Infosys case : SC rules every benefit is not taxable as income; Prior to 2000 – No provision in I-T Act to tax ESOPs – TDS not applicable as value of shares as perquisite not ascertainable; Clause (iiia) of Sec17 was prospective and not clarificatory
NEW DELHI, JAN 09, 2008 : IN a remarkably interesting ruling, involving the IT giant Infosys Technologies, the Apex Court has held that every benefit received by a person is not taxable as income unless the Legislature makes the same taxable. For period prior to 2000, there were no provisions in the Income Tax Act to tax ESOPs. As regards the TDS, it noted that ESOPs were not taxable during the lock-in period as the value of non-transferable shares (perquisite) was not ascertainable. As regards the Clause (iiia) of Sec 17 the SC held that it was not clarificatory as argued by the Revenue and very much prospective if one goes by the wordings used in the Clause and the explanatory memorandum of the Finance Act, 1999.
Brief facts of the case :
To implement Employees Stock Option Scheme (“ESOP”), the assessee created a Trust – Technologies Employees Welfare Trust, and allotted 7,50,000 warrants at Rs. 1/- each to the said Trust. Each warrant entitled the Holder thereof to apply for and be allotted one equity share of the face value of Rs. 10/- each for total consideration of Rs. 100/-. The Trust was to hold the warrant and transfer the same to the employees of the company under the Terms and Conditions of the scheme governing ESOP. During the assessment years 1997-98, 1998-99 and 1999-2000, warrants were offered to the eligible employees at Re. 1/- each by the Trust. They were issued to employees based on their performance, security and other criteria. Under the ESOP Scheme, every warrant had to be retained for a minimum period of 1 year. At the end of that period, the employee was entitled to elect and obtain shares allotted to him on payment of the balance Rs. 99. The option could be exercised at any time after 12 months but before expiry of the period of 5 years. The allotted shares were subject to a lock-in period. During the lock in period, the custody of shares remained with the Trust. The shares were non-transferable. The employee had to continue to be in service for 5 years. If he resigned or if his services be terminated for any reason, he lost his right under the scheme and the shares were to be re-transferred to the Trust for Rs.100 per share. Intimation was also given to BSE that 734500 equity shares were non-transferable and would not constitute good delivery. Till 13.9.1999 all the shares were stamped with the remark “non-transferable” . Thus the said shares were incapable of being converted into money during the lock in period.
For the assessment year 1999-2000, the AO held that the total amount paid by the employees consequent to the exercise of option was Rs. 6.64 Cr whereas the market value of those shares was Rs 171 Cr. He held that the “perquisite value” was the difference between the market value and the price paid by the employees for exercise of the option. He, therefore, treated Rs. 165 crores as ”perquisite value” on which TDS was charged at 30%. It was held that the respondent-assessee was a defaulter for not deducting TDS under Section 192 amounting to Rs 49.62 crores on the above perquisite value of Rs. 165 crores. Similar orders were also passed by the AO for assessment years 1997-98 and 1998-99. These orders were confirmed by CIT(A). No weightage was given by both the authorities to the lock in period. Both the authorities took into account the “perquisite value” as on the date of exercise of option.
Aggrieved assessee carried the matter in appeal to the Tribunal, which took the view that the right granted to the employee for participating in the scheme was not a “perquisite” under Section 17(2)(iii) of the Income Tax Act. The Tribunal’s decision was confirmed by the Karnataka High Court (2007-TIOL-95- HC-KAR-IT) , and the Revenue took the matter to the Apex Court.
After hearing both the parties the Bench observed that,
++ In the case of Govind Saran Ganga Saran Vs. Commissioner of Sales Tax, this Court had held that there are four components of tax. The first component is the character of the imposition; the second is
the person on whom the levy is imposed; the third is the rate at which tax is imposed and the fourth is the value to which the rate is applied for computing tax liability. It was further held that if there is ambiguity in any of the four concepts then levy would fail;
++ In this case, the forth concept is in dispute. There is one, more principle which is required to be noted. A benefit/receipt under the 1961 Act must be made taxable before it can be regarded as “income”;
++ During the AYs 1997-98, 1998-99 and 1999-2000 there was no provision in the said I-T Act which made the benefit by way of ESOP taxable as income specifically. It became specifically taxable only with effect from 1.4.2000 when Section 17(2) (iiia) stood inserted;
++ Since taxability is not the issue in these civil appeals, the value of a perquisite is to be considered;
++ Warrant is a right without obligation to buy. Therefore, “perquisite” cannot be said to accrue at the time when warrants were granted in this case. Same would be the position when options vested in the employees after lapse of 12 months;
++ Further, it was open to the employees not to avail of the benefit of option. It was open to the employees to resign. There was no certainty that the option would be exercised. Further, the shares were not transferable for five years (lock-in period), if an employee resigned during the lock-in period the shares had to be re-transferred. During the lock in period, the possession of the shares, which is an important ingredient of shares remained with the Trust. The Stock Exchange was duly notified about non-transferability of the shares during the lock in period. It was not open to the employees to hypothecate or pledge to said shares during the lock-in period. During the said period, the said shares have no realisable value, hence, there was no cash inflow to the employees on account of mere exercise of options;
++ On the date when the options were exercised, it was not possible for the employees to foresee the future market value of the Shares. Therefore, in our view, the benefit, if any, which arose on the date when the option stood exercised was only a notional benefit whose value was unascertainable;
++ Thus, the Department had erred in treating Rs 165 crores as perquisite value being the difference in the market value of shares on the date of exercise of option and the total amount paid by the employees consequent, upon, exercise of the said options.
