2025 (6) TMI 1329 - HC - Income Tax

Nil Tax Deduction Certificate for Income Tax u/s 197 - FPS introduced the Flipkart Stock Action Plan 2012 (FSOP) pursuant to which the petitioner was granted 2232 stock options with a vesting schedule of four years - one time compensatory payment due to reduction/diminishing of the value of the stock options issued in favour of the petitioner - Petitioner is an Indian Citizen and a salaried employee of Flipkart Internet Private Limited (FIPL) which is an Indian Subsidiary of Flipkart Marketplace Private Limited (FMPL) a Company incorporated in Singapore which is further a wholly owned subsidiary of Flipkart Private Limited Singapore (FPS) - Whether compensation received by him for reduction/diminution of the value of FSOPs was taxable as a perquisite under the head Income from Salary and that the profit or gain on sale/transfer of stocks exercised under FSOPs is liable to be taxed under the head Income from Capital Gains ? - HELD THAT - In the instant case the material on record discloses that undisputedly the petitioner did not exercise his options under the subject FSOPs nor was there any allotment or transfer of shares in his favour and the subject compensation was paid to him only towards compensation for loss on reduction/diminution in the value of stock options held by the petitioner; it is significant to note that FSOPs would become taxable only under two circumstances viz. when the petitioner exercises his option and the differential amount is taxed or when the shares allotted to him are either sold or transferred thereby becoming taxable as capital gain; as stated supra the petitioner neither exercises his option nor sold or transferred his shares and FPS made the subject payment in favour of the petitioner only towards reduction/diminution of the value of FSOPs and consequently the impugned order deserves to be quashed on this ground. The material on record indicates that the subject one time compensatory payment made to the petitioner is in the nature of capital receipt and the same cannot be brought to tax under any other Head of income including other sources and Capital receipt which is not chargeable under Section 45 of the I.T. Act is not chargeable under any other head. It is also relevant to state that in the instant case the cost of acquisition of stock auctions by the petitioner cannot be determined and therefore Section 48 of the I.T. Act cannot be applied; similarly Section 45 is not applicable because the charging section and the computation section constitute an integrated code as held by the Apex Court in Mathuram Agarwal s case 1999 (10) TMI 125 - SUPREME COURT The material on record discloses that FSOPs are a right but not an obligation to buy the underlying instrument and represent a right to subscribe to the shares of a Company. On vesting the option holder acquires an unfettered right to exercise the option and get the allotment of shares. The FSOPs have not been exercised yet and there are no shares in existence which have been allotted or transferred. A voluntary one-time payment of this nature before the allotment of shares cannot be taxed as perquisites. The stage from allotment of Stock Options to the sale of allotted shares is as follows a. Issuance of Stock Options b. Vesting of Stock Options c. Exercise of Stock Options d. Issuance of shares e. Sale of shares Out of all the stages explained above ESOPs are taxable at two instances. Firstly where an employee exercises his option then the difference between the fair market value and the exercise price is taxable as perquisite under Section 17(2)(vi) of the I.T. Act. Secondly when the shares so allotted or transferred are sold by the employee it is taxable as capital gains under Section 45 of the I.T. Act. In the present case only the vesting of FSOPs has taken place to the petitioner. At this stage there is no question of any income being computed on the FSOPs under the provisions of the Act. In any case a one-time voluntary payment made by FPS without any corresponding contractual obligation and where a number of FSOPs admittedly remains the same does not constitute a revenue receipt that can be subject to Income Tax. Delhi High Court in Sanjay Baweja s case 2024 (6) TMI 78 - DELHI HIGH COURT while dealing in the exact facts and circumstance where the onetime payment made by FPS on account of diminution of value of stock option pursuant to the divestment of PhonePe was held to be perquisites under Section 17(2)(vi) of the I.T. Act by the Revenue the Court while quashing the impugned order passed under Section 197 of the Act held that a. Section 17(2)(vi) I.T. Act does not apply before the exercise of options and before the issuance of shares. b. A onetime voluntary payment is a capital receipt and not a revenue receipt. c. Merely because the deductor has sought to deduct TDS would not determine the taxability of a transaction. d. The payment was not linked to the employment of the petitioner. e. There was no transfer of any stock options by the petitioner. f. The petitioner was entitled to apply for a refund of TDS as the amount received was not taxable in his hands. The above judgment was rendered in the case of another Employee of Flipkart in the identical set of facts and the very same transaction which is the subject matter of the present writ petition and the reasoning of the judgment squarely applies to the facts of the instant case of the petitioner. 1st respondent clearly fell in error in rejecting the application filed by the petitioner seeking issuance of Nil Tax Deduction Certificate in relation to the subject compensation amount by passing the impugned order which is illegal arbitrary and contrary to facts and law as well as the aforesaid principles and statutory provisions and consequently the impugned order deserves to be set aside and the application filed by the petitioner deserves to be allowed by directing the respondents to issue Nil Tax Deduction Certificate in favour of the petitioner within a stipulated timeframe. The respondents are directed to issue Nil Tax Deduction Certificate in favour of the petitioner as sought for by him together with all consequential benefits flowing therefrom as expeditiously as possible and at any rate within a period of six weeks from the date of receipt of a copy of this order.

