IN THE ITAT MUMBAI BENCH ‘C’ (SPECIAL BENCH)

Sumit Bhattacharya

v.

Assistant Commissioner of Income-tax, Circle 16(1), Mumbai

K.C. Singhal and Ms. Sushma Chowla, Judicial Member

And Pramod Kumar, Accountant Member

IT Appeal No. 238 (Mum.) of 2005

[Assessment year 1998-99]

January 3, 2008

Section 15, read with section 56, of the Income-tax Act, 1961 - Salaries - Chargeable as - Assessment year 1998-99 - Whether salary is a reward or consideration for services rendered by a person in employment and question of reward of his employment flowing from employer to employee in order to bring same within ambit of taxability under head ‘Income from salaries’ is redundant - Held, yes - Whether merely because an employment-related income/benefit cannot be taxed under head ‘Income from salaries’, such a benefit cannot go outside ambit of taxable income and such an income can be taxed under head ‘Income from other sources’ - Held, yes - Whether stock appreciation rights plan is a method for companies to give their management or employees a bonus if company performs well financially and, therefore, said plan is nothing other than a form of deferred cash compensation, which is contingent upon financial performance of company - Held, yes - Whether in case of redemption of stock appreciation rights redemption amount being dependent on market price of shares which can move in any direction at any time, income arises only when stock appreciation right is redeemed - Held, yes - Whether, therefore, income/benefit earned on account of redemption of stock appreciation rights can only be taxed in year of redemption and not in year of grant or vesting - Held, yes - Assessee was employed as Managing Director of Procter & Gamble India Ltd. [PGI], which was a part of group of companies headed by Procter & Gamble Co., Inc., USA (PGU) - In January, 1998, assessee received certain amount from PGU on account of redemption of certain stock appreciation rights in terms of Procter & Gamble 1983 stock plan - Assessee did not admit any tax liability on said amount and submitted that since he did not have any employer-employee relationship with PGU, amount received by him on redemption of stock appreciation rights could not be considered as perquisite in his hands and, therefore, could not be taxed as income from salaries - Whether since stock appreciation rights were granted to assessee in recognition of his contribution to long-term success and development of business of Procter & Gamble group and these grants were in accordance with Procter and Gamble 1983 stock plans, it could be said that amount received by assessee on redemption of stock appreciation rights was consideration for services rendered by assessee which was in nature of income - Held, yes - Whether since assessee had no other connection with PGU than connection as an organization connected with company PGI with which he had entered into an employment contract, anything that assessee received from PGU could not be anything but reward of his employment - Held, yes - Whether, therefore, amount in question received by assessee on redemption of share appreciation rights was taxable under head ‘Income from salaries’ - Held, yes - Whether even if it was said that amount in question was received from a person other than employer of assessee, said amount would still be taxable though under head ‘Income from other sources’ - Held, yes

Section 45 of the Income-tax Act, 1961 - Capital gains - Chargeable as - Assessment year 1998-99 - Whether in view of facts stated under heading ‘Salaries-Chargeable as’, amount in question received by assessee would not be taxable under head ‘Capital gains’ - Held, yes

Facts

The assessee, in the relevant previous year ended on 31-3-1998, was employed as Managing Director of the Procter & Gamble India Ltd. (PGI), which was a part of the group of companies headed by Procter & Gamble Co., Inc., USA (‘PGU’). In January, 1998, the assessee received certain amount from PGU on account of redemption of certain Stock Appreciation Rights [SARs] granted by PGU to the assessee in terms of Procter & Gamble 1983 Stock Plan [P&G 1983 Stock Plan]. The assessee did not admit any tax liability on the said amount and submitted that since he did not have any employer-employee relationship with PGU, i.e., the grantor of the SARs, the amount received by him on redemption of SARs could not be considered as perquisite in his hands and, therefore, could not be taxed as income from salaries. The assessee further submitted that the right to receive stock appreciation was in the nature of a capital asset, and since this asset was without any ascertainable cost of acquisition, the amount on sale of these rights would be liable to taxation in his hands under the head ‘Capital gains’. He also submitted that he was in employment with PGI, which was an ultimate subsidiary of the PGU, but since the PGU did not have more than 50 per cent shares in the PGI in the first two years of SARs grant, it could not be said that PGI, in that period, was even a subsidiary company of the PGU. The Assessing Officer though agreed that the assessee was indeed not in employment of PGU, yet observed that the true test of any income in such cases is to see whether the amount has been received by the assessee by virtue of his (employee’s) office. The Assessing Officer further held that these payments were profits of the assessee’s employment. The Assessing Officer, therefore, held that the grant of SARs to the assessee was due to employer-employee relationship and so the same would form part of income from salaries. The Assessing Officer also observed that there was no gain to the assessee when SARs were granted and since the gain crystallised only in the year in which SARs were redeemed, the same could only be taxed in the year in which SARs were redeemed. The Assessing Officer also observed that the payment received by the assessee might be gratuitous, but still the same was taxable under section 17(1). The Assessing Officer, therefore, taxed the said amount in the hands of the assessee under the head ‘Income from salaries’. On appeal, the Commissioner (Appeals) upheld the action of the Assessing Officer. Aggrieved by the said order, the assessee filed the instant appeal before the Tribunal. But as divergent views prevailed among the coordinate Benches of the Tribunal on the issue, the matter was referred to the Special Bench for deciding the taxability of the amount received by the assessee on redemption of SARs.

