Chittharanjan A. Dasannacharya Vs CIT-V (Karnataka High Court)
The Karnataka High Court considered an appeal under Section 260A of the Income-tax Act relating to AY 2006-07. The appeal challenged the Tribunal’s decision holding that gains arising from the cashless exercise of stock options were taxable partly as salary and partly as short-term capital gains, instead of as long-term capital gains. The appeal also questioned the Tribunal’s findings that stock options were not capital assets, that cashless exercise did not constitute a transfer under Section 2(47), and that an employer-employee relationship existed between the assessee and SiRF USA.
The assessee, a software engineer, had been employed with an Indian company before being deputed to SiRF Technology Inc., USA as an independent consultant between 1995 and 1998, later serving as an employee of SiRF USA from 2001 to 2004, and thereafter returning to India. While acting as an independent consultant, he was granted stock options entitling him to purchase 30,000 shares of SiRF USA at an exercise price of US $0.08 per share. The stock option plan also permitted cashless exercise, under which the broker sold the underlying shares, deducted the exercise price, and remitted the balance proceeds without allotting the shares to the assessee. During AY 2006-07, the assessee exercised the options through the cashless mechanism, received net consideration of US $283,606, treated the gain as long-term capital gains, and claimed deduction under Section 54F.
The Assessing Officer split the transaction into two components. The difference between the market value of the shares on the date of exercise and the exercise price was assessed as income under the head “Salaries,” while the difference between the sale price and the market value on the date of exercise was assessed as short-term capital gains. The claim for deduction under Section 54F was disallowed. The Commissioner (Appeals) upheld the assessment on merits while setting aside interest under Section 234B. The Tribunal, relying on the Special Bench decision in ACIT v. Sumit Bhattacharya, held that the assessee was to be regarded as an employee for the purposes of the stock option plan and treated the benefits as salary income. Both the assessee’s and Revenue’s appeals were dismissed.
Before the High Court, the assessee contended that he was an independent consultant when the stock options were granted and that no employer-employee relationship existed with SiRF USA. It was argued that the stock options constituted capital assets under Section 2(14), that cashless exercise amounted to transfer through extinguishment of rights under Section 2(47), that the Tribunal had relied upon a Special Bench decision later reversed by the Bombay High Court, and that Section 17(2)(iiia) was not in force when the options were granted in 1996. The assessee also relied upon decisions where similar gains had been treated as capital gains.
The Revenue argued that under Clause 2(f) of the stock option plan, consultants performing services for the company were treated as employees for the purposes of the plan and therefore the Tribunal had correctly treated the receipts as salary income.
The High Court examined Clauses 2(f) and 11 of the stock option plan and the communication dated 03.08.2006 issued by SiRF USA. It held that the communication established that the assessee was an independent consultant and not an employee of SiRF USA at the relevant time. Consequently, there was no employer-employee relationship, and the Tribunal’s finding treating the receipts as salary income was held to be perverse. The Court observed that, in the absence of an employer-employee relationship, the income could not be assessed under the head “Salaries.”
The Court further held that the right to purchase shares under the stock option constituted a capital asset under Section 2(14). It observed that the cashless exercise of stock options resulted in relinquishment or extinguishment of the right to acquire the underlying shares and therefore constituted a transfer within the meaning of Section 2(47). The Court also noted that the assessee never actually received the shares under the cashless exercise mechanism. It further observed that the Tribunal had relied upon the Special Bench decision in ACIT v. Sumit Bhattacharya, which had subsequently been reversed by the Bombay High Court, and also noted that Section 17(2)(iiia) was not on the statute when the options were granted in 1996.
The High Court additionally recorded that the Revenue had accepted in several other cases that gains arising from cashless exercise of stock options were taxable as capital gains and had not challenged those Tribunal decisions. Referring to the Supreme Court’s decision in Berger Paints India Ltd., the Court held that the Revenue could not adopt a different stand in the present case.
Answering all the substantial questions of law in favour of the assessee and against the Revenue, the High Court quashed the Tribunal’s order dated 31.10.2013 and allowed the appeal.
