COMMR.OF INCOME TAX,BANGALORE vs. M/S INFOSYS TECHNOLOGIES LTD

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 1 of 6 CASE NO.: Appeal (civil) 3725 of 2007 PETITIONER: Commissioner of Income Tax, Bangalore RESPONDENT: Infosys Technologies Ltd. DATE OF JUDGMENT: 04/01/2008 BENCH: S.H. Kapadia & B. Sudershan Reddy JUDGMENT: J U D G M E N T with Civil Appeal No. 16 of 2008 @ S.L.P.(C) No. 16926 of 2007 KAPADIA, J. Leave granted. 2. Respondent-assessee is public limited IT company based in Bangalore. To implement Employees Stock Option Scheme (\023ESOP\024), the assessee created a Trust known as Technologies Employees Welfare 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 under the Terms and Conditions of the scheme governing ESOP. During the assessment years 1997-98, 1998-99 and 1999-2000, warrants were offered to the eligible employees at Re. 1/- each by the Trust. They were issued to employees based on their performance, security and other criteria. Under the ESOP Scheme, 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. The employee had to continue to be in service for 5 years. If he resigned or if his services be terminated for any reason, he lost 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 \023non- transferable\024. Thus the said shares were incapable of being converted into money during the lock in period. 3. For the assessment year 1999-2000, the AO held that the total amount paid by the employees consequent to the exercise of option was Rs. 6.64 crores whereas the market value of those shares was Rs. 171 crores. He held that the \023perquisite value\024 was the difference between the market value and the price paid by the employees for exercise of the option. He, therefore, treated Rs. 165 crores as \023perquisite value\024 on which TDS was charged at 30%. It was held that the respondent-assessee was a defaulter for not deducting TDS under Section 192 amounting to Rs. 49.52 crores on the above perquisite value of Rs. 165 crores. Similar orders were also passed by the AO for assessment years 1997-98 and 1998-99. These orders were confirmed by CIT(A). No

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 2 of 6 weightage was given by both the authorities to the lock in period. Both the authorities took into account the \023perquisite value\024 as on the date of exercise of option. 4. Aggrieved by the aforesaid decisions, the respondent- assessee carried the matter in appeal to the Tribunal, which took the view that the right granted to the employee for participating in the scheme was not a \023perquisite\024 under Section 17(2)(iii) of the Income Tax Act, 1961 (\0231961 Act\024). This decision of the Tribunal stood confirmed by the impugned judgment delivered by the Karnataka High Court on 15.12.2006. Hence, these civil appeals by the Department. 5. Whether tax had to be deducted under Section 192 of the 1961 Act, by the respondent-assessee, on the amount earned by its employees from exercise of stock option granted to them by the company through the Trust, is the question which arises for determination in these civil appeals. 6. In the case of Govind Saran Ganga Saran v. Commissioner of Sales Tax and Ors. [(1985) 155 ITR 144 (SC)] this Court held that there are four components of tax. The first component is the character of the imposition, the second is the person on whom the levy is imposed, the third is the rate at which tax is imposed and the fourth is the value to which the rate is applied for computing tax liability. It was further held that if there is ambiguity in any of the four concepts then levy would fail. In this case, we are concerned with the forth concept. There is one more principle which is required to be noted. A benefit/receipt under the 1961 Act must be made taxable before it can be regarded as \023income\024. 7. During the assessment years 1997-98, 1998-99 and 1999- 2000 there was no provision in the said 1961 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. 8. At the outset, we may state that in these civil appeals we are not concerned with taxability but with the value of a perquisite. 9. The question for consideration is whether \023perquisite\024 could be said to accrue at the time when warrants were granted or at the time when the option vested in the employee or at the time when the options stood exercised or at the time when the lock-in conditions were removed or at the time when the shares were to be sold in the share market. According to the AO, the \023perquisite value\024 was the difference between the total amount paid by the employee(s) consequent to the exercise of option amounting to Rs. 6.46 crores on which date the market value of the shares was in all Rs. 171 crores. Therefore, according to the AO, the benefit arose on the date when the options stood exercised. In this case we are concerned with the period prior to 1.4.2000. 10. We quote hereinbelow Sections 17(1) and (2), which read as follows: \023"Salary", "perquisite" and "profits in lieu of salary" defined. 17. For the purposes of sections 15 and 16 and of this section,-

(1) "salary" includes- (i) wages;

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 3 of 6 (ii) any annuity or pension; (iii) any gratuity; (iv) any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages; (v) any advance of salary; (va) any payment received by an employee in respect of any period of leave not availed of by him; (vi) the annual accretion to the balance at the credit of an employee participating in a recognised provident fund, to the extent to which it is chargeable to tax under Rule 6 of Part A of the Fourth Schedule; and (vii) the aggregate of all sums that are comprised in the transferred balance as referred to in sub-rule (2) of Rule 11 of Part A of the Fourth Schedule of an employee participating in a recognised provident fund, to the extent to which it is chargeable to tax under sub-rule (4) thereof; (2) "perquisite" includes- (i) the value of rent-free accommodation provided to the assessee by his employer; (ii) the value of any concession in the matter of rent respecting any accommodation provided to the assessee by his employer; (iii) the value of any benefit or amenity granted or provided free of cost or at concessional rate in any of the following cases:- (a) by a company to an employee who is a director thereof; (b) by a company to an employee being a person who has a substantial interest in the company; (c) by any employer (including a company) to an employee to whom the provisions of paragraphs (a) and (b) of this sub-clause do not apply and whose income under the head "Salaries" (whether due from, or paid or allowed by, one or more employers), exclusive of the value of all benefits or amenities not provided for by way of monetary payment, exceeds twenty-four thousand rupees; Explanation. -For the removal of doubts, it is hereby declared that the use of any vehicle provided by a company or an employer for journey by the assessee from his residence to his office or other place of work, or from such office or place to his residence, shall not be

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 4 of 6 regarded as a benefit or amenity granted or provided to him free of cost or at concessional rate for the purposes of this sub-clause.\024 (emphasis supplied) 11. Warrant is a right without obligation to buy. Therefore, \023perquisite\024 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 retransferred. 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 \023non-transferable\024 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 in flow 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, in our view, the benefit, if any, which arose on the date when the option stood exercised was only a notional benefit whose value was unascertainable. Therefore, in our view, the Department had erred in treating Rs. 165 crores as perquisite value 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.

(a) cost means the amount actually paid for acquiring specified securities and where no money has been paid, the cost shall be taken as nil;

(b) specified security means the securities as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and includes employees stock option and

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 5 of 6 sweat equity shares; (c) sweat equity shares means equity shares issued by a company to its employees or directors at a discount or for consideration other than cash for providing know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called; and (d) value means the difference between the fair market value and the cost for acquiring specified securities;\024 (emphasis supplied)

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 6 of 6 notified. This is where the weightage ought to have been given by the AO 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. 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 \023nil\024 came to be introduced in the 1961 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.