SUPREME COURT OF INDIA

Commissioner of income-tax

v.

Infosys Technologies Ltd.

S.H. KAPADIA AND B. SUDERSHAN REDDY, JJ.

CIVIL APPEAL NO. 3725 OF 2007

January 4, 2008

Section 17(2), read with sections 192 and 201 of Income-tax Act, 1961 - Salaries - Perquisites - Assessment years 1997-98 to 1999-2000 - To implement ESOP, assessee created a Trust because of buy back problem and allotted 7,50,000 warrants at Rs. 1 each to said trust - Each warrant entitled its holder to be allotted one equity share of face value of Rs. 10 each for total consideration of Rs. 100 - Every warrant had to be retained for a minimum period of 1 year - Only after expiry of this cooling period, an employee would be entitled to elect and obtain shares allotted to him on payment of balance Rs. 99 - It was open to employees not to avail of benefit of option or resign and there was no certainty that option would be exercised - Allotted shares were subject to a lock-in period of 5 years during which shares could not be obtained by employees and custody of shares would remain with Trust - If employees stood dismissed, removed or in case of his resignation, they were required to return allotment - Further, shares were stamped with remark non-transferable making them incapable of being converted into money during lock-in period and stock exchange was also notified - Whether since prior to lock-in period of 5 years shares allotted to employee had no realizable sale value on day when he exercised his option, there was no cash inflow to employee – Held yes – Whether lock-in period neither was it possible for employee to know future value of shares allotted to him on day he exercise his option nor was it possible for assessee-company to estimate value of perquisite - Held, yes - Whether during years in question, benefit, if any, which arose on date when option stood exercised was only a notional benefit whose value was unascertainable and therefore, Department had erred in treating difference between market value of shares on date of exercise of option and total amount paid by employees consequent upon exercise of said options as possible value - Held, yes - Whether consequently, neither section 192 nor section 201(1) or section 201(1A) was applicable to facts of this case - Held, yes

FACTS

To implement Employees Stock Option Scheme (“ESOP”), the assessee created a Trust and allotted 7,50,000 warrants at Re. 1/- each to the said Trust. Each warrant entitled the Holder thereof to apply for and be allotted one equity share of the face value of Rs. 10/- each for total consideration of Rs. 100/-. The Trust was to hold the warrant and transfer the same to the employees of the company. During the relevant assessment years, warrants were offered to the eligible employees at Re. 1/- each by the Trust every warrant had to be retained for a minimum period of 1 year. At the end of that period, the employee was entitled to elect and obtain shares allotted to him on payment of the balance Rs. 99. The option could be exercised at any time after 12 months but before expiry of the period of 5 years. The allotted shares were subject to a lock-in period. During the lock-in period, the custody of shares remained with the Trust. The shares were non-transferable. An employee had to continue to be in service for 5 years. If he would resign or his service be terminated for any reason, he would lose his right under the scheme and the shares were to be re-transferred to the Trust for Rs. 100 per share. Intimation was also given to BSE that 734500 equity shares were non-transferable and would not constitute good delivery. Till 13.9.1999 all the shares were stamped with the remark ‘non-transferable’. Thus the said shares were incapable of being converted into money during the lock in period. The Assessing Officer held that the ‘perquisite value’ was the difference between the market value and the price paid by the employees for exercise of the option. He opined that on ‘perquisite value’, TDS was to be charged at 30 per cent. The respondent assessee was held a defaulter for not deducting TDS under section 192 on the above perquisite value computed by him. The orders of the Assessing Officer were confirmed by Commissioner (Appeals). The Tribunal, took the view that the right granted to the employee for participating in the scheme was not a ‘perquisite’ under section 17(2)(iii). This decision of the Tribunal stood confirmed by the impugned judgment delivered by the Karnataka High Court.

On appeal to the Supreme Court,

HELD

During relevant assessment years 1997-98, there was no provision in the Act which made the benefit by way of ESOP taxable as income specifically. It became specifically taxable only with effect from 1.4.2000 when section 17(2)(iiia) stood inserted.