Summary

The core legal questions considered in this judgment are:

1. Whether the one-time compensatory payment received by the petitioner for diminution in value of stock options (FSOPs) constitutes taxable income under the head "Income from Salary" as a perquisite under Section 17(2)(vi) of the Income Tax Act, 1961 ("I.T. Act") or is a capital receipt not chargeable to tax.

2. Whether the compensation payment can be treated as income chargeable under any other head, including capital gains under Section 45 or income from other sources.

3. Whether the petitioner's application under Section 197 of the I.T. Act for issuance of a 'Nil Tax Deduction Certificate' was rightly rejected by the Income Tax authorities.

4. Whether the availability of an alternative remedy under Section 264 of the I.T. Act bars the petitioner from approaching the High Court under Article 226 of the Constitution.

Issue-wise Detailed Analysis:

1. Nature of the One-Time Compensatory Payment: Capital Receipt or Taxable Income?

The petitioner received a one-time payment of Rs. 71,01,004/- as compensation for the reduction in value of the FSOPs following the divestment of PhonePe by Flipkart Private Limited, Singapore (FPS). The petitioner contended that this payment was a capital receipt and not taxable income, as it was a voluntary compensation for diminution in value of stock options which had not yet been exercised or converted into shares.

The respondents (Revenue) argued that the payment was taxable as income from salary, specifically as a perquisite under Section 17(2)(vi) of the I.T. Act, since it related to stock options granted by the employer or former employer.

The Court examined the legal framework and precedents, notably the landmark judgment in Padmaraje R. Kadambande v. CIT, where the Supreme Court held that "income" under Section 2(24) connotes a periodical monetary return from a definite source and excludes mere windfalls or voluntary payments without consideration. The Privy Council judgment in CIT v. Shaw Wallace & Co. was also pivotal, holding that compensation received as solatium for compulsory cessation of business or agency is a capital receipt, not taxable as business income.

The Court further analyzed a series of Supreme Court decisions such as Vijay Ship Breaking Corporation v. CIT, Canara Bank v. CIT, Ellis Bridge Gymkhana v. CIT, Kettlewell Bullen & Co. Ltd. v. CIT, Karam Chand Thapar & Bros. Pvt. Ltd. v. CIT, Oberoi Hotel (P) Ltd. v. CIT, Godrej & Co. v. CIT, and Senairam Doongarmall v. CIT, which collectively establish that compensation for loss or diminution of a capital asset or profit-making structure is a capital receipt and not taxable as income, unless it falls within the exceptions where the compensation is part of normal business or trading receipts.

Applying these principles, the Court found that the one-time payment was a voluntary, discretionary compensation for diminution in value of stock options, which are rights but not obligations to acquire shares. The petitioner had not exercised the options, nor was there any allotment or transfer of shares. The payment was not linked to salary or employment per se but was a capital receipt for loss of value of a profit-making structure.

2. Taxability of the Payment as Salary or Perquisite under Section 17(2)(vi)

The respondents contended that the payment constitutes a perquisite taxable under Section 17(2)(vi) of the I.T. Act, which includes the value of specified securities or sweat equity shares allotted or transferred by the employer or former employer.

The Court examined the statutory language and relevant case law, including the Supreme Court's decision in Srinivasa Shetty's case, which clarifies that ESOPs are taxable only upon exercise of the option and allotment of shares, and the value of the perquisite is the difference between the fair market value and the exercise price on the date of exercise.

Since the petitioner had not exercised the stock options and no shares had been allotted or transferred, the payment could not be treated as a perquisite. The Court noted that the value of specified securities for perquisite taxation is determinable only upon exercise of options, which had not occurred.

The Court also relied on the Division Bench judgment of the Delhi High Court in Sanjay Baweja v. DCIT, which dealt with identical facts and held that such one-time voluntary payments made by FPS for diminution in value of stock options are capital receipts and not taxable as perquisites under Section 17(2)(vi). The Court distinguished the contrary view taken by the Madras High Court in Nishithkumar Mukeshkumar Mehta v. DCIT, noting that the Delhi High Court's decision is binding and has not been challenged by the Revenue.

3. Applicability of Capital Gains Tax under Section 45 or Income from Other Sources

The Revenue argued that if not taxable as salary, the payment should be taxed as capital gains or income from other sources.

