'Stock appreciation rights' different from 'stock options' – redemption taxable under salary; if it is not salary, it is other income - High Court and Supreme Court judges are not employees, but their salary is taxable under heading salary : ITAT
Managing Director of Procter & Gamble Vs Procter & Gamble
MUMBAI, JAN 24, 2008 : THE Special Bench of the Tribunal, in a landmark judgement decided an issue for which there is no judicial precedence.
Tribunal expresses regret for delay in judgement: But we will start at the end. Have you ever come across judges expressing regret for delay in delivering the judgement? This is exactly what happened in this case, where in the last para of the order, the tribunal observed,
As we part the matter, we would like to place on record the fact that though this appeal was finally heard in the month of April 2007, our decision thereon could only be finalized only in the month of December 2007. The unusual delay in disposing of this Special Bench matter was due to the fact that shortly after the appeal was heard, one of us (i.e. the author) was transferred out of Mumbai benches and the meeting of the Members constituting this Special Bench, to discuss and finalise the draft order, was inordinately delayed. There were certain aspects of the matter on which we could not immediately reach a consensus in the source of our discussions immediately after the hearing was over, and, therefore, need of further discussions on those issues was felt. However, due to certain reasons beyond our control, we could not meet to discuss these issues. It was only pursuant to Hon’ble President being kind enough to facilitate a meeting of all the three of us for the said purpose, that the Members constituting this Special Bench could finally meet on 10th December 2007 to discuss those issues as also deliberate on the proposed draft order. It is in this backdrop that there is a delay in disposal of this appeal, which is regretted.
Though originally only a particular issue was referred to the special Bench, in certain peculiar circumstances, the whole appeal was transferred to the Special Bench.
The facts: The appellant taxpayer was, at the material point of time, i.e. in the previous year ending 31st March 1998, employed as Managing Director of the Procter & Gamble India Limited ('PGI') which is a part of the group of companies headed by Procter & Gamble Co., Inc., USA ('PGU'). There is no dispute about the fact that in January 1998, the assessee received a sum of US $ 12,38,084.02, which was equivalent to Rs 4,79,13,851.58, from PGU on account of redemption of certain stock appreciation rights granted in October 1997. The assessee's explanation was that these Stock Appreciation Rights were granted to the assessee by the PGU in recognition of his continuing contributions to the long term success and development of the business of Procter & Gamble, and that these-grants were in accordance with and subject to the terms of the Procter & Gamble 1983 Stock Plan and the regulations of the Stock Options Committee of the Board of Governors. It was stated that PGU had decided to redeem all the stock appreciation rights by paying the difference between market price of shares and the grant price of the shares of the PGU The stock appreciation rights were granted with respect to the common stock of the company from time to time on various dates.
The manner in which these stock appreciation rights worked was like this. A grantee was allotted stock appreciation rights in respect of a specified number of shares of the PGU. The agreed price of the shares, which normally reflected the market price, as on the date of granting the rights was taken as grant value. The grantee could exercise the right to redeem the appreciation of these shares after one year from the date of the grant. The assessee had to use this redemption right within ten years from the date of grant of these rights. On redemption of stock appreciation, the grantee would get the excess of market price of the shares as on the redemption date over the grant value of those shares. No shares are actually allotted or given to the grantee. The rights of the grantee are confined to claim the appreciation of value in respect of shares in question. There are many other conditions attached to these stock appreciation rights.
The assessee's stand, so far as taxability of this amount of Rs 4,79,13,851 was concerned, was that this amount is not taxable in the hands of the assessee for more reasons than one.
1. since the assessee did not have any employer- employee relationship with PGU, i.e. the grantor of the SARs, the amount received on redemption of SARs could not be taxed as 'income from salaries'.
2. the right to receive stock appreciation was in the nature of a capital asset, and since this asset is without any ascertainable cost of acquisition, the amount on sale of these rights would not be considered to be liable to taxation as per judicial pronouncement in the case of CIT Vs B C Srinivas Shetty.
3. in the light of the contents of the CBDT circular No. 710, which was binding on the Assessing Officer under section 119 of the Act, the grant of stock option was not liable to tax.
4. that he was in employment with PGI, which was an ultimate subsidiary of the PGU.
5. It was in recognition of assessee's long term association with the Procter & Gamble Group, and his continuing contribution to the development and success of the Group that PGU had granted him the SARs from time to time.
6. The object of the SAR plan was to enable the grantee of the SAR to benefit from future appreciation in market price of the shares, without requiring grantee to make any investments.
7. that money so received by the assessee from the PGU cannot be considered a perquisite in the hands of the assessee as there was no employer employee relationship between the assessee and the PGU.
8. PGU did not have more than 50% shares in the PGI in the first two years of SAR grants and it could not therefore be said that PGI, in that period, was even a subsidiary company of the PGU.
9. that though the rights acquired by the assessee were capital in nature, these assets were without any cost, and, therefore, no capital gains could arise due to failure of machinery provisions under the Act.
