Cashless ESOP: Independent Consultant Gets Capital Gain Benefit

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MUMBAI: The Karnataka High Court has ruled that income from the cashless exercise of stock options (ESOP) by an independent consultant of a US-based company will be taxable as over -values ​​and not as a salary.
Chittharanjan A Dasannacharya, was a software engineer, employed by Aerospace Systems in India. He was appointed in 1995 – as an independent consultant to SIRF Technology in the United States. Much later, he served as an employee of this American company during the period 2001-2004. Subsequently, he returned to India as an employee of SIRF India.
While in deputation, he was granted stock options by the American company. During the 2005-06 financial year, he exercised his right. Under the cashless exercise mechanism, the underlying shares were not allocated to him, but he was entitled to receive the proceeds from the sale of those shares after deduction of the exercise price.
He treated the income as long-term capital gains (LTCG) and claimed a deduction under Section 54-F of the Income Tax Act (IT), available for reinvestment of the sum of the LTCG in a dwelling house.
Dasannacharya argued that he was an independent consultant when he was granted the ESOPs and that there was no employer-employee relationship. Thus, during the exercise of stock options, no part of the income can be assimilated to salary income. These would be long-term capital gains.
The IT manager taxed the difference between the market value of the shares (on the exercise date) and the exercise price as salary income and the difference between the sale price of the shares and the market value of the shares on the exercise date, as capital gains, thus denying the benefit of the deduction provided for in article 54-F.
In the end, the taxpayer had to appeal to the High Court. The Karnataka high court ruled that unless there is an employer-employee relationship, income cannot be considered wages.
Relying on previous Supreme Court rulings, he further ruled that the exercise of a cashless option was a “transfer” of an asset under the Act, by “waiver or forfeiture of the right” on a fixed asset.
In her news alert, Nangia Andersen says the ordinance is a fair statement that an employer-employee relationship must exist for the taxation of income as “wages.” The High Court explained in detail that “the right to purchase the shares underlying the options” (that is, the exercise of a cashless option) falls within the realm of “immobilization” and the extinction of this right is considered a “transfer of an asset” under the provisions of the computer law, he adds.


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