The Bangalore Bench of the Income Tax Appellate Tribunal (ITAT) has held that unexercised employee stock options (ESOPs) buyback is taxable as capital gains and not salary perquisite.
The bench of Sandeep Singh Karhail (Judicial Member) and Balakrishnan S (Accountant Member) consideration received by an employee on the repurchase of vested but unexercised stock options cannot be taxed as a salary perquisite under Section 17(2)(vi) of the Income Tax Act, 1961. Instead, the Tribunal ruled that such receipts are taxable as Long-Term Capital Gains (LTCG) since the vested stock options constitute a capital asset and their repurchase amounts to a transfer.
The appellant/assessee was employed with Flipkart Internet Private Limited (FIPL), an Indian subsidiary within the Flipkart group. During his employment, he was granted 40,536 stock options under the Flipkart Stock Option Scheme, 2012, by Flipkart Private Limited, Singapore (FKS).
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During the relevant assessment year, 2,653 vested stock options were repurchased by FKS for a consideration of ₹2.33 crore. In his income tax return, the assessee treated the receipt as Long-Term Capital Gains, whereas the Revenue took the view that the amount represented a salary perquisite taxable under Section 17(2)(vi) because Form 16 reflected the payment as a perquisite and tax had been deducted at source under Section 192.
The reassessment proceedings were initiated under Sections 148A and 148 after the Department alleged that the assessee had offered the income to tax at the concessional capital gains rate instead of the higher slab applicable to salary income.
The principal question before the Tribunal was whether the amount received upon the repurchase of vested but unexercised ESOPs should be taxed as a salary perquisite under Section 17(2)(vi), or as capital gains arising from the transfer of a capital asset.
The assessee argued that the stock options had never been exercised, no shares had ever been allotted, and therefore the statutory conditions for taxing ESOPs as perquisites were absent. Instead, the vested options merely represented a valuable contractual right—a capital asset—which was transferred back to the issuer.
To resolve the controversy, the Tribunal carefully distinguished the different stages involved in an ESOP transaction: Grant of stock options; Vesting of stock options; Exercise of stock options; Allotment of shares; and Sale of shares.
It noted that in the present case only the grant and vesting stages had occurred. Since the company’s shares were never listed, the employee never exercised the options and no shares were allotted. The options were instead repurchased before exercise.
The Tribunal undertook a detailed interpretation of Section 17(2)(vi) and held that the provision taxes the value of specified securities allotted or transferred by an employer at a concessional price.
Importantly, the explanation to Section 17(2)(vi) computes the taxable value based on the fair market value on the date the option is exercised. Therefore, unless an employee actually exercises the option and receives the underlying shares, no “specified security” comes into existence for the purpose of taxation as a perquisite.
According to the Tribunal, an unexercised stock option is merely a right to subscribe to shares in the future, not the specified security itself. Consequently, no taxable perquisite arises before exercise.
The Tribunal then examined whether the vested options constituted a capital asset under Section 2(14).
Relying upon the Karnataka High Court’s decision in Chittharanjan A. Dasannacharya v. CIT and the Supreme Court’s judgment in Miss Dhun Dadabhoy Kapadia v. CIT, the Bench held that the right to subscribe to shares is itself a capital asset.
Since Flipkart Singapore repurchased the vested options, the transaction amounted to a transfer within the meaning of Section 2(47), thereby attracting capital gains taxation under Section 45. The Tribunal concluded that the assessee had correctly offered the amount to tax as Long-Term Capital Gains.
Rejecting the department’s reliance on Form 16 and TDS deduction, the Tribunal observed that deduction of tax at source is merely a mechanism for collection of tax and does not determine the true nature of income.
It emphasized that under Article 265 of the Constitution, tax can be collected only by authority of law. Therefore, merely because an employer deducted TDS treating the payment as salary does not prevent an assessee from correctly classifying the income under the appropriate head in accordance with the Income Tax Act.
The department had also relied upon the repurchase offer documents, which contained a statement that the repurchase proceeds would be taxable as salary.
The Tribunal found that the same documents expressly clarified that the tax discussion was only an indicative summary, did not constitute tax advice, and advised employees to obtain independent professional advice. Accordingly, the Tribunal held that contractual language could not override the statutory provisions governing taxability.
The Department relied upon the Madras High Court judgment in Nishithkumar Mukeshkumar Mehta v. DCIT (TDS).
However, the Tribunal distinguished that decision by noting that the compensation in that case arose from the PhonePe divestment, while the employee continued to retain all stock options. In contrast, the present case involved an actual repurchase of vested stock options, resulting in the transfer of a capital asset. Therefore, the factual foundation of the Madras High Court decision was materially different.
The ITAT held that consideration received on the repurchase of vested but unexercised stock options cannot be taxed as a salary perquisite under Section 17(2)(vi); such vested stock options constitute a capital asset; their repurchase amounts to a transfer under Section 2(47); the gains are therefore chargeable as Long-Term Capital Gains under Section 45; reliance on Form 16, TDS deduction or indicative tax clauses in the repurchase documents cannot determine the correct head of income.
The Tribunal accordingly allowed the assessee’s appeal on the substantive tax issue, held the levy of interest under Section 234B to be merely consequential, left the reassessment challenge open in view of the relief granted on merits, and observed that the challenge to penalty proceedings was premature.
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