The Bengaluru Income Tax Appellate Tribunal (ITAT) has ruled that payouts for repurchased, unexercised ESOPs are taxable as Long-Term Capital Gains (LTCG) at 12.5%, rather than as salary perquisites taxed at over 30%. This decision offers potential tax relief for employees, though tax experts warn that authorities may still challenge such arrangements under anti-avoidance rules.
The Bengaluru bench of the Income Tax Appellate Tribunal (ITAT) has provided a significant clarification regarding the tax treatment of Employee Stock Options (ESOPs). In a ruling involving a Flipkart executive, the tribunal determined that money received for the buyback of vested but unexercised ESOPs should be classified as Long-Term Capital Gains (LTCG) rather than salary income.
This distinction is important because of the difference in tax rates. Under current tax laws, salary income is taxed based on the employee's income slab, which can exceed 30% for high earners. In contrast, LTCG on such assets is taxed at a lower rate of 12.5%. The case involved Pramod Kumar Jain, an executive at the company, who received ₹2.33 crore for the repurchase of 2,653 ESOPs.
The tax department had initially argued that this payout was a salary benefit, or perquisite, and should be taxed accordingly. However, the ITAT disagreed, stating that the rule which taxes ESOPs as salary applies only when an employee exercises the option and receives shares. The tribunal concluded that until the exercise occurs, the employee holds a contractual right, which qualifies as a capital asset. Therefore, giving up this right in a buyback deal amounts to a transfer of a capital asset, making the proceeds eligible for capital gains tax treatment.
While this ruling provides a clear path for lower tax liability in similar situations, it does not guarantee automatic tax savings for all employees. Financial and tax experts emphasize that the outcome is highly dependent on the specific structure of the ESOP buyback agreement. Companies must structure these transactions as a clear repurchase and cancellation of options to potentially qualify for this benefit.
There is also a notable risk that tax authorities may still scrutinize such arrangements. Authorities could invoke the General Anti-Avoidance Rules (GAAR) if they believe the primary motive behind the transaction is tax avoidance rather than a genuine business or commercial decision. Because of this uncertainty, some companies may continue to withhold taxes as salary to remain on the safer side, leaving it to employees to claim a refund later by declaring the income as capital gains.
As Flipkart is a private company and not listed on public stock exchanges, this ruling does not impact any share prices. The primary takeaway for employees holding unexercised ESOPs is the importance of reviewing their specific option agreements and consulting with tax advisors to understand the potential implications of any buyback or repurchase offers.