The Delhi High Court emphasized that no tax could be levied on notional income, ruling that the Valuation Report obtained by the employer was inapplicable to shares subject to a lock-in stipulation and thus not sellable in the open market; consequently, the Court held that the difference between the allotted price and the market price of ESPS ( Employee Stock Purchase Scheme ) shares is not taxable as a perquisite under Section 17(2)(iiia) of the Income Tax Act, 1961.
As per Section 17(2) of the Income Tax Act of 1961 covers the salary section, which is a payment that employers give to their employees. Salary is a composition of basic salary and allowances. Section 17(2) of the Income Tax Act in India pertains to the computation of an employee’s income. It deals with the inclusion of certain perquisites or benefits provided to employees by their employers in their taxable income.
Get a Copy of Handbook To Income Tax Rules, Click here
The assessee Ravi Kumar Sinha received an allotment of 11,50,500 shares under an Employees Stock Purchase Scheme (ESPS) at an issue price of INR 15 per share, with a lock-in period of 12 months for 25% of the shares and 18 months for the remaining 75%. The share certificates provided to the assessee were marked to indicate these lock-in periods.
During the previous financial year, the assessee paid INR 10.50 per share, despite the issue price being INR 15. To assess the fair market value (FMV) of these shares, the employer engaged M/s Ernst and Young, who issued a valuation report estimating the FMV at INR 22.50 per share. The employer also informed the appellant that the share certificates were marked as non-transferable.
The assessee filed a return of income, arguing that due to the lock-in period, the FMV of the shares could not exceed their face value. However, the Assessing Officer determined that the market price of the shares at that time was INR 49.45 each. Consequently, the difference between the market price and the concessional issue price, amounting to INR 34.45 per share, was treated as a taxable perquisite under Section 17(2)(iiia) of the Income Tax Act, leading to an additional tax liability of INR 3,96,34,725 for the assessee.
Get a Copy of Handbook To Income Tax Rules, Click here
The assessee appealed to the Commissioner of Income Tax (Appeals) (CIT (A)), who ruled that due to the lock-in period restricting the shares’ tradability, the quoted market price should not be used to determine FMV. Instead, the FMV should be based on the valuation report provided by the employer, which set the value at INR 22.50 per share.
Mr. Ajay Vohra, representing the assessee, argued that the lock-in period rendered the FMV inapplicable and asserted that the FMV should reflect what the asset could realistically fetch in the open market. He contended that tax should not be imposed on notional income, and that the Valuation Report, obtained by the employer for withholding tax purposes, and should not determine the FMV for tax liability.
The Division Bench comprising Justice Yawanth Varma and Justice Ravinder Dudeja observed that given the restrictions on marketability and tradability, the FMV of the shares should not exceed their face value of INR 15. The court held that the Valuation Report was only indicative for the employer’s tax withholding obligations and was not appropriate for determining FMV in the context of a lock-in period. Consequently, the appeal by the assessee was allowed.
Subscribe Taxscan Premium to view the JudgmentSupport our journalism by subscribing to Taxscan premium. Follow us on Telegram for quick updates
