Taxability of ESOPs for Non-Residents: Mumbai ITAT Upholds FMV as Cost of Acquisition Regardless of Indian Taxation of Perquisite

The taxation of Employee Stock Ownership Plans (ESOPs) for globally mobile employees often presents complex cross-border tax challenges. A recurring dispute between the revenue authorities and non-resident individuals is the determination of the cost of acquisition when ESOP shares are sold. The core issue is whether a non-resident, whose ESOP perquisite was taxed in a foreign jurisdiction, can claim the Fair Market Value (FMV) as the cost of acquisition in India under the Income Tax Act 1961.

In a landmark ruling, the Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) in the case of Rajesh R Hemrajani Vs ITO has provided much-needed clarity. The Tribunal ruled that the FMV of shares on the date of exercise must be considered the cost of acquisition for computing capital gains, even if the perquisite value was not subjected to tax in India.

This comprehensive summary and analysis of the judicial decision delves into the factual matrix, the legal arguments presented by both sides, and the Tribunal's strict interpretation of statutory provisions.

The Mechanics of ESOP Taxation in India

To appreciate the gravity of the Tribunal's decision, it is essential to understand the dual-stage taxation mechanism for ESOPs under the Income Tax Act 1961:

1. **At the time of Allotment (Exercise)😗* When an employee exercises their options, the difference between the FMV of the shares on the exercise date and the exercise price paid by the employee is treated as a perquisite. This amount is taxable under the head "Income from Salaries" as per Section 17(2)(vi). The FMV is determined strictly in accordance with Rule 3(8)(ii) of the Income Tax Rules.
2. **At the time of Sale (Transfer)😗* When the employee subsequently sells these shares, the profit or loss is taxed under the head "Capital Gains". To prevent double taxation of the same economic benefit, Section 49(2AA) mandates that the FMV previously considered for computing the perquisite shall be deemed as the cost of acquisition for calculating capital gains.

The complexity arises when the assessee is a non-resident, and the employment services were rendered outside India. In such scenarios, the salary and the associated perquisite do not accrue or arise in India under Section 5 read with Section 9(1)(ii). Consequently, the perquisite is taxed in the foreign jurisdiction. The revenue authorities in India frequently argue that since the perquisite was never taxed in India, the benefit of the stepped-up cost of acquisition under Section 49(2AA) should be denied.

Factual Matrix of Rajesh R Hemrajani Vs ITO

The assessee in the present dispute was an individual qualifying as a non-resident Indian for the Assessment Year 2019-20. He was a tax resident of the United Kingdom, employed with the UK branch of L&T Infotech Ltd.

During the relevant financial year, the assessee exercised his vested ESOPs and acquired 1,540 equity shares of the Indian parent company. The financial specifics of the transaction were as follows:

• Exercise Price: Re. 1 per share
• Fair Market Value (FMV) on Exercise Date: Rs. 1,753.58 per share
• Total Sale Consideration: Rs. 25,99,863 (shares were sold on various dates during the year)