Held

Basic Features of Procter & Gamble 1983 Stock Plan

Article A of the P&G 1983 Stock Plan provided for grant of Stock Options or stock appreciation rights to those key employees of the Procter & Gamble Company and its subsidiaries who were largely responsible for the long-term success and development of the business to increase their proprietary and other interest in the Company’s progress. Article J(8) of the said plan provided that upon the exercise of stock appreciation rights, the recipient would be entitled to receive a redemption differential for each such stock appreciation right which would be the difference between the then fair market value of one share of the common stock of the Company and the exercise price of one stock appreciation right then being exercised. [Para 24]

On going through the terms of the P & G 1983 Stock Plan under which the assessee was granted the SARs, it was clear that the redemption value of the SARs was primarily a deferred wage or bonus payment, in cash or otherwise, measurable with reference to the appreciation of market price of company’s shares. In contrast, under the stock options scheme, the beneficiary of the same would be allowed to buy the shares in the company, though subject to several conditions attached, at a price lower than the prevailing market price as at the point of time when the stock option would be exercised. In the case of Stock Options, it was provided under Article K, that upon the exercise of a stock option, payment in full of the exercise price would be made by the optionee. The above scheme clearly showed that connotations of the expression ‘stock options’ and ‘stock appreciation rights’ were quite distinct and these two expressions could not be used interchangeably. The tax implications of stock options and stock appreciation rights were also at variance. [Para 25]

Thus, by way of stock appreciation rights, it could be said that a person is allowed a reward contingent upon performance of the company in the stock market. By way of a stock option, on the other hand, a person is allowed to acquire the shares of a company at a price lower than prevailing market price. The exact quantum of benefit or reward is thus ascertained at the point of time when stock appreciation rights are redeemed, while the exact quantum of benefit, in the case of share acquisition at concessional rate, i.e., stock plan, can only be ascertained when the shares are actually sold. However, from a theoretical point of view and assuming that the shares are acquired without any special conditions attached, which is seldom the case, the quantum of benefit can indeed be divided into two parts - reward for employment to the extent of excess of market price of shares as on the time of acquisition vis-a-vis the acquisition price of such shares, and capital gain or loss to the extent of difference in sale consideration of shares vis-a-vis the market price of shares as on the time of acquisition of such shares. The legal position regarding the amount received on redemption of stock appreciation rights and the value of benefit received by way of acquisition of shares at concessional prices cannot, therefore, be decided by the same yardstick. These two benefits have several and significant distinguishing features. Exercise of a stock appreciation right involves payment to the beneficiary, while exercise of a stock option involves payment, albeit concession, by the beneficiary. The former results in receipt of a reward, though measurable in terms of the money value by which the share price has gone up, to the beneficiary, while the latter results in acquisition of an asset at a concessional price by the beneficiary. There cannot be a loss situation in the stock appreciation rights because the exercise of stock appreciation rights is not mandatory and the same can be allowed to expire at the option of the beneficiary. There can, however, be a loss situation in the acquisition of shares in the stock options scheme, because no matter how much below market price the shares are offered under the scheme, market forces can drive the shares to even lower levels. On a conceptual frame, thus, the stock appreciation rights plan can be said to be a method for companies to give their management or employees a bonus if the company performs well financially. It is, however, very distinct from a typical stock options plan, which involves allowing the employees to buy the shares of the company on a concessional or nominal price. SARs provide the employee with a cash payment based on the increase in the value of a stated number of shares over a specific period of time. SARs generally do not have a specific settlement date and the employees have flexibility in when to choose to exercise the SARs - of course within an outer limit on the expiry of which the right would lapse. In effect, therefore, SARs plan is nothing other than a form of deferred cash compensation, which is contingent upon financial performance of the company. In character, therefore, a stock appreciation right is not the same thing as a typical stock option. Unlike a stock option plan, which aims at what can be termed as employee’s participation in ownership, a stock appreciation right is a scheme of bonus payment, which is on the basis of financial performance of the company. That is the reason perhaps of the stock appreciation right being generally confined to key personnel of the company who can make a significant contribution to financial success of the company. [Para 26]

