2011 (8) TMI 480 - AT - Income Tax

Capital gain or not - Assessment under section 143(3) read with section 147 - sale of shares which the assessee received on account of stock option - The claim of the assessee was that he had acquired a valued right, i.e., right to subscribe to shares in future - Though subject to certain conditions stipulated at the time of grant of options, and, therefore, the amount so received on exercise of this valuable right should be treated as a long-term capital gain - The Assessing Officer did not agree with these submissions - He was of the view that since the holding period of these shares, i.e., from the date of exercising the stock option to sale of the shares, was less than twelve months, the gains on sale of such shares cannot be treated as capital gains - the assessee has been offered by JJ USA is not specified number of shares in the company at the specified price but only an option to exercise the right to buy, in a specified time frame, a specified number of shares at a specified price-subject to fulfilment of certain further conditions set out in the document. There is no compulsion on the assessee to buy these shares as the assessee has been granted an option to buy, at the market rate prevailing as on the date of grant of option, the specified number of shares within certain time frame - which essentially implies that the assessee may, if so desires, buy the shares or may not buy these shares - It means the assessee was not the owner of these shares before the shares were sold, and entries, to that extent, were mere notional in nature - Section 45(1) provides that any profits or gains from the transfer of capital asset are taxable as capital gains, but then, even going by the documents produced by the assessee, here is a case in which the assessee did not own any capital asset in the form of shares when he claims to have sold the same - The impugned gains are, therefore, cannot be taxed under the head Capital gains - Decided in favour of assessee.

Issues Involved:
1. Classification of income from the sale of stock options (LTCG, STCG, speculation income, income from other sources, or salary).
2. Determination of the holding period for stock options.
3. Legality of stock options without RBI approval.
4. Applicability of CBDT Circular No. 704.
5. Precedent value of rulings by the Authority for Advance Ruling.
6. Constructive delivery of shares.
7. Applicability of the Special Bench decision in Sumit Bhattacharya's case.
8. Binding nature of judicial precedents.

Issue-wise Detailed Analysis:

1. Classification of Income from the Sale of Stock Options:
The core issue was whether the income from the sale of stock options should be treated as Long-Term Capital Gains (LTCG), Short-Term Capital Gains (STCG), speculation income, income from other sources, or salary. The CIT(A) had directed that the income be treated as LTCG, allowing indexation benefits as per the Income-tax Act, 1961. However, the Assessing Officer (AO) argued that the income should be treated as STCG, speculation income, or income from other sources, and/or salary. The Tribunal concluded that the income should be treated as STCG, as the shares were not held for more than 12 months.

2. Determination of the Holding Period for Stock Options:
The CIT(A) held that the holding period should be considered from the date of acceptance of the stock option offer, thus treating the income as LTCG. The AO disagreed, stating that the holding period should be from the date of exercising the stock option to the sale of shares, which was less than 12 months. The Tribunal agreed with the AO, emphasizing that the shares were not actually acquired until the option was exercised, thus the holding period was less than 12 months, making it STCG.

3. Legality of Stock Options without RBI Approval:
The AO argued that without the Reserve Bank of India's (RBI) approval to pay the purchase price in foreign currency, the contract granting the right to acquire shares was unlawful. The CIT(A) countered that the acceptance of the stock option offer constituted a contract, and the shares were treated as purchased when the offer was accepted, despite the RBI's stipulation. The Tribunal found that the shares were not intended to be acquired at any point, and the scheme allowed employees to benefit from the appreciation in value of shares without actual acquisition, thus supporting the AO's view.

4. Applicability of CBDT Circular No. 704:
The AO contended that the purchase and sale of shares must be effected in the manner stated in CBDT's Circular No. 704 for it to be treated as capital gains. The CIT(A) did not address this issue directly. The Tribunal did not find it necessary to delve into this aspect, as the primary reasoning for their decision was based on the nature of the stock options and the holding period.

5. Precedent Value of Rulings by the Authority for Advance Ruling:
The AO relied on a ruling by the Authority for Advance Ruling, which stated that stock option profit is taxable as income from salary. The CIT(A) dismissed this reliance, noting that such rulings do not have precedence value. The Tribunal did not specifically address this point, focusing instead on the nature of the stock options and the holding period.

6. Constructive Delivery of Shares:
The CIT(A) held that the assessee had taken 'constructive delivery' of the shares, thus supporting the treatment of the income as LTCG. The Tribunal disagreed, stating that the shares were not actually acquired until the option was exercised, and the entries in the broker's account were notional, not indicating actual ownership of shares.

7. Applicability of the Special Bench Decision in Sumit Bhattacharya's Case:
The AO and the Tribunal referenced the Special Bench decision in Sumit Bhattacharya's case, which dealt with stock appreciation rights and concluded that gains from such rights should be included as income from salary. The Tribunal found this decision relevant, as the stock options in the present case were akin to stock appreciation rights, supporting the AO's view that the gains should not be treated as LTCG.

8. Binding Nature of Judicial Precedents:
The Tribunal noted that a decision rendered in ignorance of an earlier binding precedent does not have precedent value. The Tribunal found that the decision in Bomi S. Billimoria's case, which was in favor of the assessee, was rendered without considering the earlier decision in Shripad S. Nadkarni's case, which was against the assessee. Therefore, the Tribunal followed the earlier decision, emphasizing the binding nature of judicial precedents.

Conclusion:
The Tribunal vacated the relief granted by the CIT(A) and restored the AO's order, concluding that the gains on exercise of stock options should be treated as short-term capital gains. The Tribunal emphasized that the shares were not actually acquired until the option was exercised, and the holding period was less than 12 months. The Tribunal also noted the importance of following binding judicial precedents and found that the decision in Shripad S. Nadkarni's case should be followed over the decision in Bomi S. Billimoria's case.

← Previous Next →