The order came in a case involving a former Flipkart employee whose vested stock options were repurchased after Walmart acquired the e-commerce company.
The employee had treated the proceeds from the buyback as long-term capital gains. However, the Income Tax Department argued that the amount should be taxed as salary income, pointing to the employer’s tax deduction at source (TDS) and reporting in Form 16.
The tribunal rejected the tax department’s argument and held that since the employee had only vested options and had not exercised them, no shares were allotted. Therefore, the ESOP perquisite taxation provisions under Section 17(2)(vi) of the Income Tax Act were not applicable.
Tax liability arises only after shares are allotted
The ITAT observed that ESOP taxation as a salary perquisite is triggered only when an employee exercises the stock option and receives shares.
Until exercise, a vested option only represents a right to acquire shares in the future and is considered a capital asset, the tribunal said.
Since the options were bought back before they were exercised, the transaction amounted to a transfer of a capital asset. Any gains arising from the transfer would therefore fall under the “Capital Gains” category, allowing the employee to report the income accordingly.
TDS does not decide tax treatment
The tribunal also dismissed the Revenue’s reliance on Form 16 and the tax treatment mentioned in the ESOP repurchase documents.
It said tax deducted by an employer is only a mechanism for collecting tax in advance and does not determine the final tax liability of an employee.
The ITAT added that the tax calculation mentioned in the repurchase offer documents was only indicative and could not override the provisions of the Income Tax Act.
Relief for startup employees
The ruling could have wider implications for employees of startups who receive ESOP payouts during acquisitions, mergers or secondary share sales.
If such proceeds are treated as long-term capital gains instead of salary income, eligible employees could potentially face a lower tax burden. In some cases, the tax rate could fall to 20% compared with the higher slab rates applicable to salary income.
The decision comes at a time when ESOPs have become a popular tool for startups to attract and retain talent, with employees often receiving liquidity only when companies are acquired or offer exit opportunities.