The Bench also did not find merit in the contention advanced on behalf of the Department that Section 17(2)(iiia) inserted by Finance Act, 1999 w.e.f. 1.4.2000 was clarificatory and therefore, retrospective in nature.
The Bench observed that,
++ unless a benefit/receipt is made taxable, it cannot be regarded as “income”. This is an important, principle of taxation under the 1961 Act. Applying the above principle to the insertion of clause (iiia) in Section 17(2) one finds that for the first time w.e.f. 1.4.2000 the word “cost” stood explained to mean the amount actually paid for acquiring specified securities and where no money had been paid, the cost was required to be taken as nil;
++ In CIT vs B.C. Srinivasa Setty case (2002-TIOL-587- SC-IT-LB) this Court had held that the charging section, and computation provision under the 1961 Act constituted an integrated code;
++ The mechanism introduced for the first time under the Finance Act, 1999 by which “cost” was explained in the manner stated above was not there prior to 1.4.2000. The new mechanism stood introduced w.e.f. 1.4.2000 only. With the above definition of the word “cost” introduced vide clause (iiia), the value of option became ascertainable. There is nothing in the Memorandum to that Finance
Act, 1999 to say that this new mechanism would operate retrospectively;
++ Further, a mechanism which explains “cost” in the provisions cannot be read retrospectively unless the Legislature expressly says so. It was not capable of being implemented retrospectively. Till 1.4.2000, in the absence of the definition of the word “cost” value of the option was not ascertainable;
++ In our view, clause (iiia) is not clarificatory. Moreover, the meaning of the words “specified securities” in section (iiia) was defined or explained for the first time vide Finance Act, 1999 w.e.f. 1.4.2000. Moreover, the words allotted or transferred in clause (iiia) made things clear only after 1.4.2000. Lastly, it may be pointed out that even clause (iiia) has been subsequently deleted w.e.f. 1.4.2001. For the aforestated reasons, we are of the view the clause (iiia) cannot be read as retrospective.
Finally, in the background of lucid illustration of the laws prevailing during the relevant period, the Bench held that every benefit received by the person is not taxable as income. In our view, it is not so. Unless the benefit is made taxable, if cannot, be regarded as income. During the relevant assessment years, there was no provision in law which made such benefit taxable as income. Further, as slated, the benefit was prospective. In this case, the shares could not be obtained by the employees till the lock-in period was over. On facts, we hold that in the absence of legislative mandate a potential benefit could not be considered as “income” of the employee(s) chargeable under the head “salaries”. The stock was non-transferable and the stock exchange was also accordingly notified. This is where the weightage ought to have been given by the AO to an important factor – the lock in period. This has not been done. It is important to bear in mind that if the shares allotted to the employee had no realizable sale value on the then there was no cash inflow to the employee. It was not possible for the employee to know the future value of the shares allotted to him on the day he exercises his option. Even the cost of acquisition as “nil” came to be introduced in the 1961 Act by the Finance Act, 1999 only with effect from 1.4.2000.
The Bench was thus of the view that the Department had erred in treating Rs. 165 crores as a perquisite value. During those years, the fifth anniversary had not taken place and, therefore, it was not possible for the assessee company to estimate the value of the perquisite during that period, it was not open to the Department to ignore the lock in period. Therefore, the Department had erred in treating the respondent herein as an assessee in default for not deducting the TDS at 30% as stated in the order of assessment. This is not the case of tax evasion. The assessee had floated the Trust because of the buy back problems, which were genuine problems in cases where the employees stood dismissed, removed or in the case of resignation in which cases they were required to return the allotment.
Estimation of TDS under Section 192 in the absence of clear provisions on valuation of “perquisite” in this case would not justify the Department in treating the respondent as assessee in default, Therefore, in our view, the AO and the CIT(A) had erred in treating the respondent as defaulter for not deducting TDS under Section 192. Consequently, Section 201(1) and 201(1A) were also not applicable to the facts of this case and that the Department had erred in invoking the said two sections against the assessee, the Bench held.