UK-Based Employee Wins ESOP Tax Case After Rs 26 Lakh Share Sale Is Questioned

A United Kingdom (UK)-based has won relief from the Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) after the tax department disputed the way he calculated gains on shares acquired through an employee stock option plan (ESOP).

The taxpayer, Hemrajani, was employed with the UK branch of L&T Infotech and had received ESOPs as part of his remuneration. During assessment year 2019-20, he exercised 1,540 options at Re 1 per share. The fair market value (FMV) of the shares on the exercise date was around Rs 1,754 per share.

He later sold the 1,540 listed shares through a recognised stock exchange for about Rs 25.99 lakh.

Why The Tax Department Disputed The Calculation

While calculating capital gains, Hemrajani treated the FMV on the date of exercise as the cost of acquisition under Section 49(2AA) of the Income-tax Act, 1961. On that basis, he reported a short-term capital loss of about Rs 1 lakh, according to a recent report by The Economic Times.

The difference between the exercise price and the FMV had already been taxed as an employment perquisite in the UK.

The assessing officer, however, took a different view. Since the ESOP perquisite was not taxable in India, the officer held that the benefit of Section 49(2AA) was not available. The cost of acquisition was, therefore, restricted to the actual exercise price of Re 1 per share.

This turned what the taxpayer had reported as a loss into a sizeable taxable gain. The Dispute Resolution Panel also upheld the assessing officer’s approach, prompting Hemrajani to approach the ITAT.

What Mumbai ITAT Said

The tribunal disagreed with the tax authorities. It observed that Section 49(2AA) provides a specific method for determining the cost of acquisition of specified securities or sweat equity shares received through ESOPs.

Under the provision, the relevant cost is the FMV taken into account for valuing the perquisite under Section 17(2)(vi). The tribunal said the law does not require that the perquisite must actually have been taxed in India for this valuation rule to apply.

In other words, valuation of the ESOP perquisite and the question of where that perquisite is ultimately taxed are separate issues.

The ITAT directed the assessing officer to recompute the capital gains by taking the exercise-date FMV as the cost of acquisition. The taxpayer’s appeal was accordingly allowed.

The ruling is important for employees working overseas who receive shares of an Indian company through ESOPs. It underlines that the statutory method of determining acquisition cost cannot be altered merely because the related employment benefit was taxed in another country.

FAQs

1. What did the Mumbai ITAT rule on the cost of ESOP shares?
The ITAT held that the fair market value on the date of exercising the ESOP should be treated as the cost of acquisition for calculating capital gains.

2. Does Section 49(2AA) apply if the ESOP perquisite was taxed outside India?
Yes. The tribunal said the provision does not require the ESOP perquisite to have actually been taxed in India for the FMV-based acquisition cost to apply.

3. Why is this ruling important for employees working overseas?
It clarifies that employees receiving Indian-company ESOPs may use the prescribed FMV as the acquisition cost even when the employment benefit was taxed in another country.