted by the employer or the payer.
The ruling provides important guidance on the tax treatment of ESOP-related transactions involving the repurchase of vested but unexercised stock options. The ITAT has reaffirmed that the perquisite taxation mechanism under section 17(2)(vi) of the Act is triggered only upon the exercise of stock options resulting in the allotment or transfer of the underlying specified securities.
Leave a Reply