Further, the distinction between the nature of stock appreciation rights and the stock option is so fundamental that it affects the tax treatment of these two benefits. While in stock option, the assessee gets a capital asset at a concessional or nominal price and what is to be taxed is the value of this benefit, in the case of the stock appreciation rights, what the assessee actually receives is a kind of cash bonus, which is in the nature of deferred wages and which is contingent upon the company doing well in financial terms. There is no need, as in the case of stock options, to convert the benefit into monetary terms because what is received by the assessee is itself in monetary terms. One cannot convert money into money. There cannot be a serious dispute about the point of time when the taxability is to be triggered because the redemption amount being dependent on the market price of shares which can move in any direction at any time, the income arises only when the stock appreciation right is redeemed. Even if one is to proceed on the basis that grant of a stock appreciation right gives some benefit to the assessee, it is beyond dispute that such a benefit is contingent upon the market behaviour for value of shares in question. It is well-settled, based on the principle of conservatism, that an anticipated income cannot be brought to tax until it actually accrues or unless there is a specific provision to that effect. Therefore, the assessee’s contention that the benefit on account of stock appreciation right could only be taxed in the year of grant or vesting, and not in the year of redemption, could not be accepted. [Para 27]

Further, on going through the meaning of the expression ‘subsidiary’ as defined in P&G 1983 stock plan, it was clear that what was material for the purpose of PGI was that fifty per cent or more of the shares - whether directly or indirectly - were held by the PGU. It was, therefore, immaterial whether or not the shares were held directly by the PGU or through another company. Therefore, there was no relevancy of the assessee’s repeatedly highlighting the fact that PGU’s shareholding in the PGI was through another company. Further, so far as SARs were concerned, even this benchmark of fifty per cent was not really relevant because the aforesaid meaning of the expression ‘subsidiaries’ also specifically provides that the board may designate for participation in this plan as ‘subsidiary’, except for the granting of incentive stock options, those additional companies affiliated with the company, in which direct or indirect ownership is less than fifty per cent of the total combined voting powers of all classes of such company’s stock. Nothing, therefore, turned on the fact that in the first two years of SARs grant, in which SARs were granted by PGU to the assessee-PGU had less than fifty per cent ownership of the PGI and that the ownership control of the PGU was not direct but through another intermediary corporate. [Para 31]

Nature of Receipt of Money Received on Account of Redemption of Stock Appreciation Rights

The amount received by the assessee on redemption of share appreciation rights was nothing but a deferred wage contingent upon performance of the company’s shares in the market. The very preamble of the plan, under which share appreciation rights had been given to the assessee, also stated that it was in the nature of the deferred awards related to the increase in the price of the common stock of the company. On going through the various articles of the said plan, it could be clearly said that the SARs were granted to assessee in recognition of his continuing contributions to the long-term success and development of the business of Procter & Gamble Group. Thus, the amount received by the assessee on redemption of stock appreciation rights was in the nature of consideration for services rendered by the assessee. Therefore, the amount received by the assessee on redemption of stock appreciation rights was in the nature of income. [Para 34]

Taxability of Amount Received on Redemption of Stock Appreciation Rights

There was no dispute that the amount received by the assessee was in the nature of, as admitted by the assessee, ‘fruits of employment’. The natural corollary of this undisputed factual position was that the said amount/income should be taxed under the head ‘Income from salaries’, but one of the basic arguments of the assessee against such a taxability was that since there was no employer-employee relationship between PGU and the assessee, the amount received by him from PGU, on redemption of his stock appreciation rights, could not be taxed under the head ‘Income from salaries’. This argument rested on the assumption that taxability under the head ‘Income from salaries’ was confined to what was received by an employee from his employer. [Para 36]

The Supreme Court in the case of Justice Deoki Nandan Agarwal v. Union of India [1999] 237 ITR 872, has held that the theory of compensation for services rendered flowing from employer to the employee being sine qua non for taxability under the head ‘Income from salaries’ is no longer valid. What is material is that the amount received by the assessee should be in the nature of salaries. The ratio decidendi of the said judgment is that what Judges receive, as salary, is reward for their services and it is for this reason that such reward is brought within the scope of salary. This decision thus has the effect of expanding the scope of head of income ‘salary’ as it holds that what is relevant is the salary being a reward for employment rather than existence of an employer in conventional sense of the expression. The question of reward for employment flowing from employer to employee, in order to bring the same within the ambit of taxability under the head ‘Income from salaries’, is thus redundant. [Para 39]

