A sweat equity case had to sweat it out at the apex court recently. It was about the ESOP (employees stock option) scheme of Infosys, the Bangalore-based information technology giant.
As you may know, the current law is clear. The benefit arising under an ESOP is taxable as fringe benefit tax (FBT) on the date on which the options vest with the employee; and FBT is payable by the employer at the time of allotment or transfer of shares to the employee. Further, the employer has been given an option to recover the FBT from the employee.
"Nevertheless, the Infy decision highlights and reiterates a few fundamental principles of taxation, while at the same time providing guidance as to the basis of taxation of any benefit provided to an employee by his employer," opines Mr Vikas Vasal, Executive Director, KPMG. Accordingly, the principles laid down in this decision are equally applicable in the case of other business transactions, he adds.
First, the story. The company had implemented an ESOP scheme by creating Technologies Employees Welfare Trust, and allotting 7,50,000 warrants at Re 1 each to the Trust. "Each warrant entitled the holder thereof to apply for and be allotted one equity share of the face value of Rs 10 each for total consideration of Rs 100. The Trust was to hold the warrant and transfer the same to the employees of the company under the terms and conditions of the scheme governing ESOP," informs a paragraph in the text of the Supreme Court verdict dated January 4.
Read on: "During the assessment years 1997-98, 1998-99 and 1999-2000, warrants were offered to the eligible employees at Re 1 each by the Trust. They were issued to employees based on their performance, security and other criteria. Under the ESOP scheme, every warrant had to be retained for a minimum period of one year. At the end of that period, the employee was entitled to elect and obtain shares allotted to him on payment of the balance Rs 99. The option could be exercised at any time after 12 months but before expiry of the period of five years. The allotted shares were subject to a lock-in period."
During the lock-in period, the custody of shares remained with the Trust and the shares were non-transferable. "The employee had to continue to be in service for five years. If he resigned or if his services were terminated for any reason, he lost his right under the scheme and the shares were to be re-transferred to the Trust for Rs 100 per share. Intimation was also given to BSE that 7,34,500 equity shares were non-transferable and would not constitute good delivery. Till September 13, 1999, all the shares were stamped with the remark `non-transferable'. Thus the said shares were incapable of being converted into money during the lock-in period."
ESOPs met with trouble at the taxman's end. "For the assessment year 1999-2000, the assessing officer held that the total amount paid by the employees consequent to the exercise of option was Rs 6.64 crore whereas the market value of those shares on the date of exercise of option was Rs 171 crore. He held that the `perquisite value' was the difference between the market value and the price paid by the employees for exercise of the option. He, therefore, treated Rs. 165 crore as `perquisite value' on which TDS (tax deducted at source) was charged at 30 per cent."
He said that Infy was at default for not deducting TDS under Section 192 amounting to Rs 49.52 crore on the above perquisite value, and passed similar orders for the preceding two assessment years. The Bangalore CIT (Commissioner of Income-tax) confirmed the AO's order. And, at the subsequent two levels of appeal, viz. the tribunal and the High Court, the company met with no relief.
"It is pertinent to note that a new provision, taxing the benefit arising under an ESOP at the time of exercise was introduced for the first time with effect from April 1, 2000," states Mr Vasal, discussing the verdict over an e-mail exchange with Business Line. "This provision laid out the mechanism as to how the benefit is to be computed and accordingly the terms `value' and `cost' were specified. This provision was deleted from the very next year, that is, from April 1, 2001."
Justices S. H. Kapadia and B. Sudershan Reddy of the apex court noted that till April 1, 2000, value of the option was not ascertainable, in the absence of a definition of `cost'. However, the Memorandum to the Finance Act, 1999 had not said that the new mechanism would operate retrospectively.
Which explains why the court had to apply the principles laid down by it in the B. C. Srinivasa Setty case and hold that the value of the options was not ascertainable in the absence of the definition of `cost', Mr Vasal reasons.
Another important observation of the court was that unless a benefit/receipt is made taxable, it couldn't be regarded as income. "This is an important principle of taxation under the 1961 Act," the court said, considering the focus of the case on the value of a perquisite prior to April 1, 2000, rather than taxability.
"In the instant case, in absence of a legislative mandate a potential benefit could not be considered as income of the employee," Mr Vasal elaborates. "Also, the shares allotted to the employee had no realisable sale value on the day when he exercised his option as there was no cash inflow to the employee. Further, the same was subject to lock-in period of five years during which these shares were non-transferable."
Of interest is the reference in the judgment to `the four components of tax,' as laid down in Govind Saran Ganga Saran vs Commissioner of Sales Tax (1985). "The first component is the character of the imposition, the second is the person on whom the levy is imposed, the third is the rate at which tax is imposed and the fourth is the value to which the rate is applied for computing tax liability," the court recounted. If there were ambiguity in any of the four concepts then the levy would fail, the court added. Relevant to the Infy case was the fourth concept.