Cases Discussed
- Sumit Bhattacharya vs. ACIT (Bombay High Court), (2020) 118 taxmann.com 371 (Bom)
- Addl. CIT vs. Bharat V. Patel (Supreme Court), (2018) 98 taxmann.com 386
- R. Ravikrishnan vs. ACIT, 2018 SCC Online ITAT 20272
- Muthian Sivathanu vs. ACIT, I.T.A. No.553/CHNY/2018 dated 24.10.2018
- Shri Kamlesh Bahedia vs. ACIT, 2014 SCC Online ITAT 3857
- Berger Paints India Ltd. vs. CIT (Supreme Court), (2004) 135 Taxman 586 (SC)
- ACIT vs. Sumit Bhattacharya (Special Bench ITAT Mumbai), (2008) 300 ITR (AT) 34 (MUM) (SB)
- Mangalore Electric Supply Co. Ltd. vs. CIT (Supreme Court), (1978) 113 ITR 655 (SC)
- Dhun Dadabhoy Kapadia vs. CIT (Supreme Court), (1967) 63 ITR 651 (SC)
- CIT vs. L.W. Russell (Supreme Court), (1964) 53 ITR 91 (SC)
FULL TEXT OF THE JUDGMENT/ORDER OF KARNATAKA HIGH COURT
This appeal under Section 260A of the Income Tax Act, 1961 (hereinafter referred to as the Act for short) has been preferred by the assessee. The subject matter of the appeal pertains to the Assessment year 2006-07. The appeal was admitted by a bench of this Court vide order dated 07.10.2014 on the following substantial question of law:
Whether, on the facts, in the circumstances and on the grounds urged:
i. The Hon’ble Tribunal was right or justified in confirming the order passed by the CIT(A) holding that the gains arising on cashless exercise of stock options would be taxable as income under the heads ‘income from salaries’ and ‘short term capital gains’, as against income under the head ‘long term capital gains’ as claimed by the Appellant?
ii. The Hon’ble Tribunal was correct in holding that stock options did not constitute a ‘capital asset’ under Section 2(14) of the Act?
iii. The Hon’ble Tribunal was right in concluding that cashless exercise of stock options does not constitute transfer of a long term capital asset under Section 2(47) of the Act?
iv. The Hon’ble Tribunal was right in holding that the difference between the option/exercise price of the stock option and the fair market value of the shares on the date of exercise of the stock options by the Appellant would be taxable under the head ‘income from salaries’ despite there being no employer-employee relationship between SiRF, USA and the Appellant?
v. The finding of the Hon’ble Tribunal that there was an employer-employee relationship between SiRF, USA and the Appellant is contrary to the material on record and thus perverse?
2. Facts leading to filing of this appeal briefly stated are that the assessee is a software engineer who was employed with Aerospace Systems Pvt. Ltd., a company registered in India between the period from 1995-1998. He was deputed to SiRF Technology Inc., U.S. in the year 1995 by Aerospace Systems Pvt. Ltd., India as an independent consultant. The appellant served SiRF USA from 1995-1998 as an independent consultant and later as an employee of SiRF USA from 2001-2004. The assessee thereafter returned to India and was employed in SiRF India. While on deputation to SiRF USA, the assessee was granted stock option by SiRF USA whereunder the assessee was given right to purchase 30,000 shares of SiRF USA at an exercise price of US $0.08 per share. The assessee also had an option of cashless exercise of stock options which is an irrevocable direction to the broker to sell the underlying shares and deliver the proceeds of sale of shares after deducting the exercise / option price which was to be delivered to SiRF USA. In cashless exercise, the underlying shares are not allotted to the assessee and he is only entitled to receive the sale proceeds less the exercise price. The assessee in assessment year 200607 exercised his right under stock option plan by way of cashless exercise and received a net consideration of US $ 283,606 and offered the gain as a long term capital gain as the stock options were held nearly for ten years. The assessee also claimed deduction under Section 54F of the Act.
