Stock appreciation rights

Written by HP Ranina | Updated: Sep 28 2008, 07:15am hrs
Stock appreciation rights generally provide an employee with a cash payment based on the increase in the value of a number of shares over a specific period of time. Stock appreciation rights do not have a settlement date. The employees have the flexibility to decide the time for exercising them, of course within a time frame, on the expiry of which the right would lapse. In effect, stock appreciation right schemes provide a form of deferred cash compensation, which is contingent upon financial performance of the company.

When a stock option is exercised, an employee has to pay the grant price and acquire the underlying security. However, when a stock appreciation right is exercised, the employee does not have to pay to acquire the underlying security. Instead, the employee would receive the appreciation value of the underlying security, which would be equal to the current market value less the grant price. In character, therefore, a stock appreciation right is not the same thing as a typical stock option. Unlike a stock option plan, which aims at what can be termed as employees' participation in ownership, a stock appreciation right is a scheme of bonus payment, which is on the basis of the financial performance of the company. This point was considered by a special bench of the income tax appellate tribunal in Sumit Bhattacharya v CIT (300 ITR (AT) 347).

The facts in this case were that the assessee was employed as managing director of PGI, which was part of a group of companies headed by PGU of the USA. In January 1998, the assessee received a sum of $12,38,084.02, which was equivalent to Rs 4,79,13,851.58, from PGU, on account of redemption of certain stock appreciation rights granted in October 1997, in accordance with and subject to the terms of the PG Stock Plan. The manner in which these stock appreciation rights worked was as follows.

A grantee was allotted stock appreciation rights in respect of a specified number of shares in PGU. The agreed price of the shares, which normally reflected the market price as on the date of granting the rights, was taken as the grant value. The grantee could exercise the right to redeem the appreciation in value of these shares after one year from the date of the grant. The assessee had to use this redemption right within ten years from the date of grant of these rights. On redemption of stock appreciation, the grantee would get the excess of the market price of the shares as on the redemption date over the grant value of those shares.

No shares were actually allotted or given to the grantee. The rights of the grantee were confined to claiming the appreciation in value in respect of the shares in question. The assessee claimed that this amount was not taxable in his hands as income from salaries because the assessee did not have any employer- employee relationship with PGU, i.e., the grantor of the stock appreciation rights and that the grant of stock option was not liable to tax. The assessee submitted that at best the stock appreciation rights could be taxed at the point of time when they were granted but since grant was at the market value of shares, no advantage was accrued to the assessee. Those payments were, according to the assessing officer, profits of the assessee's employment. The view of the assessing officer was confirmed in appeal, by the commissioner (appeals). On appeal, the tribunal held that the amount received by the assessee on redemption of share appreciation rights was in the nature of consideration for services rendered by the assessee and nothing but a deferred wage contingent upon performance of the company's shares in the market. The very preamble to the plan, under which share redemption rights were given to the assessee, also stated that it was in the nature of deferred awards related to the increase in the price of the common stock of the company.

It was in consideration of the assessee agreeing not to leave employment of PG and any of its subsidiary companies for a period of one year, and not to engage in competitive business for three years that the assessee got the stock appreciation rights. The assessee had no connection with PGU other than as an organisation connected with the company with which he had entered into an employment contract, The assessee's receipts of whatever nature, in connection with his employment, were to be taxable under the head salaries.

In the case of stock appreciation rights, what the assessee actually receives is a kind of cash bonus, which is in the nature of deferred wages and which is contingent upon the company doing well in financial terms. There is no need, as in the case of stock options, in converting the benefit into monetary terms because what is received by the assessee is itself in monetary terms.

As the redemption amount is dependent on the market price of shares, which can move in any direction at any time, the income arises only when the stock appreciation rights are redeemed.

According to the tribunal, grant of a stock appreciation right gives some benefit to the assessee, and such a benefit is contingent upon the market behaviour for the value of the shares in question. An anticipated income cannot be brought to tax until it actually accrues or unless there is a specific provision to that effect. Therefore, the benefit on the account of stock appreciation rights cannot be taxed in the year of grant or vesting, but only in the year of redemption.

The special bench of the tribunal concluded that even if the amount received by the assessee on redemption of share appreciation rights was held to be not taxable under the head salaries, this fact, by itself, would not take it outside the ambit of taxable income, since, in such an eventuality, the amount would be taxable under the head income from other sources. Redemption of stock appreciation rights was an employment-related benefit, in the nature of deferred wages contingent upon the financial performance of the ultimate employer, i.e., the parent company of the company with which the assessee had entered into an employment contract. In coming to this conclusion, the court relied on the judgment of the Supreme Court in Emil Webber v CIT (200 ITR 483). While the assessee may appeal against this decision as a substantial question of law is involved, it is unlikely that the tribunal's order will be reversed.

The author is advocate, Supreme Court