KPMG Flash News 13 October 2011

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1 KPMG IN INDIA KPMG Flash News 13 October 2011 TAX Right to exercise an option to sell stock allotted under the Employee Stock Option Plan (held through a Trust) to be considered as a capital asset. Background The Honourable Delhi Income Tax Appellate Tribunal 1 ( ITAT ) has held that allotment of non-distinctive number of shares issued under the Employee Stock Option Plan ( ESOP ) through a Trust cannot be detrimental to the proposition that taxpayer s valuable right of claiming shares was held in Trust. Accordingly, such definite, valuable and transferrable rights can be termed as a capital asset and taxable as long term capital gain (as held for more than 36 months). Facts of the Case During the Financial Year ( FY ) , taxpayer was an employee of M/s. PepsiCo India Holdings (P) Ltd. ( PHIL ) in an executive position. PHIL is a part of PepsiCo Inc. The taxpayer was granted valuable rights in shares of PepsiCo Inc. under the ESOP scheme of PepsiCo Inc. The stocks were held with Barry group of Merrill Lynch USA ( The Trust ). The rights were conferred on various dates during the FY and FY The taxpayer sold these shares on 25 February 2004 relevant to FY The taxpayer received the differential amount between gross sale consideration and the cost price (price agreed at the time of grant to be paid for acquiring the right). 1 Abhiram Seth vs JCIT in ITA No. 2302/Del/2010 1

2 Taxpayer filed his Return of Income ( ROI ) of FY , considering the gains on such sale as long term capital gain and claimed exemption under section 54F of the Income- tax Act, 1961( the Act ) by investing the sale proceeds in a residential house. An initial intimation was passed in the normal course for the said ROI. Subsequently, the assessment was reopened. The Assessing Officer ( AO ) was of the view that the capital gains were short term capital gains and not eligible for exemption in respect of investment in residential house. During reassessment, AO held that, the issue date or date of grant was immaterial. The shares were allotted to the taxpayer and sold by him on the same day. Accordingly, they were liable to tax as short term capital gains. The taxpayer preferred an appeal before the Commissioner of Income Tax (Appeals) [ CIT(A) ]. The CIT(A) relied on the ITAT decision in the case of Jaswinder Singh Ahuja 2 and upheld the AO s order. The taxpayer, being aggrieved by the CIT(A) s order filed an appeal before the ITAT. Issue before the ITAT Whether capital gains derived by the taxpayer on account of transfer of ESOP shares be characterized as long term capital gains? Taxpayer s Contention The reliance placed by the AO on various cases 3, was misplaced because facts of taxpayer s case was materially different. The ESOP scheme and especially the terms stock and option has not been correctly appreciated by the AO. The property transferred was a valuable right and not tangible shares because distinctive shares were not allotted to the taxpayer. A valuable right to exercise an option to sell stock was a long term capital asset, as it was created on the date of acceptance (i.e. 27 July 1995 and other dates). 2 ACIT vs. Shri Jaswinder Singh Ahuja in ITA No. 185 & 186/ Del/ Infosys Technologies Ltd. Vs. CIT, Garric D Silv Vs. JCIT (2006) 105 TJ 445 (T del T) and Gridhar Krishan Vs. ACIT (2008) 117 TTJ (Bang) 965 2