3. The Assessing Officer by an order dated 26.12.2018 passed an order under Section 143(3) of the Act and artificially split the transaction into two and brought to tax the difference between the market value of shares on the date of exercise and the exercise price as ‘income from salary’ and the difference between the sale price of shares and market value of shares on the date of exercise of ‘income from short term capital gains’. The claims for deduction under Section 54F was disallowed. The assessee thereupon approached the Commissioner of Income Tax (Appeals) who by an order dated 31.10.2011 dismissed the appeal on merits. However, the interest levied under Section 234B of the Act was set aside. The assessee as well as the revenue filed the appeals before the Income Tax Appellate Tribunal (hereinafter referred to as ‘the tribunal’ for short). The tribunal by an order dated 31.10.2013 by placing reliance on a decision Special Bench of the tribunal in ACIT vs. SUMIT BHATTACHARYA, (2008) 300 ITR (AT) 34 (MUM) (SB) held that the assessee was to be regarded as employee for the purposes of the Plan and the benefits arising there from was to be treated as income in the nature of salary in the hands of the assessee. The tribunal dismissed both the appeals. In the aforesaid factual background, the assessee has approached this court.
4. Learned counsel for the assessee submitted that the finding recorded by the tribunal that assessee was an employee of SiRF USA is perverse and therefore, the finding of the tribunal that consideration received on transfer of stock options is in the nature of income from salaries cannot be sustained in the eye of law. It is further submitted that the tribunal ought to have appreciated that there was no relationship of employer and employee between SiRF USA and therefore, no part of the income from exercise of stock option can be treated as ‘income from salaries’. It is further pointed out that the tribunal ought to have appreciated that stock option was granted to the assessee when he was an independent consultant with SiRF USA and therefore, cannot be treated to be an employee for the purposes of Sections 15 to 17 of the Act. Our attention has also been invited to Clause 11 of the Stock Option Plan. It is contended that the tribunal has failed to take note of the communication dated 03.08.2006 issued by SiRF USA which clearly shows that the amount was to be treated on the gains and the tax was withheld in the USA. It is also argued that once the amount is received for transfer of the stock options is not in the nature of salaries, it can only be income from capital gains as the right to purchase the shares of the companies is a capital asset under Section 2(14) of the Act and relinquishment / extinguishment of a right in the same is a transfer within the meaning of Section 2(47) of the Act. It is urged that cashless exercise option was a transfer of capital asset by way of extinguishment of right in the capital asset. It is also pointed out that reliance of the tribunal on the decision on the special bench of the tribunal in ACIT vs. SUMIT BHATTACHARYA, (2008) 300 ITR (AT) 34 (MUM) (SB) is misconceived as the aforesaid decision was reversed by Bombay High Court in SUMIT BHATTACHARYA VS. ACIT (2020) 118 TAXMANN.COM 371 (Born) by placing reliance on the decision of the Supreme Court in Add!. CIT vs. BHARAT V. PATEL (2018) 98 TAXMANN.COM 386. It is also pointed out that at the time of grant of option in the year 1996 Section 17(2) (iiia) was not in existence. It is also urged that revenue in case of two other assessees placed in similar circumstances has accepted the fact that on cashless exercise of options, there arises income in the nature of capital gains and the revenue has not challenged the correctness of the view taken by the tribunal in the aforesaid decisions and therefore, it is not open for the revenue to challenge its correctness in case of other assesses. In support of aforesaid submissions, reliance has been placed on decisions in ‘CIT VS. L.W.RUSSEL‘, (1964) 53 ITR 91 (SC) AT PAGE 5, ‘DHUN DADABHOY KAPADIA VS. CIT‘, (1967) 63 ITR 651 (SC), ‘MANGALORE ELECTRIC SUPPLY CO. LTD. VS. CIT‘, (1978) 113 ITR 655 (SC), ‘BERGER PAINTS INDIA LTD. VS. CIT‘, (2004) 135 TAXMAN 586 (SC).