As per the dictionary meaning, the expression ‘salary’ means recompense or consideration given to a person for his pains bestowed upon another man’s business. It was not even the assessee’s case that the stock appreciation rights that he had received were not in the nature of ‘recompense or consideration’ given to him for anything other than his employment. The only defence for his non-taxability under the head ‘Income from salaries’ was that the stock appreciation rights were not received from the employer, and, therefore, the same could not be taxed under the head ‘Income from salaries’. This plea of the assessee was, therefore, not sustainable in law. [Para 40]

It was also not in dispute that PGI was treated as a subsidiary of the PGU because unless it was so, the assessee could not have been granted stock appreciation rights in the first place. The PGI was a party to the entire scheme of granting of stock appreciation rights, as evident from the P&G 1983 Stock Plan. A plain reading of the various clauses of the P&G 1983 stock plan showed that the assessee’s employer had got valuable rights and protection under the scheme of allotment of stock appreciation rights. It was in consideration of the assessee agreeing not to leave employment of the Procter & Gamble and any of its subsidiary companies for a period of one year, and not to engage in competitive business for three years that the assessee got the SARs. The interest of the assessee’s employer was also protected in the said scheme inasmuch as in case the assessee would violate the said agreement, the employer-company was entitled to injunctive or other appropriate relief. It was also agreed that this scheme would constitute an agreement between the assessee and the PGU and its subsidiaries, including successors thereof. The PGI was all along an important and integral party to all these arrangements. The assessee had no other connection with PGU than the connection as an organisation connected with the company PGI with which he had entered into an employment contract, and, therefore, anything that the assessee received from PGU could not be anything but the reward of his employment. It is well-settled that what is to be taxed under the head ‘Income from salaries’ is whatever constitutes ‘salary’. The expression ‘salary’, though not specifically defined under the Act is the reward or consideration for services rendered by a person in employment. The assessee’s receipts of whatever nature, in connection with his employment, were, therefore, to be treated as ‘salaries’. [Paras 44 and 46]

It is well-settled that the Tribunal is competent to change the head of income even at the instance of the respondent when all the relevant facts are already on record and as long as both the parties are heard on that issue. In the instant case, it was the alternate contention of the revenue that in the event the Tribunal came to the conclusion that the amount in question was not taxable under the head ‘Income from salaries’, the Tribunal might also adjudicate on the question whether or not the impugned amount be held as income from other sources. [Para 47]

The Supreme Court in the case of Emil Webber v. CIT [1993] 200 ITR 483/67 Taxman 532 has held that merely because an employment-related income/benefit cannot be taxed under the head ‘Income from salaries’, such a benefit cannot go outside the ambit of taxable income and such an income can be taxed under the head ‘Income from other sources’. [Para 50]

Therefore, even if the amount received by the assessee on redemption of share appreciation rights was held to be not taxable under the head ‘Income from salaries’, this fact, by itself, would not take the same outside the ambit of taxable income. Since, in such an eventuality and following the Supreme Court’s judgment in Emil Webber’s case (supra), the said amount would be taxable under the head ‘Income from other sources’. Therefore, even if it was held that the amount in question was received from a person other than the employer of the assessee, and that in order for an income to be taxed under the head ‘Income from salaries’ it is a condition precedent that the salary, benefit or the consideration must flow from employer to the employee, the amount received by the assessee on redemption of stock appreciation rights would still be taxable - though under the head ‘Income from other sources’. The plea raised by the assessee that the amount in question could not be taxed as ‘income from salaries’ was thus irrelevant. [Para 51]

Further, there was also no merit in the plea of the assessee that the amount in question could only be taxed under the head ‘Capital gains’ as the receipt was on account of transfer of a capital asset consisting of right to receive stock appreciation rights. As held earlier, the amount in question was revenue receipt in nature, and it was only the quantification of this amount which was linked to a capital asset and that was value of shares. The taxability was not in respect of the stock appreciation right per se but the amount received as a fruit of employment which was measured by way of a formula envisaged in the stock appreciation rights scheme. [Para 54]

Therefore, the assessee was indeed liable to tax in respect of the amount received on redemption of stock appreciation rights. The taxability of this amount was under the head ‘Income from salaries’ but the assessee’s plea that the amount in question was received from a person other than the de jure employer, even if it was to be accepted, would not have any material difference to the taxability per se, because, in such an event, the amount would have been taxed under the head ‘Income from other sources’. [Para 55]

Therefore, the appeal was liable to be dismissed.