The Court referred to the Supreme Court's decision in D.P. Sandu Bros. Chembur (P.) Ltd. v. CIT, which held that capital gains chargeable under Section 45 constitute income, but if the computation provisions cannot be applied (e.g., cost of acquisition is indeterminable), the receipt cannot be taxed under any other head. The Court also cited Cadell Weaving Mill Co. Ltd. v. CIT, which emphasized that capital gains not chargeable under Section 45 are not income under Section 2(24).

Since the petitioner's stock options had no ascertainable cost of acquisition and no exercise or transfer had taken place, the payment could not be taxed as capital gains. Nor could it be taxed as income from other sources under Section 56, as the charging provisions for capital gains are an integrated code and the receipt did not satisfy those provisions.

4. Maintainability of the Petition and Alternative Remedy under Section 264

The Revenue contended that the petitioner's challenge to the impugned order was not maintainable due to the availability of an alternative remedy of revision under Section 264 of the I.T. Act.

The Court observed that the impugned order was passed with approval of the Commissioner of Income Tax, and the revision remedy under Section 264 would lie before the same authority or an authority of equal rank, rendering it an ineffective remedy ("appeal from Caesar to Caesar").

The Court relied on the Delhi High Court's decision in Manpowergroup Service India (P.) Ltd. v. CIT and the Bombay High Court's decision in Tata Teleservices (Maharashtra) Ltd. v. DCIT, which held that in such circumstances, writ jurisdiction under Article 226 is maintainable.

5. Application of Law to Facts and Treatment of Competing Arguments

The Court carefully examined the facts, including the nature of the FSOP, the vesting and exercise schedule, and the fact that the petitioner had not exercised the options or received shares. It considered the one-time voluntary payment as a capital receipt compensating for diminution in value due to divestment of PhonePe.

The Court rejected the Revenue's contention that the payment was taxable as a perquisite, holding that the statutory provisions and judicial precedents require exercise of options and allotment of shares before taxability arises under Section 17(2)(vi).

The Court gave due weight to the binding precedent of the Delhi High Court and distinguished the contrary Madras High Court ruling, noting pending appeal against the latter.

The Court also rejected the Revenue's argument that the petitioner's failure to disclose all facts before the Assessing Officer in Section 197 proceedings justified rejection, noting that the petitioner had provided all relevant details and the Revenue had not sought further clarification.

The Court emphasized that the Revenue's unilateral decision to withhold tax does not determine taxability and that the character of the receipt must be determined by law and facts.

Significant Holdings:

"It is well settled that TDS cannot be deducted if payment does not constitute income and the power of the respondents-revenue to direct deduction of tax under Section 197 of the I.T. Act can be exercised only if there is an income chargeable to tax."

"Income, their Lordships think, in the Indian Income Tax Act, 1961 defines in an inclusive manner what 'income' is. The word 'income' connotes periodical monetary return coming in with some regularity or expected regularity from definite sources... excluding anything in the nature of a mere windfall." (Padmaraje R. Kadambande case)

"The compensation received in this case was chargeable to tax is supported by Hancock v. General Reversionary and Investment Co.; Commissioners of Inland Revenue v. Newcastle Breweries; ... but where the sum received is in the nature of a solatium for cessation of a part of the business, the sum received is a capital receipt." (Shaw Wallace case)

"Where on a consideration of the circumstances, payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business, ... the receipt is revenue: where by the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of the assessee's income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt." (Kettlewell Bullen & Co. Ltd. case)

"The perquisites, as defined in Section 17(2) of the Act, constitute a list of benefits or advantages, which are made taxable and are incidental to employment and received in excess of salary. The value of any specified security or sweat equity shares shall be the fair market value on the date on which the option is exercised by the assessee."

"The one-time voluntary payment made by FPS was not linked to the employment of the petitioner. Section 17(2)(vi) I.T. Act does not apply before the exercise of options and before the issuance of shares." (Delhi High Court in Sanjay Baweja's case)

"Capital gains chargeable under Section 45 alone are treated as income by the Legislature. Capital gains not chargeable for any reason under Section 45 cannot be brought to tax as income under any other head." (D.P. Sandhu Bros. case)

"The impugned order passed by the 1st respondent rejecting the application filed by the petitioner under Section 197 of the I.T Act for issuance of 'Nil Tax Deduction Certificate' is illegal, arbitrary and contrary to law and facts and the same deserves to be quashed."

Final Determinations:

- The one-time voluntary compensatory payment received by the petitioner for diminution in value of FSOPs is a capital receipt and not taxable as income under any head, including salary or capital gains.

- The payment does not qualify as a perquisite under Section 17(2)(vi) of the I.T. Act as the petitioner had not exercised the stock options nor had shares been allotted or transferred.

- The impugned order rejecting the petitioner's application for a Nil Tax Deduction Certificate under Section 197 is quashed.

- The respondents are directed to issue the Nil Tax Deduction Certificate to the petitioner within six weeks.

- The availability of an alternative remedy under Section 264 does not bar the petitioner from invoking writ jurisdiction under Article 226.