income tax

Supreme Court Ruling on ESOP Taxability: Key Insights from Infosys Case

Infosys Case: Supreme Court Rules on Taxability of Benefits from ESOPs

Introduction

On January 9, 2008, the Supreme Court delivered a significant ruling concerning the taxation of benefits related to Employee Stock Option Plans (ESOPs) in the case involving Infosys Technologies. The Court emphasized that not every benefit received by an individual is taxable unless explicitly stated by the Legislature.

Key Findings of the Supreme Court

The Supreme Court ruled that prior to the year 2000, there were no provisions in the Income Tax Act that mandated the taxation of ESOPs. Notably, the ruling included the following observations:

  • Tax Deducted at Source (TDS): ESOPs were not subject to TDS during the lock-in period as the value of the non-transferable shares (perquisite) could not be determined.
  • Clause (iiia) of Section 17: The Court determined that this Clause was prospective and not merely clarificatory, contrary to the Revenue's argument.

Background of the Case

The case stemmed from Infosys's implementation of an ESOP, wherein the Technologies Employees Welfare Trust was created. The Trust issued 750,000 warrants at a nominal value of Rs. 1 each. Each warrant entitled the holder to apply for one equity share valued at Rs. 10, for a total consideration of Rs. 100. Employees were given warrants based on various performance metrics and had to retain them for a minimum of one year.

Assessment of TDS and Perquisite Value

For the assessment years 1997-98, 1998-99, and 1999-2000, employees exercised their options at Re. 1 each. An assessment officer (AO) claimed that the market value of the shares at that time was Rs. 171 crores, resulting in a "perquisite value" calculated by the difference between the market value and the exercise price, leading to a TDS liability of Rs. 49.62 crores.

The case progressed through various authorities, including the CIT(A) and eventually the Karnataka High Court, which upheld the Tribunal's ruling that the benefits were not taxable perquisites under Section 17(2)(iii) of the Income Tax Act.

Supreme Court's Observations

Upon appeal, the Supreme Court addressed several critical components:

  1. Tax Components: Citing Govind Saran Ganga Saran Vs. Commissioner of Sales Tax, the Court reaffirmed that unambiguous provisions are necessary for a tax levy to be valid.

  2. Taxability of Benefits: The Court emphasized that a benefit must be expressly made taxable to be considered income. The provisions relating to the taxation of ESOPs came into effect only on April 1, 2000, when Section 17(2)(iiia) was inserted.

  3. Perquisite Value Assessment: Since warrants are rights without obligations, the Court held that no perquisite value could accrue when they were granted. The conditions of non-transferability during the lock-in period rendered the shares unable to generate any cash inflow.

Conclusion

The Supreme Court concluded that the AO mistakenly treated Rs. 165 crores as a perquisite value without accounting for the legislative context of the ESOPs during the assessment years in question. The Court ruled that the Department erred in imposing TDS under Section 192, confirming that the respondent was not an assessee in default. It reiterated that the absence of a clear valuation provision regarding the perquisite in this case invalidates any TDS charges, thereby aligning the ruling with existing tax principles. This landmark decision underscores the importance of legislative clarity in determining the taxability of employee benefits.