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The Mumbai ITAT held that Fair Market Value(‘FMV’) of ESOP shares on the exercise date would constitute the cost of acquisition under section 49(2AA) of the Income-tax Act, 1961 (the ‘Act’), notwithstanding that the related ESOP perquisite was not taxable in India. The Tribunal ruled that section 49(2AA) of the Act does not require actual taxation of the perquisite in India and directed recomputation of capital gains by considering FMV of ESOP shares as the cost of acquisition.
BRIEF FACTS OF THE CASE1
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The taxpayer was an individual who qualified as a non-resident in India during the relevant year and was also a tax resident of the United Kingdom. He was employed with the UK branch of L&T Infotech Ltd. and rendered services outside India.
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Under the employee stock option scheme of the employer, the taxpayer was granted 7,700 stock options in respect of shares of L&T Infotech Limited, an Indian listed company, at an exercise price of Rs. 1 per share. The options were scheduled to vest in five tranches.
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During FY 2018-19, the taxpayer exercised the first vested tranche comprising 1,540 options by paying the specified exercise price. Pursuant thereto, 1,540 shares were allotted and credited to his demat account.
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The fair market value of the shares on the exercise date, determined in accordance with Rule 3(8)(ii) of the Income-tax Rules, 1962 (the ‘Rules’), was approximately INR 1,753.58 per share, whereas the exercise price paid by the taxpayer was Rs. 1 per share. Accordingly, the difference represented the ESOP perquisite value.
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The taxpayer contended that the ESOP benefit pertained to employment exercised outside India and consequently did not accrue or arise in India. It was further submitted that the perquisite value had been subjected to tax in the United Kingdom.
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During the same year, the taxpayer sold all 1,540 shares through a recognised stock exchange for an aggregate consideration of approximately Rs. 26 lakh. While computing capital gains, he adopted the FMV on the exercise date as the cost of acquisition in accordance with section 49(2AA)of the Act, resulting in a short-term capital loss.
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The Assessing Officer rejected the claim on the ground that since the ESOP perquisite was not taxable in India, the benefit of section 49(2AA) of the Act was unavailable. The Assessing Officer therefore considered only the exercise price as the cost of acquisition and assessed the difference as taxable short-term capital gains. The DRP affirmed the Revenue's position.
ASSESSEE’SCONTENTIONS:
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Section 49(2AA) of the Act specifically provides that cost of acquisition of ESOP shares shall be the FMV adopted for purposes of section 17(2)(vi) of the Act. The provision does not require the perquisite to have been taxed in India.
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The ESOP benefit arose from employment exercised outside India and therefore was not taxable in India under the domestic law framework governing taxation of non-residents.
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Under Article 16 of the India-UK DTAA, remuneration relating to employment exercised outside India could not be taxed in India. Consequently, the ESOP perquisite fell outside Indian taxing rights.
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Denial of FMV as cost would effectively result in indirect taxation of the same ESOP benefit under the capital gains provisions despite India not having taxing rights over the underlying perquisite.
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The taxpayer also invoked the non-discrimination provisions under Article 26 of the India UK DTAA, arguing that a non-resident employee should not be placed in a less favourable position than a resident employee for purposes of section 49(2AA)of the Act.
AO’S CONTENTIONS:
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Since the ESOP perquisite did not form part of taxable income in India, the benefit of section 49(2AA) of the Actwas unavailable.
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The cost of acquisition should be restricted to the amount actually paid by the taxpayer for acquiring the shares, namely the exercise price.
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The subsequent transfer of shares of an Indian company gave rise to capital gains taxable in India and such gains should be computed by considering the exercise price as cost and not the fair value of the shares on the date of exercise.
ITAT’S OBSERVATIONS:
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The expression "taken into account" used in section 49(2AA) of the Act has a wider import and refers to FMV determined under the valuation mechanism prescribed under section 17(2)(vi) of the Act read with Rule 3 of the Rules. It does not require that the resulting perquisite should have actually formed part of taxable income in India.
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Computation of perquisite value and chargeability of such perquisite operate in different fields. Consequently, non-taxability of the ESOP perquisite in India does not affect determination of cost of acquisition under section 49(2AA)of the Act.
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To infer that the ESOP perquisite must have been first taxed in India before section 49(2AA) of the Act can apply, would amount to importing words into the statute that Parliament has consciously not enacted.
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The judicial precedents relied upon by the Revenue primarily dealt with taxation of salary/perquisites in the hands of non-residents and did not examine the scope of section 49(2AA) of the Act while determining the cost of acquisition of ESOP shares. Accordingly, such precedents were held to be distinguishable.
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The Tribunal also disagreed with the DRP's distinction between perquisites taxed in India and perquisites taxed overseas, noting that section 49(2AA) of the Act itself draws no such distinction.
Accordingly, the taxpayer was entitled to adopt the FMV determined on the exercise date as the cost of acquisition while computing capital gains on subsequent transfer of the shares.
AURTUS COMMENTS
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This ruling provides guidance on the interpretation of section 49(2AA) of the Act in the context of cross-border ESOP arrangements. The Tribunal has held that availability of FMV as the cost of acquisition is linked to the valuation mechanism prescribed under section 17(2)(vi) of the Act and is not dependent on whether the corresponding perquisite was taxable in India.
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This judgement may provide respite to expatriate employees who would not have paid any tax on the ESOP shares in India but can still take FMV of ESOP shares as deemed cost of acquisition for the purpose of capital gains calculation at the time of transfer of the said shares.
Footnote
1 Rajesh R Hemrajani v. ITO (ITA No. 1284/Mum/2025)
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