Facts of the Case

The petitioner, a former employee of Flipkart Internet Private Limited, challenged an order dated 15.07.2023 passed under Section 197 of the Income Tax Act, 1961 rejecting his application for a Nil Tax Deduction at Source (TDS) certificate.

Under the Flipkart Stock Option Plan (FSOP), the petitioner had been granted stock options by the Singapore parent entity. Following the disinvestment of PhonePe by Flipkart Pvt. Ltd., the value of these stock options declined. As a one-time measure, the parent company decided to pay USD 43.67 per option as compensation for the diminution in value of unexercised options.

Issues Involved

  1. Whether compensation for loss in value of unexercised ESOPs constitutes a taxable perquisite under Section 17(2)(vi).
  2. Whether such payment forms part of “salary” under the Income Tax Act.
  3. Whether the petitioner was entitled to a Nil TDS certificate under Section 197.

Petitioner’s Arguments

The petitioner argued that ESOPs represent merely a right to subscribe to shares and become taxable only when exercised or when shares are subsequently sold. Since the options had not been exercised, no taxable event had occurred.

It was further contended that the payment was voluntary and unrelated to employment, as it was made by the parent company at its discretion to compensate for loss in value following corporate restructuring.

Reliance was placed on judicial precedents distinguishing capital receipts from revenue receipts and emphasizing that voluntary payments without consideration may not constitute taxable income.

Respondent’s Arguments

The Revenue contended that the payment was linked to ESOPs and therefore constituted a perquisite taxable under the head “Salaries.” It argued that compensation for diminution in value of stock options should receive the same tax treatment as ESOP benefits.

The Revenue also submitted that Section 197 proceedings are administrative in nature and that the authority was not required to conduct an in-depth factual inquiry. Additionally, it was argued that since the transaction had already occurred, the petition had become infructuous.

Court Order / Findings

  • ESOPs constitute a right, not an obligation, to acquire shares.
  • Taxation of ESOP benefits under Section 17(2)(vi) arises only when options are exercised and shares are allotted or transferred.
  • In the present case, the petitioner had not exercised the options; therefore, the statutory conditions for treating the benefit as a perquisite were not satisfied.
  • The compensation was a one-time voluntary payment made at the discretion of the company and not pursuant to any contractual or legal obligation.
  • The payment did not arise from employment and could not be classified as salary.
  • The characterization of payment by the deductor (payer) is not determinative of taxability; the true nature of the receipt must be examined.

Important Clarification

The judgment clarifies that compensation paid for diminution in value of unexercised ESOPs is not automatically taxable as salary or perquisite. Taxability depends on the occurrence of a statutory trigger—exercise or transfer of shares.

It also underscores that voluntary payments unrelated to employment obligations may constitute capital receipts and cannot be taxed merely because they arise in the context of employee benefits.

This ruling has significant implications for employees and former employees receiving ESOP-related compensation, especially in cases of corporate restructuring, buybacks, or spin-offs.

Link to download the order -  https://www.mytaxexpert.co.in/uploads/1772178407_SANJAYBAWEJAVsDEPUTYCOMMISSIONEROFINCOMETAXTDSCIRCLE771DELHIANR.pdf  

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