Sold ESOP shares after moving abroad? ITAT Mumbai says exercise-date FMV can be treated as cost of acquisition

A UK-based employee who sold shares acquired through an employee stock option plan (ESOP) for nearly ₹ 26 lakh has won a tax dispute after the Mumbai bench of the Income Tax Appellate Tribunal (ITAT) ruled that the fair market value (FMV) of the shares at the time of exercising the options should be treated as their cost of acquisition.

The case involved Rajesh R. Hemrajani, a non-resident and UK tax resident who was employed with the UK branch of L&T Infotech Ltd. He had exercised 1,540 ESOPs at ₹ 1 per share and later sold the shares for about ₹ 25.99 lakh.

While filing his capital-gains computation, Hemrajani treated the FMV of the shares on the exercise date, about ₹ 1,754 per share, as the cost of acquisition. This resulted in a short-term capital loss of around ₹ 1 lakh.

The tax department disputed this treatment and argued that the cost should instead be restricted to the ₹ 1-per-share amount actually paid to exercise the options.

The ITAT Mumbai, however, allowed Hemrajani's appeal and directed the assessing officer to recompute the capital gains by adopting the FMV as the cost of acquisition.

According to the ITAT order, Hemrajani had been granted 7,700 ESOPs relating to shares of L&T Infotech. During the relevant year, he exercised the first tranche of 1,540 options at an exercise price of ₹ 1 per share.

The FMV of the shares on the date of exercise was determined at approximately ₹ 1,753.58 per share under the valuation mechanism prescribed under the Income-tax Act and Rules.

Hemrajani subsequently sold all 1,540 shares through a recognised stock exchange for an aggregate consideration of approximately ₹ 26 lakh.

For calculating capital gains, he relied on section 49(2AA) of the Income-tax Act. The provision deals with the cost of acquisition of specified securities or sweat equity shares acquired under an ESOP and refers to the FMV taken into account for determining the value of the perquisite under section 17(2)(vi).

Using the exercise-date FMV as his cost of acquisition, Hemrajani reported a short-term capital loss of ₹ 1,00,650.

The Revenue's position was that the ESOP benefit was not taxable in India because Hemrajani was a non-resident and the relevant employment services were rendered outside India. Therefore, according to the tax authorities, the FMV could not be treated as the cost of acquisition under section 49(2AA).

The assessing officer instead restricted the cost to the actual exercise price of ₹ 1 per share. The Dispute Resolution Panel subsequently upheld the department's position.

The provision states that the cost of acquisition of specified securities or sweat equity shares acquired through an ESOP is the FMV that has been taken into account for the purposes of section 17(2)(vi).

The ITAT held that the provision does not contain a requirement that the FMV must actually have been subjected to tax in India or included in the taxpayer's total income.