Editor’s Note

In view of the decision of the Special Bench of the Delhi Tribunal in the case of Motorola Inc. v. Dy. CIT [2005] 95 ITD 269 when all the monies received by the assessee were subject to tax deduction at source, he could not be said to have committed default in not paying the advance tax and he was entitled to take into account the tax which was deductible by the payer though not actually deducted.

Case Review

Justice Deoki Nandan Agarwal v. Union of India [1999] 237 ITR 872 (SC); Emil Webber v. CIT [1993] 200 ITR 483/67 Taxman 532 (SC); Motorola Inc. v. Dy. CIT [2005] 95 ITD 269 (Delhi)(SB) followed.

Cases referred to

Bharat V. Patel v. Addl. CIT [IT Appeal No. 2241 (Ahd.) of 2002] (para 2), Infosys Technologies Ltd. v. Dy. CIT [2003] 78 TTJ (Bang.) 598/130 Taxman 129 (Bang.)(Mag.) (para 2), CIT v. B.C. Srinivasa Shetty [1981] 128 ITR 294/5 Taxman 1 (SC) (para 7), Wright v. Boyce [1958] 1 WLR 832 (para 8), XYZ, In re [1999] 235 ITR 565/102 Taxman 74 (AAR) (para 9), CIT v. L.W. Russel [1964] 53 ITR 91 (SC) (para 12), CIT v. Infosys Technologies Ltd. [2003] 86 ITD 342 (Bang.) (para 12), CIT v. Infosys Technologies Ltd. [2007] 159 Taxman 440 (Kar.) (para 12), Wipro Ltd. v. Dy. CIT [2003] 80 TTJ (Bang.) 106 (para 12), V.M. Salgaonkar & Bros. (P.) Ltd. v. CIT [2000] 243 ITR 383/110 Taxman 67 (SC) (para 12), Asstt. Director of Income-tax v. Green Emirates Shipping & Travels [2006] 100 ITD 203 (Mum.) (para 14), Abbot v. Philben, (Inspector of Taxes) [1962] 44 ITR 144 (HL) (para 15), Mattulal v. Radhelal [1974] 2 SCC 365 (para 16), CIT v. Tata Services Ltd. [1980] 122 ITR 594/[1979] 1 Taxman 427 (Bom.) (para 17), Hari Bros. (P.) Ltd. v. ITO [1964] 52 ITR 399 (Punj.) (para 17), CIT v. D.P. Sandhu Bros. Chembur (P.) Ltd. [2005] 273 ITR 1/142 Taxman 713 (SC) (para 18), Nalinkant Ambalal Mody v. CIT [1966] 61 ITR 428 (SC) (para 18), CIT v. Smt. T.P. Sidhwa [1982] 133 ITR 840/[1981] 6 Taxman 91 (Bom.) (para 18), J.R. Daniel v. CIT [2001] 248 ITR 174/[2000] 108 Taxman 195 (Mad.) (para 20), Asstt. CIT v. Tea Agency Trading Centre [2004] 88 ITD 96 (Gau.) (TM) (para 20), Steel Containers Ltd. v. CIT [1978] 112 ITR 995 (Cal.) (para 20), CIT v. Gilbert & Barkar Mfg. Co. [1978] 111 ITR 529 (Bom.) (para 20), Bishamber Nath Ram Swarup v. CIT [1987] 163 ITR 87/[1986] 25 Taxman 52 (Delhi) (para 20), Dy. CIT v. Atco Healthcare Ltd. [IT Appeal Nos. 2427 to 2429 (Mum.) of 2003] (para 20), Emil Webber v. CIT [1993] 200 ITR 483/67 Taxman 532 (SC) (para 20), CIT v. Gaya Sugar Mills Ltd. [1986] 160 ITR 933/27 Taxman 20 (Pat.) (para 20), Mrs. Roma Bose v. CIT [1974] 95 ITR 299 (Cal.) (para 20), CIT v. G.R. Karthikeyan [1993] 201 ITR 866/68 Taxman 145 (SC) (para 20), CIT v. Sunderam Industries Ltd. [2002] 253 ITR 396/123 Taxman 774 (Mad.) (para 21), Justice Deoki Nandan Agarwal v. Union of India [1999] 237 ITR 872 (SC) (para 38), Emil Weber v. CIT [1978] 114 ITR 515 (Bom.) (para 48), Asstt. CCE v. Dunlop India Ltd. [1985] 154 ITR 172 (SC) (para 52) and Motorola Inc. v. Dy. CIT [2005] 95 ITD 269 (Delhi) (SB) (para 58).

S.E. Dastur, Sanjeev Shah and H.G. Buch for the Appellant.

P.K. Das for the Respondent.