2020 (10) TMI 1169 - HC - Income Tax

Correct head of income - gains arising on cashless exercise of stock options - taxable as income under the heads 'income from salaries' and 'short term capital gains' or 'long term capital gains' as claimed by the Appellant - Whether stock options did not constitute a 'capital asset' under Section 2(14) of the Act? - cashless exercise of stock options constitute transfer of a long term capital asset under Section 2(47) or not? - HELD THAT - Assessee was an independent consultant to SiRF USA and was not an employee of SiRF USA at the relevant time. Thus, there was no relationship of employer and employee between the SiRF USA and the assessee and therefore, the finding recorded by the tribunal that the income from the exercise of stock option has to be treated as income from salaries is perverse as it is trite law that unless the relationship of employer and employee exists, the income cannot be treated as salary. See CIT VS. L.W.RUSSEL 1964 (4) TMI 4 - SUPREME COURT Revenue in case of several other assessee's have accepted the fact that on cashless exercise of option, there arises a income in the nature of capital gains. However, in the case of the assessee the aforesaid stand was not taken. It is also pertinent to mention here that nothing was brought to our notice that the view taken by the tribunal in the following cases has been challenged by the revenue. See SHRI KAMLESH BAHEDIA C/O ABOBE SYSTEM INDIA PVT. LTD 2014 (8) TMI 843 - ITAT DELHI , N.R. RAVIKRISHNAN 2018 (12) TMI 1255 - ITAT BANGALORE and DR. MUTHIAN SIVATHANU 2018 (11) TMI 1112 - ITAT CHENNAI Thus in view of law laid down by the Supreme Court in Berger paints 2004 (2) TMI 4 - SUPREME COURT it was not open for the revenue to take one stand in case of the assessee and to challenge the correctness of the same in case of other assessee. For this reason also, the revenue cannot be permitted to take a different view in this appeal. - Decided in favour of assessee.

Summary

Issues:
1. Taxation of gains from cashless exercise of stock options under different heads.
2. Classification of stock options as a capital asset.
3. Determination of employer-employee relationship for tax implications.

Analysis:
1. The appeal concerned the taxation of gains from cashless exercise of stock options for the Assessment year 2006-07. The appellant claimed the gains as long term capital gains, while the Assessing Officer split the transaction, treating part as income from salary and part as short term capital gains. The Commissioner of Income Tax (Appeals) upheld this decision, leading to the appeal before the High Court.

2. The appellant, a software engineer, was granted stock options by a US company during his tenure as an independent consultant and later as an employee. The High Court analyzed the clauses of the stock plan and communication from the US company, concluding that the appellant was not an employee of the US company at the relevant time. Therefore, the income from stock options could not be treated as salary without an employer-employee relationship.

3. The High Court determined that stock options constitute a capital asset under Section 2(14) of the Income Tax Act. The cashless exercise of stock options was considered a transfer of a capital asset by relinquishment of rights, falling under Section 2(47) of the Act. The court also highlighted that the appellant did not receive the underlying shares, further supporting the capital asset classification.

4. The court noted that the revenue had accepted similar cases where cashless exercise of options resulted in capital gains, indicating inconsistency in their approach. Relying on previous decisions and the principle of consistency in taxation, the court held that the revenue could not challenge the treatment of gains in this case after accepting similar treatments in other cases.

5. Ultimately, the High Court ruled in favor of the appellant, quashing the order of the Income Tax Appellate Tribunal and allowing the appeal. The substantial questions of law were answered in favor of the assessee, emphasizing the capital asset nature of stock options and the absence of an employer-employee relationship in this case.