A lot of employers now-a-days offer innovative forms of employee compensation, with an intent to better align their personal interests with the company’s interests. Employee stock options or “sweat equity” is a common form of compensation widely established in the IT sector.
Also read – Taxation of ESOP/ESPP/RSU/SAR in India
However, some employers offer a variation of this model known as “Stock Appreciation Rights” (SAR). Under this option, there is no giveaway of stock options or equity shares, however the employee participates only in the “appreciation” in the value of company’s shares on a specified date.
Situation becomes more complex where the SAR is not given by employer but its parent company. Situation becomes even more complex when the SAR benefit is taxed in that overseas country in addition to India.
In this regard, recently I came across an interesting decision of Chennai Bench of Income Tax Appellate Tribunal in the case of Soundarrajan Parthasarathy v. Deputy Commissioner of Income-tax, Chennai asreported in[2016] 70 taxmann.com 27. Let us discuss the broad points and learning from this case.
Facts of the case
- Assessee was an employee of Cognizant Technologies India, which was a subsidiary of CTS Corporation, USA (parent company of Cognizant USA).
- Cognizant USA promoted an incentive plan to the employees of Cognizant India known as ‘1999 Incentive Compensation Plan’. As per this plan, an option was given to the employees of Cognizant Technologies India for providing Stock Appreciation Rights (SARs). The eligibility for participation for the SARs was that recipients should be employees of the company.
- During the year, Cognizant India deducted tax at source by treating the SARs as a perquisite in the hands of the assessee. SARs were also subjected to tax in USA hence Cognizant USA also deducted tax on the same.
Counter points by the assessee and ITD
By the ITD:
- Going by Section 17(2)(vi) of Income Tax Act, when the value of specified security or sweat equity shares was transferred directly or indirectly by the employer either free of cost or at concessional rate, the same has to be treated as “perquisite” in the hands of the recipient employee and hence should be taxed as “income from salaries”
- SARs constitute “indirect” benefit as benefit was given to the assessee being employees of Indian company which was subsidiary to the USA company.
By the assessee:
- SARs offered to them was a capital asset, therefore, the realization of the value of the SARs was nothing but capital gain.
- No employer-employee relationship existed as the company giving the SAR (CTS USA) was not an employer of assessee.
- During vesting period of SAR, assessee was a non-resident and since services were rendered outside India, the same was not taxable in India.
- The SAR has already suffered tax in USA (by way of tax deduction by CTS) hence it should not be taxed again in India
Decision of ITAT
Following are the main points of the Tribunal’s decision:
- If the assessee were not employees of the Cognizant Technologies India Pvt. Ltd., a subsidiary company of Cognizant Technology Solutions Corporation, a Delaware Corporation, USA, they would not have been given option of availing the SAR. This option helped Cognizant to motivate the employees to perform their best in their work. Therefore, the assessee’s existing employer (Cognizant Technologies India Pvt. Ltd.) would be directly benefited and indirectly Cognizant USA is also benefited. Therefore, the contention of the assessee the incentive was not provided by the employer of the assessee is not correct. Therefore, what was received by the assessee is in nature of perquisite or benefit in lieu of salary hence has to be included as income in the hands of the assessee.
- There is no merit in the contention of the assessee that SAR is a capital asset. The incentive was given to the assessee as a compensation for the services rendered to Cognizant India & not for any transfer of capital asset or termination of any source of income& hence the same is liable for taxation as revenue receipt.
- Benefit was conferred on the assessee in the form of SAR for the services rendered to the subsidiary company, Cognizant India. Hence, merely because the assessee was non-resident during the vesting period of the SAR is no ground to claim that it was not taxable in India. When the assessee exercised the option for SAR, he was residents in India. Hence, irrespective of residency, SAR benefit is liable for taxation in India.
- As regards assessee contention that value of SAR has already suffered tax in the USA, assessee has not provided any proof/documentation (e.g. W-8 certificate, USA tax return etc.) to prove that tax was paid in USA. Hence, matter is remitted back to the Assessing Officer for limited purpose of examining whether the assessee has paid tax in USA on & also evaluate impact of India USA DTAA on the taxability of this transaction in India.
My learning from this case
Though there have been prior judgements on taxability of SAR, this case assumes importance especially due to the peculiar facts. Some of my learning pointers from this case are as follows:
- Given this ruling, Indian tax authorities now have an even stronger case to tax each and every SAR transaction of returning NRIs irrespective of residential status at the time of vesting & even if SARs were received not from employer directly but its parent/associated enterprise.
- For a returning NRI who now qualifies as a proper Indian resident, any SAR value received must be offered for tax in India. Not offering it to tax can also give a reason to the AO to initiate penalty proceedings for concealment of income. Also read – Retuning NRI/OCI’s Guide to India’s Black Money Act
- In the instant case, the assessee made two mistakes: first, he should have disclosed this income clearly and claimed DTAA benefit. Second, at the appeal stage, he should have produced the documentary proof of paying USA taxes on this money. Since none was available, ITAT could not comment anything on the DTAA impact of the transaction.
- Speaking on India-USA DTAA, with this decision, it is very likely that SAR will fall in purview of Article 16 i.e. “Dependant Personal Services” and not “Capital Gains”.
- One has to closely watch this space for any conflicting judgements & DTAA interpretation.
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