Voluntary ESOP-Related Payments Under Disinvestment Compensation Not Taxable As Salary Perquisite under Section 17 of the IT Act 

Voluntary ESOP – Section 17(2), read with Rule 3 of the Income Tax Rules, provides for the valuation of perquisites for computing taxable income under the head ‘Salary.’

As per Section 17(2)(vi) of the IT Act, the value of any specified security or sweat equity shares (voluntary ESOP) allotted or transferred, directly or indirectly, by the employer, or former employer, free of cost or at a concessional rate to the taxpayer is taxable in the hands of employees as ‘perquisite’. The differential value between Fair Market Value (FMV) and exercise price of Voluntary ESOP shall be regarded as perquisite. Taxability arises on the exercise of option by employee otherwise allotment of specified security or sweat equity shares (Voluntary ESOP) is not a taxable event.

In this case, Sanjay Baweja v. DCIT[i], the Delhi High Court (‘DHC’) addresses the tax implications of a one-time voluntary payment (‘OTVP’) made by Flipkart Pvt. Ltd., Singapore (‘FPS’) to its employees, specifically concerning stock options under the Flipkart Stock Option Plan (‘FSOP’).

The petitioner Mr. Sanjay Baweja is an ex-employee of the company namely Flipkart Internet Private Limited [“FIPL”] which is a wholly owned subsidiary of Flipkart Marketplace Private Limited [“FMPL”]. In addition thereto, the FMPL is the wholly-owned subsidiary of Flipkart Pvt. Ltd., Singapore [“FPS”].

 In 2012, the FPS rolled out an Employee Stock Option Plan [“ESOP”] called as Flipkart Stock Option Plan [“FSOP”], wherein, the FPS granted certain stock options to the eligible persons, including employees of its subsidiaries. As per the clauses of FSOP, the petitioner was granted 1,27,552 stock options on and from 01.11.2014 to 31.11.2016 with a vesting schedule of 4 years.

On 23.12.2022, FPS announced the disinvestment of its wholly- owned subsidiary called PhonePe. Thereafter, the value of the stock options of FPS fell pursuant to the disinvestment and subsequent remittances to the shareholders of FPS on account of dividend payments, buy-back etc. Consequently, on 21.04.2023, the petitioner received a communication from FPS stating that as a one-time measure, FPS had decided to grant the option holders a payment of USD 43.67 per option as compensation towards loss in the value of the options and it was based on the number of options held by the petitioner as on 23.12.2022. Furthermore, it was also stated that the FPS would be withholding tax on the said compensation. Subsequently, the petitioner preferred an application under Section 197 of the Act seeking a „Nil‟ declaration certificate on the deduction of TDS by FPS. Based on application received, the Revenue passed the impugned order dt: 31 May 2024 rejecting the petitioner‟s application on the score that the amount received would be in the nature of perquisite under Section 17(2)(vi) of the Act.

Mr. Tarun Gulati, learned Senior Counsel, appearing on behalf of the petitioner submitted that SOPs are taxable only in two contingencies, firstly, when the employee exercises his option and secondly, when the shares are sold by an employee. He iterated that in the present case, the stock options were merely held by the petitioner and the same had not been exercised till date. Furthermore, he argued that the one-time voluntary payment made by FPS was not in relation to the employment of the petitioner with FIPL and thus, cannot partake the character of salary which was liable to be taxed under Section 15 of the Act.

The Hon’ble Delhi High Court held that voluntary payment received in lieu of diminution in the value of unexercised Voluntary ESOP is not a perquisite, but rather a capital receipt. While coming to this conclusion. the Hon’ble Delhi High Court made the following observations:

• From the detailed calculation of the vesting of options, it is undisputed that the taxpayer has not exercised his vested right with respect to stock options under ESOP to date, which signifies that the right of holding the stocks under his name had not been exercised.

• The determination as to whether a particular receipt would be tantamount to a capital receipt or revenue receipt is dependent on the facts of a particular case. The Hon’ble Supreme Court in Saurashtra Cement Ltd. has laid out a similar principle while ruling on capital receipt vis-à-vis revenue receipt.

• Reliance placed by the taxpayer on the Hon’ble Supreme Court’s decision in the case of Shrimant Padmaraje R. Kadambande is affirmed wherein a one-time voluntary cash allowance was given to the taxpayer and it was held that it was a capital receipt not liable to tax.

• Reliance was also placed on the Hon’ble Supreme Court’s decision in the case of Godrej and Co.⁶ wherein it was held that one-time payments given to the taxpayer in lieu of a change in contractual terms between the taxpayer and the management company are capital receipts and thereby not taxable.

• The tax officer’s contention that the facts pertaining to the exercise of the options held by the taxpayer were not apprised to him in the proceedings is incorrect since the taxpayer had duly placed the details relating to ESOP in the application made under Section 197 of the IT Act.

• Reliance placed by the tax authorities on the Hon’ble Supreme Court’s decision in National Petroleum Construction Co. is misplaced since the issue, in that case, pertained to the determination of permanent establishment in Section 197 proceedings.

• It is pertinent to note that the manner or nature of payment, as comprehensible by the deductor, would not determine the taxability of such transaction. It is the quality of payment that determines its character and not the mode of payment. Unless the charging Section of the Act elucidates any monetary receipt as chargeable to tax, the tax authorities cannot proceed to charge such receipt as revenue receipt and that too on the basis of the manner or nature of payment, as comprehensible by the deductor.

• Reference was also made to the decision of the Hon’ble Supreme Court in the case of Empire Jute Co. Ltd. wherein it was held that the fact that a certain payment constitutes income or capital receipt in the hands of the recipient is immaterial in determining whether the payment is revenue or capital disbursement qua the payer. Whether a particular expenditure is capital or revenue should be determined on the basis of the nature of transaction and other relevant factors.

• Explanation (c) to Section 17(2)(vi) of the IT Act provides that the value of specified security –  could only be calculated when the option is exercised. A literal understanding of the provision would provide that the value of specified securities or sweat equity shares is dependent upon the exercise of the option by the taxpayer. Therefore, for an income to be included in the inclusive definition of ‘perquisite’, it is essential that it is generated from the exercise of options, by the employee.

• However, the present facts of the case suggest that the stock options were merely held by the taxpayer and the same were not exercised to date therefore, they do not constitute income chargeable to tax in the hands of the taxpayer as none of the contingencies specified in Section 17(2)(vi) of the IT Act have occurred.

• FPS was under no legal or contractual obligation to provide compensation for loss in current value or any potential losses on account of future accretion to the ESOP holders. FPS, at its own discretion, has estimated and decided to pay USD 43.67 as compensation for each stock option as held on the record date.