2008 (1) TMI 17 - SC - Income Tax

Deduction of tax at source - Department consider the respondent-assessee as assessee in default for not deducting TDS at the rate of 30% on ESOP- The obligation to deduct TDS arises only when the employee exercise his option and realize money from shares, hence department contention was not valid

Issues Involved:
1. Tax Deduction at Source (TDS) under Section 192 of the Income Tax Act, 1961.
2. Definition and timing of "perquisite" under Section 17 of the Income Tax Act, 1961.
3. Applicability and retrospectivity of Section 17(2)(iiia) of the Income Tax Act, 1961.
4. Valuation of perquisites and the impact of the lock-in period on the valuation.

Detailed Analysis:

1. Tax Deduction at Source (TDS) under Section 192 of the Income Tax Act, 1961:
The primary issue was whether the respondent-assessee was required to deduct TDS on the amount earned by its employees from the exercise of stock options granted through the Trust. The Assessing Officer (AO) had determined that the "perquisite value" was the difference between the market value of the shares and the price paid by the employees at the time of exercising the option, resulting in a significant TDS liability. However, the Tribunal and the Karnataka High Court ruled that the benefit from the ESOP scheme was not a "perquisite" under Section 17(2)(iii) of the Income Tax Act, 1961, during the relevant assessment years.

2. Definition and timing of "perquisite" under Section 17 of the Income Tax Act, 1961:
The court examined whether "perquisite" could be said to accrue at various stages: when warrants were granted, when the option vested, when the options were exercised, when the lock-in conditions were removed, or when the shares were sold. The AO had considered the perquisite value to arise at the time of exercising the options. However, the court noted that during the lock-in period, the shares were non-transferable and had no realizable value, making the benefit only notional and unascertainable at the time of exercising the options.

3. Applicability and retrospectivity of Section 17(2)(iiia) of the Income Tax Act, 1961:
The court addressed whether Section 17(2)(iiia), inserted by the Finance Act, 1999, effective from 1.4.2000, was clarificatory and thus retrospective. The court concluded that the section was not retrospective as it introduced a new mechanism for defining "cost" and "specified securities," which was not present before 1.4.2000. The court emphasized that for a benefit to be taxable, it must be explicitly included as income by the Legislature.

4. Valuation of perquisites and the impact of the lock-in period on the valuation:
The court highlighted that the shares during the lock-in period were non-transferable and had no realizable value, which the AO failed to consider. The benefit, if any, arising from the exercise of options was notional and unascertainable due to the lock-in period and the uncertainty of future market value. The court held that the Department erred in treating Rs. 165 crores as perquisite value and the respondent as a defaulter for not deducting TDS.

Conclusion:
The court concluded that the Department had erred in treating the respondent as an assessee in default for not deducting TDS under Section 192. The court found no merit in the civil appeals and dismissed them with no order as to costs. The court also clarified that it expressed no opinion on the law prevailing after 1.4.2000, except as indicated in the judgment.

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