Can money received from an Employee Stock Options (ESOPs) buyback be taxed as salary even if the employee never exercised the stock options? The Bangalore Bench of the Income Tax Appellate Tribunal (ITAT) has answered this question in a significant ruling involving a former Flipkart employee. The Tribunal held that when vested ESOPs are bought back before they are exercised and no shares are allotted, the proceeds should be taxed as capital gains and not as salary perquisite, even if the employer has reported the amount as salary in Form 16.
What is the case?
The case concerns Pramod Kumar Jain vs DCIT before the Bangalore Bench of the Income Tax Appellate Tribunal (ITAT). The dispute was over the tax treatment of Rs 2.33 crore received by a Flipkart employee when the company repurchased his vested ESOPs. The employee had treated the amount as long-term capital gains (LTCG) in his income tax return, while the Income Tax Department argued that it was a salary perquisite taxable under Section 17(2)(vi) of the Income Tax Act because the amount arose from ESOPs granted during his employment. Based on Form 16 and the employer’s tax deduction, the Assessing Officer reopened the assessment and taxed the amount as salary.
Before the Tribunal, the employee argued that although the stock options had vested, they were never exercised and no shares were ever allotted. He contended that an unexercised stock option is only a right to acquire shares in the future and is therefore a capital asset. Since Flipkart Singapore repurchased only the vested options, the payment should be taxed as capital gains and not as salary. The tax department, however, maintained that the ESOPs were granted because of the employment relationship and that Form 16 and the repurchase offer clearly treated the payment as salary income.
The ITAT ruled in favour of the employee. It held that Section 17(2)(vi) applies only when the employee exercises the stock option, and shares are actually allotted or transferred. Since the assessee never exercised the options and no shares came into existence, there was no “specified security” on which a perquisite could be taxed under the salary head. Therefore, the amount received on the repurchase of the unexercised vested stock options could not be taxed as salary, and the Tribunal accepted the employee’s stand that the receipt was taxable under the head Capital Gains.
What does this ruling mean for taxpayers?
The ruling has been delivered by the Income Tax Appellate Tribunal (ITAT) and not by a High Court or the Supreme Court. While it is not binding on all courts, it serves as a strong persuasive precedent that taxpayers in similar ESOP buyback cases can rely on. However, the Income Tax Department may choose to challenge the decision before the Karnataka High Court, meaning the legal position could evolve further depending on the outcome of any appeal.
How are ESOP buybacks taxed?
There are two stages of taxation for ESOPs in India:
When you exercise your ESOPs and receive shares
- The difference between the fair market value (FMV) of the shares and the price you pay is treated as a salary perquisite.
- This is taxed under Section 17(2)(vi) of the Income Tax Act.
When you later sell those shares
- Any profit or loss is taxed as capital gains under Section 45 of the Income Tax Act.
“The Pramod Kumar Jain ruling doesn’t change this framework. It clarifies what happens in a situation the law did not explicitly address, a company buying back vested but unexercised ESOPs where no shares were ever allotted,” an tax expert said.
How should taxpayers report it in their Income Tax Return?
Case 1: ESOPs were never exercised (same as Jain’s case)
- Report the amount under Capital Gains.
- Do not report it as salary, even if Form 16 reflects it as salary income.
- Whether the gain is long-term or short-term depends on the holding period of the option itself, starting from the grant date, and not on any notional shares.
Case 2: ESOPs were exercised and shares were allotted
- The benefit received at the time of exercise is taxable as Salary (Perquisite).
- When the shares are later sold or bought back, the perquisite value already taxed at the time of exercise remains salary income, while any subsequent appreciation is taxed as capital gains. The cost of acquisition for capital gains purposes is the FMV that was already taxed when the ESOPs were exercised.
- Even if the employer has deducted TDS on the entire amount as salary, as happened in Jain’s case, taxpayers can still report the income under the correct head in their ITR. Form 16 and Form 26AS are not conclusive proof of the nature of income. The TDS credit reflected in these forms can still be claimed while computing the final tax liability.
“Given how contested this area still is, employees receiving similar buyback payouts should preserve all relevant documents, including the ESOP grant letter, vesting schedule, buyback or repurchase agreement, and proof that the options were never exercised. That documentation was critical in Jain’s case,” she said.
