The Delhi High Court (‘HC’) held that one-time voluntary payment for diminution in unexercised ESOP value is capital receipt and not taxable as perquisite under section 17(2)(vi) of the Income Tax Act, 1961 (‘the Act’).

Brief Background

• The Assessee was granted stock options of the Company vesting over four years. The company announced disinvestment plans of one of its businesses which led to fall in stock option value and therefore, offered one-time compensation to option holders;
• The stock options were merely held by the Assessee and the same was not exercised till date;
• The issue in hand is whether it is chargeable to tax as perquisite under section 17(2)(vi) of the Act or not.

Key excerpts from the ruling

• The ruling specifies that revenue cannot be a tax receipt unless elucidated as taxable by the charging section. Value of specified security can be calculated only when option is exercised and in the instant case, stock options were merely held by Assessee not exercised.
• The one-time voluntary payment made on behalf of the company to the petitioner cannot be pegged as perquisite under Section 17(2)(vi) of the Act as the petitioner has not exercised his vested right with respect to stock option, which signifies that the right of holding the stocks under his name had not been exercised.
• The amount in question was a one-time voluntary payment made to all option holders in lieu of disinvestment of existing business. The management of Company in its communication said that it was under no legal or contractual right to provide compensation for loss in current value or any potential losses on account of future accretion to the ESOP holders, and that the Company, on its own discretion, has estimated and decided to pay compensation for each stock option as held on the record date.
• The Court held that that it was compensation/ voluntary payment made without any legal or contractual obligation and is nowhere linked to Assessee’s employment.
• Therefore, the amounts received by the assessee should not be subject to perquisite taxation.

This ruling will carry a lot of weightage specific to stock options scheme / phantom stocks / SAR’s especially while adopting a view that payment against such schemes is not subject to perquisite taxation. Therefore, it is imperative to analyse the ESOP policy if such a view is possible or not. Needless to say, the position adopted in this regard should also be in congruence with TDS/ withholding tax obligations from the Company perspective.