No tax on ESOPs, rules apex court

The Supreme Court has ruled that the benefit given to the staff of a company under the employees' stock option scheme (ESOPs) cannot be considered taxable income and the company not obliged to deduct tax at source.

The court, thus, dismissed the appeal of the Commissioner of Income Tax, Bangalore against the judgment of the Karnataka High Court that had ruled in favour of Infosys Technologies Ltd, India's second largest IT services provider.

The company had created the Technologies Employees Welfare Trust in 1999 and allotted 750,000 warrants at Re 1 each. Such warrants could be used after a five-year lock-in period to obtain shares. The plan was floated because of buy-back problems when employees left their jobs for one reason or the other.

The stock exchange was informed that the shares were non-transferable during the lock-in period.

The tax authorities, however, determined that the total amount paid by employees while exercising their option was Rs 6.64 crore whereas the market value of those shares was Rs 171 crore.

The difference was treated as "perquisite value" on which tax deducted at source was charged at 30 per cent. The company was treated as a defaulter for not deducting the perquisite value of Rs 165 crore.

The tax tribunal and the High Court, however, held in favour of Infosys when it moved the courts.

Dismissing the appeal of the tax authorities, the Supreme Court bench headed by Justice S H Kapadia ruled that the company was not bound to deduct tax on the amount earned by its employees exercising stock options granted to them through the trust.

"A warrant is a right without obligation to buy. Therefore, [a] perquisite cannot be said to accrue at the time when the warrants were granted," the judgment explained.

The employee could resign, and there was no certainty that his option would be exercised after the lock-in period. "The benefit, if any, which arose on the date when the option stood exercised was only a notional benefit, the value of which was unascertainable," Justice Kapadia said.

The court also asserted that a change in the law introduced in the Finance Act in 2000 was not retrospective but prospective and unless a benefit was in the nature of income it was not taxable.