ITAT Holds That Repurchase Of Vested But Unexercised ESOPs Is Taxable As Capital Gains And Not Salary

The Bangalore Bench of the ITAT has delivered an important ruling clarifying the tax treatment of consideration received on repurchase of vested but unexercised employee stock options (ESOPs). The Tribunal held that such consideration is taxable as capital gains and not as salary since the options were never exercised and no shares were allotted.

BRIEF FACTS OF THE CASE¹

• The Assessee was employed with Flipkart Internet Private Limited (‘FIPL’), an Indian company and a step-down subsidiary of Flipkart Private Limited, Singapore (‘FKS’). During the course of his employment, the Assessee was granted 40,536 stock options under the Flipkart Stock Option Plan, 2012 (‘FSOP2012’) byFKS.
• During FY 2019-20, FKS offered to repurchase certain vested stock options. Pursuant thereto, the Assessee surrendered 2,653 vested stock options for a consideration of approximately INR 2.34 Crore. Notably, the stock options were never exercised and no underlying shares were allotted to the Assessee.
• While filing his return of income, the Assessee offered the gains arising from such repurchase to tax under the head "Capital Gains". However, the Assessing Officer (‘AO’) held that the consideration represented a perquisite arising from employment and was taxable under the head "Salaries" under section 17(2)(vi) of the Income-tax Act, 1961 (‘the Act’). Accordingly, reassessment proceedings were initiated and the amount received on repurchase of the vested stock options was brought to tax as salary income.
• TheCommissioner of Income-tax (Appeals) ['CIT(A)'] upheld the AO's findings. Aggrieved by the order of the CIT(A), the Assessee preferred an appeal before the Bangalore Bench of the Income TaxAppellate Tribunal(‘ITAT’)

ASSESSEE’SCONTENTIONS:

• The Assessee contended that the stock options granted under the FSOP 2012 were never exercised and no underlying shares were ever allotted. Since section 17(2)(vi) of the Act taxes the value of a "specified security" on the date of exercise of the option, the necessary condition for taxation as a perquisite was never satisfied.
• It was further submitted that a vested stock option merely confers a right to subscribe to shares at a future date and constitutes a "capital asset" within the meaning of section 2(14) of the Act. Accordingly, the repurchase of such vested stock options by FKS amounted to a transfer of a capital asset under section 2(47), and the gains arising therefrom were rightly offered to tax as Long-Term Capital Gains under section 45of the Act.
• TheAssessee also contended that the consideration was received from FKS, which was not its employer. Therefore, the tax treatment indicated in the repurchase offer documents, or the deduction of tax at source under section 192 and disclosure in Form 16, could not determine the correct head of income, which had to be decided in accordance with the provisions of the Act.

AO’S CONTENTIONS:

• TheAOcontended that the stock options were granted to the Assessee solely by virtue of his employment with FIPLunder the group-wideFSOP2012.Accordingly,theconsideration received on repurchase of such options constituted a benefit arising from employment and wastaxableas aperquisite under section 17(2)(vi) of the Act.
• TheAOfurthersubmittedthattheemployerhadclassified the repurchase consideration as a perquisite in Form 16 and deducted tax at source under section 192 of the Act. In addition, the Letters of Offer governing the repurchase expressly provided that the consideration would be taxable under the head "Income from Salaries". Accordingly, the Assessee could not subsequently re-characterise the receipt as capital gains while filing the return of income.
• TheAOalsoarguedthatthedecisions relied upon by the Assessee were distinguishable on facts and therefore had no application to the present case. Accordingly, the amount received on repurchase of the vested stock options was liable to be assessed under the head"Salaries" and not as capital gains.

ITAT’S OBSERVATIONS:

• The ITAT analysed the lifecycle of an ESOP and observed that it comprises five distinct stages, namely issuance of option, vesting, exercise of option, allotment of shares and sale of shares. In the present case, only the first two stages had occurred, since the vested stock options were never exercised and no underlying shares were ever allotted to the Assessee.
• TheITAT observed that section 17(2)(vi) of the Act taxes the value of a "specified security" allotted or transferred by the employer to an employee. The Tribunal noted that the mechanism prescribed under Explanation (c) to section 17(2)(vi) determines the value of such specified security with reference to the fair market value on the date the option is exercised. Accordingly, the exercise of the option is the taxable event for invoking the perquisite provisions.
• Sincethe stock options were never exercised, the Tribunal held that no "specified security" came into existence and, consequently, no value could be assigned for the purposes of section 17(2)(vi). Relying on the Supreme Court's decision in CIT v. B.C. Srinivasa Setty, the Tribunal reiterated that where the computation provisions fail, the charging provision itself cannot operate. Therefore, the consideration received on repurchase of the vested stock options could not betaxed as a perquisite under the head"Salaries".
• TheTribunal further held that a vested stock option merely represents a right to subscribe to shares at a future date and constitutes a capital asset under section 2(14) of the Act. Accordingly, the repurchase of such vested stock options amounted to a transfer of a capital asset within the meaning of section 2(47), and the gains arising therefrom were chargeable to tax under the head"CapitalGains“
• The ITAT also rejected the Revenue's reliance on Form 16, the deduction of tax at source under section 192 and the indicative tax treatment contained in the repurchase documentation, holding that the correct head of income must be determined in accordance with the provisions of the Act and cannot be governed by the characterization adopted bythe employer or the payer.
• Theruling provides important guidance on the tax treatment of ESOP-related transactions involving the repurchase of vested but unexercised stock options. The ITAT has reaffirmed that the perquisite taxation mechanism under section 17(2)(vi) of the Act is triggered only upon the exercise of stock options resulting in the allotment or transfer of the underlying specified securities.
• The decision also reinforces that the correct head of income must be determined in accordance with the provisions of the Act and cannot be governed solely by the employer's withholding position or the characterization adopted in contractual documentation. The ruling is likely to have wider relevance for multinational groups implementing global ESOP plans involving buybackor cash settlement of vested stock options prior to exercise.

Footnote

1 Pramod Kumar Jain Vs. DCIT [ITA 3034/BANG/2025]

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