3 The calculation of capital gains made by the AO was based upon sale and purchase dates, which is exercise date and sale date. If this contention is accepted then, the difference between sale and exercise date would not arise (as the sale price and purchase price would be same). This cannot result in any gain or loss. Accordingly, question of taxation of capital gain would not arise. The AO has on one hand accepted the price paid by the taxpayer on the dates of acceptances of offer as the cost but had not accepted them to be dates as the dates of respective of acquisitions. Department s Contention The shares were never issued in the name of employee but the same were held by a Trust. At best the shares were allotted to the taxpayer and sold by him on the same date. Accordingly, they were liable to tax as short term capital gains. ITAT s Decision Clauses of allotment clearly reveals that the particular numbers of shares were allotted to taxpayer in different years at different prices; only distinctive numbers were not allotted which has not been disputed by department. The apparent benefit to taxpayer out of ESOPs scheme was that it had not to pay the purchase price immediately at the time of allotment but the same was to be deducted at the time of sale or redemption of shares. As there was an apparent fixed consideration of ESOPs shares, the right to allotment of particular quantity of shares accrued to the taxpayer at relevant time. The benefit of deferment of purchase price cannot lead to an inference that no right accrued to taxpayer. Non-allotment of distinctive number of shares by Trust cannot be detrimental to the proposition that taxpayer s valuable right of claiming shares was held in Trust and stood sold by the Company. Accordingly, there was a definite, valuable and transferable right which can be termed as a capital asset in favour of the taxpayer. ITAT also observed that, if they were to accept the AO s contention, no capital gain would arise (as the date of allotment of shares and the sale of shares would be the same and hence purchase price would be unascertainable). 3

4 The ITAT relied upon the decisions in the cases of Bomi S. Bilimoria and Dhurjati Gupta 4 and held that the right of shares constitutes capital assets and the gains arising on transfer of such shares should be taxed under the head Long Term Capital Gains as the holding period is more than 36 months. Our comments This is an important ruling by Honourable Delhi ITAT, which highlights the principle that, non-allotment of distinctive number of shares issued under the ESOP scheme by a Trust cannot be detrimental to the proposition that taxpayer s valuable right of claiming shares was held in Trust. Accordingly, such definite, valuable and transferrable rights can be termed as a capital asset. Further, this ruling pertains to FY wherein, there was a concessional tax treatment available in respect of ESOPs which were in compliance with the ESOP Central Government Guidelines. Accordingly, the benefit arising to employees under an ESOP which were in accordance with ESOP Central Government Guidelines was taxable only at the time of sale of shares. As per the current tax provisions, the gains on ESOPs become taxable at two stages viz., once when the shares are allotted on exercise and again when the employee sells the shares. In case you need any further information/clarification, please contact: Sanjiv Chaudhary Parizad Sirwalla Executive Director Executive Director Delhi Mumbai Phone: Phone: For details on International Executive Services (IES), please click here 4 Mr. Bomi S Bilimoria vs. ACIT (2009) 124 TTJ (Mumbai) 960 and ACIT vs. Dr. Dhurjati Gupta (2010) 127 TTJ (Hyd) 356 4

5 Bangalore Maruthi Infotech Centre, 11-12/1 Inner Ring Road Koramangala, Bangalore Phone: Fax: Chennai KPMG House No.10, Mahatma Gandhi Road, Nungambakkam High Road, Chennai Phone: Fax: Chandigarh SCO st Floor, Sector 8 C Madhya Marg Chandigarh Tel: Fax: Mumbai Lodha Excelus, Apollo mills compound, NM Joshi Marg, Mahalaxmi, Mumbai India Phone: Fax: Pune 703, 7th Floor Godrej Castlemaine, Next to Ruby Hall Clinic, Bund Garden Road, Pune Phone: /65 Fax: Kochi 4/F, Palal Towers, M. G. Road, Ravipuram, Kochi Phone: +91 (484) Fax: +91 (484) Delhi DLF Cyber City, Building no. 10, Block B, Phase II Gurgaon, Haryana Phone: Fax: Hyderabad KPMG, /2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad Phone: Fax: Kolkata KPMG Infinity Benchmark Plot No. G-1, 10th floor Block - EP & GP, Sector V, Salt Lake City Kolkata Phone: Fax: The information contained herein is of a general nature and is not intended to address the circumstances of any 2011 KPMG, an Indian Partnership and a member firm particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no of the KPMG network of independent member firms guarantee that such 2011 information KPMG, is an accurate Indian as Partnership of the date it is and received a member or that it firm will of continue the KPMG to be accurate network in of the independent affiliated member with KPMG firms International affiliated with Cooperative ( KPMG future. No one KPMG should act International such information Cooperative without appropriate ( KPMG professional International ), advice after a Swiss a thorough entity. examination All rights of reserved. International ), a Swiss entity. All rights reserved. the particular situation. 1

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