Unexercised ESOP Buyback Gains Taxable As Capital Gains: ITAT Rules

India's Income Tax Appellate Tribunal (ITAT) has ruled that gains arising from the repurchase of vested, unexercised employee stock options (ESOPs) will be taxed as long-term capital gains (LTCG) rather than salary perquisites. This decision potentially lowers the tax liability for employees, as LTCG generally attracts a lower tax rate than income taxed as salary.

The ITAT's Bengaluru bench held that stock options represent a right to subscribe to shares at a future date and cannot, by themselves, be treated as "specified securities" under the Income Tax Act. Consequently, gains from the repurchase of such unexercised options constitute a transfer of capital assets, making them eligible for taxation under the capital gains regime.

The ruling originated from a case involving a senior executive at Flipkart, where the Income Tax department sought to reclassify the buyback proceeds as a salary perquisite. After failing to get relief from lower appellate authorities, the executive appealed to the ITAT.

Tax experts note that this ruling applies to a specific scenario where vested options are cancelled and compensated with cash, rather than being exercised. Transactions where options are exercised and subsequently sold are still taxed as salary. This creates a differential tax treatment for economically similar outcomes, potentially leading to distortions.

As ESOP schemes become more prevalent, especially in startups and new-age companies, such tax disputes are likely to increase. The ITAT ruling adds to a landscape of conflicting decisions from various high courts on similar issues, highlighting a need for clearer policy guidance.