2008 (1) TMI 17 - SC - Income Tax

Tax authority wrongly treated employee stock options held through trust as perquisite; s.192 and ss.201(1)/201(1A) inapplicable

COMMISSIONER OF INCOME-TAX Versus INFOSYS TECHNOLOGIES LTD.

SC held that the tax department erred in treating the value of employee stock options held through a trust as a perquisite for AYs 1997-2000 and in ... Deduction of tax at source (TDS) u/s 192 - income earned by employees from exercise of stock option granted to them by the company through the Trust - Meaning of 'perquisite' u/s 17(2)(iii) - Whether 'perquisite' could be said to accrue at the time when warrants were granted or at the time when the option vested in the employee or at the time when the options stood exercised or at the time when the lock-in conditions were removed or at the time when the shares were to be sold in the share market. HELD THAT:- As stated, unless a benefit/receipt is made taxable, it cannot be regarded as 'income'. This is an important principle of taxation under the 1961 Act. Applying the above principle to the insertion of clause (iiia) in Section 17(2) one finds that for the first time w.e.f. 1.4.2000 the word 'cost' stood explained to mean the amount actually paid for acquiring specified securities and where no money had been paid, the cost was required to be taken as nil. On facts, we hold that in the absence of legislative mandate a potential benefit could not be considered as 'income' of the employee(s) chargeable under the head 'salaries'. The stock was non-transferable and the stock exchange was also accordingly notified. This is where the weightage ought to have been given by the Assessing Officer to an important factor, namely, lock in period. This has not been done. It is important to bear in mind that if the shares allotted to the employee had no realizable sale value on the day when he exercised his option then there was no cash inflow to the employee. It was not possible for the employee to know the future value of the shares allotted to him on the day he exercises his option. Even the cost of acquisition as 'nil' came to be introduced in the 1961 Act by the Finance Act, 1999 only with effect from 1.4.2000. In fact, the later deletion of clause (iiia) is an indicator of the Ineffective Charge. Thus, we are of the view that the Department had erred in treating Rs. 165 crores as a perquisite value for the assessment years 1997-98, 1998-99 and 1999-2000. During those years, the fifth anniversary had not taken place and, therefore, it was not possible for the assessee company to estimate the value of the perquisite during that period. It was not open to the Department to ignore the lock in period. Therefore, the Department had erred in treating the respondent herein as an assessee in default for not deducting the TDS at 30% as stated in the order of assessment. This is not the case of tax evasion. The assessee had floated the Trust because of the buy back problems, which were genuine problems in cases where the employees stood dismissed, removed or in the case of resignation in which cases they were required to return the allotment. Estimation of TDS under Section 192 in the absence of clear provisions on valuation of 'perquisite' in this case would not justify the Department in treating the respondent as assessee in default. Therefore, in our view, the Assessing Officer and the CIT(A) had erred in treating the respondent as defaulter for not deducting TDS under Section 192. Consequently, Section 201(1) and 201(1A) were also not applicable to the facts of this case and that the Department had erred in invoking the said two sections against the assessee. We express no opinion on the law prevailing after 1.4.2000 except to the extent indicated hereinabove. Accordingly, we find no merit in these civil appeals which stand dismissed. Issues Involved:1. Tax Deduction at Source (TDS) under Section 192 of the Income Tax Act, 1961.2. Definition and timing of 'perquisite' under Section 17 of the Income Tax Act, 1961.3. Applicability and retrospectivity of Section 17(2)(iiia) of the Income Tax Act, 1961.4. Valuation of perquisites and the impact of the lock-in period on the valuation.Detailed Analysis:1. Tax Deduction at Source (TDS) under Section 192 of the Income Tax Act, 1961:The primary issue was whether the respondent-assessee was required to deduct TDS on the amount earned by its employees from the exercise of stock options granted through the Trust. The Assessing Officer (AO) had determined that the 'perquisite value' was the difference between the market value of the shares and the price paid by the employees at the time of exercising the option, resulting in a significant TDS liability. However, the Tribunal and the Karnataka High Court ruled that the benefit from the ESOP scheme was not a 'perquisite' under Section 17(2)(iii) of the Income Tax Act, 1961, during the relevant assessment years.2. Definition and timing of 'perquisite' under Section 17 of the Income Tax Act, 1961:The court examined whether 'perquisite' could be said to accrue at various stages: when warrants were granted, when the option vested, when the options were exercised, when the lock-in conditions were removed, or when the shares were sold. The AO had considered the perquisite value to arise at the time of exercising the options. However, the court noted that during the lock-in period, the shares were non-transferable and had no realizable value, making the benefit only notional and unascertainable at the time of exercising the options.3. Applicability and retrospectivity of Section 17(2)(iiia) of the Income Tax Act, 1961:The court addressed whether Section 17(2)(iiia), inserted by the Finance Act, 1999, effective from 1.4.2000, was clarificatory and thus retrospective. The court concluded that the section was not retrospective as it introduced a new mechanism for defining 'cost' and 'specified securities,' which was not present before 1.4.2000. The court emphasized that for a benefit to be taxable, it must be explicitly included as income by the Legislature.4. Valuation of perquisites and the impact of the lock-in period on the valuation:The court highlighted that the shares during the lock-in period were non-transferable and had no realizable value, which the AO failed to consider. The benefit, if any, arising from the exercise of options was notional and unascertainable due to the lock-in period and the uncertainty of future market value. The court held that the Department erred in treating Rs. 165 crores as perquisite value and the respondent as a defaulter for not deducting TDS.Conclusion:The court concluded that the Department had erred in treating the respondent as an assessee in default for not deducting TDS under Section 192. The court found no merit in the civil appeals and dismissed them with no order as to costs. The court also clarified that it expressed no opinion on the law prevailing after 1.4.2000, except as indicated in the judgment.