ESOP share sale not taxable as capital gains where no cost of acquisition existed and exercise and sale occurred on the same day

Shares acquired under an ESOP were treated as a capital asset, but no short-term capital gain arose because the assessee incurred no cost of acquisition and the then-applicable regime did not tax the stock-option benefit as fringe benefit. Applying the rule that capital gains cannot be computed where the cost of acquisition is indeterminable, the sale proceeds could not be brought to tax. Even on the alternative view that exercise date market value was a deemed benefit, the shares were exercised and sold on the same day, so no taxable gain emerged.

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Issues: Whether the amount realised on sale of shares acquired under an employees stock option plan was taxable as capital gains, and if so whether any taxable gain arose when no cost of acquisition was incurred and the option was exercised and sold on the same day.

Analysis: The shares obtained under the stock option plan were treated as a capital asset, so the receipt on sale fell to be examined under the head of capital gains. The assessee had not made any payment for acquiring the shares, and the statutory regime then in force did not tax the stock-option benefit as a fringe benefit. Applying the principle that where the cost of acquisition is indeterminable no capital gains computation can be made, the amount realised could not be brought to tax. Even on the alternative assumption that the market value at exercise represented a deemed benefit, the exercise and sale occurred on the same date, leaving no taxable difference between acquisition value and sale proceeds.

Conclusion: The amount received on sale of the ESOP shares was not taxable as short-term capital gains, and the addition was deleted.

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