Whether Compensation received from ' for loss in value of ESOP due to disinvestment is taxable?
Apr 15, 2025
An Employee Stock Option Plan (ESOP) is a form of employee benefit where employees are given the option to purchase company stock at a predetermined price, often referred to as the "exercise" or "strike" price. This price is typically lower than the current market value, giving employees the opportunity to profit if the company’s stock price increases over time.
The Income Tax Appellate Tribunal (ITAT) recently held that compensation received by Flipkart employees for the loss in value of Employee Stock Option Plans (ESOPs) due to disinvestment is not taxable as a perquisite.
Facts of the Case
Petitioner - Sanjay Baweja, an ex-employee of Flipkart Internet Private Limited (FIPL)
Flipkart Pvt.Ltd., Singapore (FPS) Granted stock options to its employees.
Grant period - 01.11.2014 to 31.11.2016
Vesting schedule – 4 Years
Flipkart Pvt. Ltd., Singapore (FPS) announced the disinvestment of its wholly-owned subsidiary called PhonePe on 23.12.2022.
This decision of the management resulted in fall of the value of stock options.
Compensation of USD 43.67 per option was granted to the option holders by FPS.
FPS stated that the compensation paid towards the loss in value of options was considered as a perquisite under Section 17(2)(vi) and is taxable.
The case was held at the Delhi High Court after the Assessing Officer (AO) rejected the application filed by the petitioner under Section 197 seeking a ‘Nil’ deduction certificate.
Judgement
The High Court held that the amount in question cannot be considered as a perquisite under Section 17(2)(vi) as the stock options were not exercised by the petitioner, and the amount in question was a one-time voluntary payment made by FPS to all option holders in lieu of the disinvestment of PhonePe business.
Section 17(2)
(vi) The value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer, or former employer, free of cost or at concessional rate to the assessee. (c) the value of any specified security or sweat equity shares shall be the fair market value of the specified security or sweat equity shares, as the case may be, on the date on which the option is exercised by the assessee as reduced by the amount actually paid by, or recovered from, the assesse in respect of such security or shares;
In this case, the petitioner had merely held the stock options without exercising them, so they do not constitute taxable income for the petitioner since none of the contingencies specified in Section 17(2)(vi) have occurred.
The ITAT, after carefully reviewing the case, concluded that the compensation did not qualify as a perquisite for the following reasons:
Nature of Compensation: The compensation was paid solely to restore the value of the ESOPs that had been diminished due to the disinvestment. It was not an additional benefit or profit arising from the employer-employee relationship, which is a crucial condition for taxation under "perquisites."
Capital Receipt: Baweja argued that the payment was a capital receipt due to the diminished value of his ESOPs and should not be taxed as income. He contended that no capital asset was transferred, as he retained his ESOPs, thus making the compensation exempt from capital gains tax. This is significant because capital receipts, unless specifically defined as income, are generally not taxable under Indian income tax laws.
No Employment Linkage: The compensation was not provided as a benefit tied to the employee's services or position. Rather, it was compensatory in nature, aimed at addressing a loss suffered due to corporate restructuring outside the employees' control.
Not a Salary Component: Under Section 17(2) of the Income Tax Act, a perquisite is generally tied to salary income, covering benefits like rent-free accommodation or other allowances. Since the compensation related to a loss of capital rather than income from employment, the ITAT ruled it outside the scope of salary-based taxation.
Implications of the Ruling
For Employees: This judgment offers relief, especially to those who receive compensations tied to corporate events like mergers, acquisitions, or disinvestments, ensuring they won’t face an undue tax burden when compensated for a loss in the value of their stock options.
For Employers: Companies offering ESOPs need to consider this ruling when designing ESOP compensation structures, particularly in the event of corporate actions that might affectstock values. This ruling emphasizes the importance of providing clarity on the nature of compensatory payments to avoid potential tax disputes.
For Tax Authorities: The ITAT’s decision provides a nuanced interpretation of what constitutes taxable perquisites. It distinguishes between compensations related to capital losses and those derived from employment benefits, which could influence future tax assessments and disputes involving ESOPs.
The ITAT’s judgment is a pivotal one, providing clarity on the taxability of compensation for ESOP losses and offering reliefto affected employees. As ESOPs continue to be a significant part of employee compensation in high-growth sectors, thisruling will undoubtedly influence future tax considerations.
Disclaimer:
“The information contained herein is only for informational purpose and should not be considered for any particular instance or individual or entity. We have obtained information from publicly available sources, there can be no guarantee that such information is accurate as of the date it is received, or it will continue to be accurate in future. No one should act on such information without obtaining professional advice after thorough examination of particular situation.”
Author:
Harshitha Nagarajan
Prepared On:
15/04/25
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