5. On the other hand, learned counsel for the revenue while inviting the attention of this court to clause 2( f) of the stock plan submitted that even an consultant who performs services for the company or a subsidiary shall be treated as an employee. Therefore, the assessee shall be treated as an employee of SiRF USA. It is further submitted that the tribunal has taken into account various provisions of the stock plan including clause 11 and has rightly concluded that the assessee was an employee of SiRF USA and the amount received by the assessee has rightly been treated as income from salary. The order passed by the tribunal is based on meticulous appreciation of material on record and does not call for any interference.
6. We have considered the submissions made by learned counsel for the parties and have perused the record. Before proceeding further, it is apposite to take note of the relevant clauses of the stock plan viz., clause 2( f) and 11, which reads as under:
2(f) Employee shall mean (i) any individual who is a common-law employee of the company or of a subsidiary, (ii) a member of the Board of Directors, or (iii) a consultant who performs services for the Company or a subsidiary. Service as a member of the Board of Directors or as a consultant shall be considered employment for all purposes under the Plan except the second sentence of Section 4(a).
11. No Employment Rights: No provision of the Plan, nor any Option granted or other right to acquire shares awarded under the Plan, shall be construed to give any person any right to become, to be treated as, or to remain an Employee. The company and its subsidiaries reserve the right to terminate any person’s service at any time and for any reason.
7. From perusal of communication dated 03.08.2006 sent by the SiRF USA to the assessee, it is evident that the assessee was an independent consultant to SiRF USA and was not an employee of SiRF USA at the relevant time. Thus, there was no relationship of employer and employee between the SiRF USA and the assessee and therefore, the finding recorded by the tribunal that the income from the exercise of stock option has to be treated as income from salaries is perverse as it is trite law that unless the relationship of employer and employee exists, the income cannot be treated as salary. [See: CIT VS. L.W.RUSSEL supra].
8. The Supreme Court in ‘DHUN DADABHOY KAPADIA AND HARI BROTHERS (P.) LTD supra has held that right to subscribe to shares of a company was treated to be a capital asset under Section 2(14) of the Act. The stock option being a right to purchase the shares underlying the options is a capital asset in the hands of the assessee under Section 2(14) of the Act, which is also evident from Explanation 1( e) to Section 2(42A) of the Act, which uses the expression ‘in case of a capital asset being a right to subscribe any financial asset’. The cashless exercise of option therefore was a transfer of capital asset by way of a relinquishment / extinguishment of right in capital asset in terms of Section 2(47) of the Act. It is also pertinent to mention that the assessee never received the shares in stock options. The tribunal also erred in placing reliance on special bench decision ACIT VS. SUMIT BHATTACHARYA which was reversed by Bombay High Court in Sumit Bhattacharya vs. ACIT supra. It is also pertinent to mention here that at the time of grant of options to the assessee in the year 1996, Section 17(2)(iiia ) of the Act was not there in the statute.
9. It is pertinent to mention here that the revenue in case of several other assessee’s have accepted the fact that on cashless exercise of option, there arises a income in the nature of capital gains. However, in the case of the assessee the aforesaid stand was not taken. It is also pertinent to mention here that nothing was brought to our notice that the view taken by the tribunal in the following cases has been challenged by the revenue.
- SHRI KAMLESH BAHEDIA VS. ACIT (2014 SCC ONLINE ITAT 3857),
- R.RAVIKRISHNAN VS. ACIT, 2018 SCC ONLINE ITAT 20272
- MUTHIAN SIVATHANU VS. ACIT I.T.A.NO.553 /CHNY /2018 DATED 24.10.2018.
10. Therefore, in view of law laid down by the Supreme Court in Berger paints supra, it was not open for the revenue to take one stand in case of the assessee and to challenge the correctness of the same in case of other assessee. For this reason also, the revenue cannot be permitted to take a different view in this appeal.
In view of preceding analysis, the substantial questions of law framed by in this appeal are answered in favour of the assessee and against the revenue. In the result, the order passed by the Income Tax Appellate Tribunal dated 31.10.2013 is hereby quashed. In the result, the appeal is allowed.
