Salary or capital gains? ITAT clarifies tax treatment of ESOP buyback payouts in Flipkart employee’s case

The tribunal held that if the options were never exercised and no shares were allotted, the amount should instead be taxed as capital gains.

The ruling came in the case (Pramod Kumar Jain vs DCIT, Circle-3(3)(1), Bengaluru). Jain, a former Flipkart employee, had received over Rs 2.33 crore when Flipkart Singapore repurchased a part of his vested ESOPs during FY 2020-21.

While Jain reported the amount as long-term capital gains (LTCG) in his income tax return (ITR), the Income Tax Department treated it as a salary perquisite under Section 17(2)(vi) of the Income-tax Act and reopened his assessment.

Allowing the taxpayer’s appeal, the ITAT held that the department’s approach was not supported by the law because the ESOPs had never been exercised and no shares had ever been allotted to the employee.

What was the dispute?

Jain worked with Flipkart Internet Pvt. Ltd. and was granted 40,536 stock options under the Flipkart Stock Option Scheme, 2012 by Flipkart Singapore. During the relevant financial year, Flipkart Singapore repurchased 2,653 vested stock options from him for Rs 2.33 crore before they were exercised.

Jain disclosed the gains under the head ‘Capital Gains’ in his income tax return.

However, the Income Tax Department took a different view. It argued that since the ESOPs were granted because of his employment and the employer had shown the amount as a perquisite in Form 16 while deducting TDS, the payout should be taxed as salary instead of capital gains.

Both the Assessing Officer and the Commissioner of Income Tax (Appeals) agreed with the department, prompting the taxpayer to approach the ITAT.

Why the ITAT ruled in favour of the employee

The Tribunal examined how an ESOP works and observed that the process broadly involves five stages—grant of the option, vesting, exercise, allotment of shares and, finally, sale of shares. In this case, only the first two stages had taken place. The employee never exercised the options and no shares were allotted.

This distinction became crucial.

The Bench held that Section 17(2)(vi), which taxes ESOPs as a perquisite, comes into play only when the option is exercised and shares are allotted to the employee. Until then, the employee merely holds a right to subscribe to shares. That right, the Tribunal said, is a capital asset and not a taxable salary perquisite.

The Tribunal also pointed out that the Income-tax Act itself provides that the value of the perquisite is to be determined on the date the option is exercised. Since there was no exercise in this case, the machinery for valuing the perquisite did not operate. It relied on the Supreme Court’s decision in CIT vs B.C. Srinivasa Setty to reiterate that where the computation mechanism fails, the charging provision itself cannot apply.

Repurchase amounted to transfer of a capital asset

After holding that an unexercised stock option is a capital asset, the Tribunal examined whether Flipkart’s repurchase amounted to a transfer.

It concluded that the repurchase extinguished the employee’s rights over the stock options and therefore constituted a transfer under the Income-tax Act. As a result, the gains were rightly taxable under the head Capital Gains, as reported by the taxpayer.

Commenting on the significance of the ruling, Jignesh Shah, Partner – Direct Tax, Bhuta Shah & Co LLP, said: “Bangalore Tribunal’s ruling is significant, though its application is largely confined to cases where vested stock options are repurchased before exercise and before any shares are allotted. Bangalore Tribunal held that taxation as a perquisite under section 17(2)(vi) of the Income-tax Act, 1961 arises only upon exercise of the option and allotment of the underlying shares.”

“Until then, the employee merely holds a right to subscribe to shares, which constitutes a capital asset. Importantly, relying on the Hon’ble Supreme Court’s decision in the case of CIT v. B.C. Srinivasa Setty (1981) 128 ITR 294 (SC), the Bangalore Tribunal reiterated that where the computation mechanism cannot operate, the charging provision itself fails. Accordingly, gains from repurchase of unexercised options were held taxable as capital gains and not salary,” Shah further said.

Form 16 and TDS are not the final word

One of the important aspects of the ruling relates to Form 16.

The tax department had relied heavily on the fact that the employer had shown the amount as salary in Form 16 and deducted tax at source under Section 192.

The Tribunal rejected that argument. It observed that TDS is only a mechanism for collecting tax in advance and does not determine the correct head of income. Taxability has to be decided strictly according to the provisions of the Income-tax Act and not merely on the basis of how the employer reported the payment.

The Bench also declined to rely on Flipkart’s own repurchase documents, noting that the tax discussion contained in those documents was only indicative and expressly advised employees to seek independent tax advice.

Explaining what employees should do in such situations, Shah said employees should independently evaluate the true character of the income rather than relying solely on its disclosure in Form No. 16. Various courts, he said, have consistently held that TDS deduction by the payer is not determinative of the correct head of income.

“Where vested stock options are repurchased before exercise and no shares were allotted, the employees may examine whether the receipt represents salary / perquisite or consideration for transfer of a capital asset based on facts of their case and the terms of ESOP scheme. The Bangalore Tribunal also noted that taxability must ultimately flow from the statute and not from the treatment adopted by the employer. Subject to facts and adequate documentation, taxpayers may report the receipt under the appropriate head and seek consequential refund of excess taxes, if any.”

What this ruling means

The ruling does not change the tax treatment of all ESOP transactions.

Instead, it draws a clear distinction between vested but unexercised stock options and exercised ESOPs.

The Tribunal itself clarified that once an employee exercises the options and shares are allotted, the provisions relating to ESOP perquisites can apply. The relief granted in this case is confined to a situation where the options were repurchased before exercise.

Summing up the broader significance of the judgment, Shah said: “The Bangalore Tribunal has reaffirmed that the tax treatment of ESOP-related receipts must be determined by the legal nature of the transaction and not merely by Form No. 16 disclosures or TDS treatment. The ruling draws an important distinction between an unexercised stock option, which constitutes a capital asset, and an exercised ESOP that may result in a taxable perquisite.”

It is important to note that this is a ruling of the Income Tax Appellate Tribunal (ITAT). ITAT decisions can be challenged before the High Court and, thereafter, the Supreme Court. Therefore, legal positions may evolve depending on further appeals.

Disclaimer: This article is for informational purposes only and does not constitute professional tax advice. Tax laws and regimes are subject to frequent changes by the government. Readers should verify details with official Income Tax Department notifications or consult a Chartered Accountant before making any financial decisions.

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