Redemption of Stock Appreciation Rights Taxable as Capital Gains & Not Perquisite !

Stock Appreciation Right (SAR) are part of various kinds of stock options used by companies to incentivize and keep the employee with them. In case of Stock Appreciation Right (SAR) , the employee does get shares or cash payments equivalent to appreciation in the value of shares of the company.So , world over ,Stock Appreciation Right (SAR) is one of the alternatives adopted for implementing an equity based compensation plan .SARs can be structured as either ‘Equity settled–SARs’ or ‘Cash settled–SARs’.

For the purpose of this post , the main issue is “whether when an employee settles ( get redemption ) of SAR i.e companies gives him the appreciated value of the shares vested in him , the income received by him is taxable as perquisite or capital gains ?

Further , if capital gains , what is the nature of gains -short term or long term

Gujarat HC: Redemption of Stock Appreciation Rights Falls Under Capital Gains

We have the benefit of the decision of Gujarat High Court in CIT-1 vs Bharat V Patel [2015] 54 170 (Gujarat) on the issue whether the redemption of Stock Appreciation Rights by an employee is taxable as salary as perquisite or under section 45 as capital gains . The facts involved in the case was

We are not giving further elaborate reasons for the same as in the case of Infosys Technologies Ltd. (supra) it is held by the Hon’ble Supreme Court that the revenue had erred in treating amount being difference in market value of shares on the date of exercise of option and total amount ‘paid’ by employees consequent upon exercise of the said options as perquisite value as during the lock-in period there was no cash inflow to employees to foresee future market value of shares and the benefit if any which arose on date when option stood exercised was only a notional benefit whose value was unascertainable.

  1. In view of the above, the questions raised for consideration in the present appeals are answered in favour of the assessee and against the revenue. The Tribunal was correct in treating the amount received on redemption of Stock Appreciation Rights as capital gain as against treated as perquisite under Sec.17(2)(iii) of the I.T. Act and in treating the amount received on exercising the opinion of Employee’s Stock Option Plan (EOSP) as long term capital gains instead of treating the same as short term capital gains. However, the Tribunal was not justified in holding that capital gain arose to the assessee on redemption of Stock Appreciation Rights which were having no cost of acquisition. Tax Appeals stand disposed of accordingly.

ITAT, Mumbai Special Bench on SAR

The first big decision on the taxation of the Stock Appreciation Rights was given by Mumbai Special Bencg of ITAT  in Sumit Bhattacharya vs CIT (300 ITR AT 347) in which following two , one of which is contrary to decision of High Court was as under :

  1. Stock Appreciation Rights is a benefit which   cannot be taxed in the year of grant or vesting only in the year of redemption, because at the time of vest or grant , there is no appreciation , but one can merely anticipate appreciation.

  2. It is definitely taxable , even if such benefit is not taxable as salary

  3. The Special Bench , however , held that since the  redemption of stock appreciation rights was an employment-related benefit, in the nature of deferred wages contingent upon the financial performance of the ultimate employer, that is, the parent company of the company with which the assessee had entered into an employment contract. In coming to this conclusion, the court relied on the judgment of the Supreme Court in Emil Webber vs CIT (200 ITR 483). Ultimately , the Bench held it it as taxable as perquisite in the year of receipt of appreciation value.

Conclusion on Taxability of SAR

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It must be noted that from the day FBT ( Asst Year 2009-10)  was abolished, the taxation of ESOP was brought in once again u/s 17(2) of the Income Tax Act and specific Rule 3 contains method to find out the value of ESOP benefits.

When an employee is vested with stock appreciation rights , he does not get anything till he actually receives either in form of shares or cash. Therefore , at the time of vesting , no gain actually arises to him. But the moment , he exercises the SAR option to convert it ( i.e redemption of rights) in either shares or cash, the benefit comes to him.

Since the right under Stock Appreciation Rights is legally enforceable right, such a right falls under capital asset . There fore , if such rights are held for more than 36 months , the gain shall be long term capital gains. That is what the Hon’ble Gujarat High Court held relying in the decision of the Supreme Court.

As per the law of precedence , since High Court of Gujarat has pronounced the nature of SAR gains taxable u/s 45 and not section 17(2) as perquisite, it should be followed , unless a contrary judgment of jurisdictional high court is available on the same issue.


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