Warrant is a right without obligation to buy. Therefore, ‘perquisite’ cannot be said to accrue at the time when warrants were granted in this case. Same would be the position when options vested in the employees after lapse of 12 months, it is important to note that in this case options were exercisable only after the cooling period of 12 months. Further, it was open to the employees not to avail of the benefit of option. It was open to the employees to resign. There was no certainty that the option would be exercised. Further, the shares were not transferable for 5 years (lock-in period). If an employee resigned during the lock-in period the shares had to be re-transferred. During the lock-in period, the possession of the shares, which is an important ingredient of shares, remained with the Trust. The Stock Exchange was duly notified about non-transferability of the shares during the lock-in period. The shares were stamped with the remark “non-transferable” during the lock-in period. It was not open to the employees to hypothecate or pledge the said shares during the lock-in period. During the said period, the said shares have no realisable value. Hence, there was no cash inflow to the employees on account of mere exercise of options. On the date when the options were exercised, it was not possible for the employees to foresee the future market value of the shares. Therefore, the benefit, if any, which arose on the date when the option stood exercised was only a notional benefit whose value was unascertainable and, therefore, the Department had erred in treating the amount being the difference in the market value of shares on the date of exercise of option and the total amount 'paid’ by the employees consequent upon exercise of the said options perquisite value.

As stated above, unless a benefit /receipt is made taxable, it cannot be regarded as ‘income’. This is an important principle of taxation under the Act. Applying the above principle to the insertion of clause (iiia) in section 17(2) one finds that for the first time with effect from 1.4.2000, the word ‘cost’ stood explained to mean the amount actually paid for acquiring specified securities and where no money had been paid, the cost was required to be taken as nil.

The mechanism introduced for the first time under the Finance Act, 1999 by which “cost” was explained in the manner stated above was not there prior to 1.4.2000. The new mechanism stood introduced with effect from 1.4.2000 only. With the above definition of the word ‘cost’ introduced vide clause (iiia), the value of option became ascertainable. There is nothing in the Memorandum to the Finance Act, 1999 to say that this new mechanism would operate retrospectively. Further, a mechanism which explains ‘cost’ in the manner indicated above cannot be read retrospectively unless the Legislature expressly says so. It was not capable of being implemented retrospectively. Till 1.4.2000, in the absence of the definition of the word ‘cost’, value of the option was not ascertainable. In our view, clause (iiia) is not clarificatory. Moreover, the meaning of the words ‘specified securities’ in section (iiia) was defined or explained for the first time vide Finance Act, 1999 with effect from 1.4.2000. Moreover, the words allotted or transferred in clause (iiia) made things cleat only after 1.4.2000. Lastly, it may be pointed out that even clause (iiia) has been subsequently deleted with effect from 1.4.2001. For the aforestated reasons, clause (iiia) cannot be read as retrospective.

The question is whether every benefit received by the person is taxable as income? It is not so. Unless the benefit is made taxable, it cannot be regarded as income. During the relevant assessment years, there was no provision in law which made such benefit taxable as income. Further, as stated, the benefit was prospective. Unless a benefit is in the nature of income or specifically included by the Legislature as part of income, the same is not taxable. In this case, the shares could not be obtained by the employees till the lock-in period was over. In the absence of legislative mandate a potential benefit could not be considered as “income” of the employee(s) chargeable under the head ‘salaries’. The stock was non-transferable and the stock exchange was also accordingly notified. This is where the weightage ought to have been given by the Assessing Officer to an important factor, namely, lock-in period. This has not been done. It is important to bear in mind that if the shares allotted to the employee had no realizable sale value on the day when he exercised his option, then there was no cash inflow to the employee and it was not possible for the employee to know the future value of the shares allotted to him on the day he exercises his option. Even the cost of acquisition as ‘nil’ came to be introduced in the Act by the Finance Act, 1999 only with effect from 1.4.2000. In fact, the later deletion of clause (iiia) is an indicator of the Ineffective Charge.

For the aforestated reasons, the Department had erred in treating the difference between amount paid by employer and market value of corresponding shares as a perquisite value for the relevant assessment years. During relevant years, the fifth anniversary had not taken place and, therefore, it was not possible for the assessee company to estimate the value of the perquisite during that period. It was not open to the Department to ignore the lock-in period. Therefore, the Department had erred in treating the respondent as an assessee in default for not deducting the TDS at 30 per cent as stated in the order of assessment. This was not the case of tax evasion. The assessee had floated the Trust because of the buy back problems, which were genuine problems in cases where the employees stood dismissed, removed or in the case of resignation, in which cases they were required to return the allotment. Estimation of TDS under section 192 in the absence of clear provisions on valuation of ‘perquisite’ in this case would not justify the Department in treating the respondent as assessee in default. Consequently, sections 201(1) and 201(1A) were also not applicable to the facts of this case and that the Department had erred in invoking the said two sections against the assessee.

Therefore, the civil appeals were dismissed.

CASE REVIEW:

Judgment of the Karnataka High Court in case of CIT v. Infosys Technologies Ltd. [2007] 159 Taxman 440/293 ITR 146 affirmed