10. It was also pointed out that there was no contract for purchase or sale of any shares or stock and hence the transactions do not fall within the purview of Section 43(5) of the Act.
None of these erudite submissions impressed the Assessing Officer. While he agreed that the assessee was indeed not in employment of PGU, he also noted that the letter granting stock appreciation rights to the assessee itself makes mention of assessee's contribution to the long term success and development of business of Procter & Gamble. The Assessing officer also observed that that payment received by the assessee maybe gratuitous but still the same is taxable under section 17(1) of the Act. It was in this backdrop that the amount of Rs 4,79,13,851 was taxed by the Assessing Officer under the head 'income from salaries'.
Aggrieved, the assessee carried the matter in appeal before the CIT (A) but without any success. The stand of the Assessing Officer was upheld and confirmed in the cryptic order passed by the CIT (A). The assessee was unsatisfied and the matter was, therefore, carried in further appeal before a Division Bench of the Tribunal. The Division Bench noted that the CIT (A) did not give any opportunity of hearing to the assessee on the ruling given by the Authority for Advance Ruling, on which the CIT (A) had relied, and that a number of documents, including the scheme under which stock appreciation rights were granted, were filed for the first time before the Tribunal. It was in this background that the matter was remitted to the file of the CIT (A) .
In the remanded proceedings also, the CIT (A) confirmed the action of the Assessing Officer. He concluded that the payment has arisen to the appellant because of his employment with Procter & Gamble, and that the payment received by the appellant is nothing but profits in addition to salary and form part of the salary under section 17(1)(iv) of the Act. The action of the Assessing Officer was thus upheld, and in fact fortified by the CIT (A) in this round of proceedings. The assessee is not satisfied and is in further appeal before ITAT.
This appeal originally came up before a Division Bench but has now been referred to the Special Bench.
The Special bench observed,
1. Connotations of the expression "stock options" and "stock appreciation rights" are quite distinct, and that these two expressions cannot be used interchangeably.
2. By way of stock appreciation rights, a person is allowed a reward contingent upon performance of the company in the stock market. By way of a stock option, on the other hand, a person is allowed to acquire the shares of a company at a price lower than prevailing market price.
3. Unlike a stock option plan, which aims at what can be termed as employee's participation in ownership, a stock appreciation right is a scheme of bonus payment which is on the basis of financial performance of the company.
4. That is the reason perhaps of the stock appreciation right being generally confined to key personnel of the company who can make a significant contribution to financial success of the company.
5. This distinction between the nature of stock appreciation rights and the stock options is so fundamental and that it affects the tax treatment of these two benefits.
6. While in stock option, the assessee gets a capital asset at a concessional or nominal price, what is to be taxed is the value of this benefit. In the case of the stock appreciation rights what the assessee actually receives is a kind of cash bonus, which is in the nature of deferred wages and which is contingent upon the company doing well in financial terms.
The Tribunal found that there are no judicial precedents or specific legislative provisions so far on the question of taxability of stock appreciation rights and that the distinction between the nature of stock options and stock appreciation rights is so fundamental that the decisions and legislative provisions in the context of stock options have no relevance to determine the taxability of amount received on redemption of stock appreciation rights.
The question then arises whether the receipt of money on account of redemption of stock appreciations rights is in the nature of income or not.
• As observed by the Supreme Court in the case of Emil Weber Vs CIT , the definition of income, under section 2(24), is an inclusive definition.
• It adds several artificial categories to the concepts of income, but , on that account, the expression ‘income’ does not lose its natural connotation.
• Indeed, it has been repeatedly said that it is difficult to define the expression ‘income’ in precise terms’ anything which can be properly described as income is taxable under the Act, unless, of course, it is exempt under one or other provisions of the Act.
• The expression ‘income’ is of widest amplitude so as this expression may be given its natural land grammatical meaning, it should be construed in the widest sense.
The Tribunal held:
The amount received by the assessee on redemption of share appreciation rights, is nothing but a deferred wage contingent upon performance of the company’s shares in the market. The very preamble of the scheme, under which share redemption rights have been given to the assessee, also states that it is on the nature of deferred awards related to the increase in the price of the Common Stock of the Company. It is thus clear that the amount received on redemption of stock appreciation rights is in the nature of consideration for services rendered by the assessee. This amount is in revenue nature because the consideration for the amount so received is the services rendered by the assessee. Therefore, the amount received by the assessee on redemption of stock appreciation rights is in the nature of income.
The next question then is the head of income under which the amount so received by the assessee is to be taxed.
There is no dispute that the amount received by the assessee is in the nature of, what the assessee prefers to term as ‘fruits of employment. The natural corollary of this undisputed factual position is that the said income should be taxed under the head ‘income from salaries’ but one of the basic arguments of the assessee against such a taxability is that since there is no employer employee relation between PGU and the assessee, the amount received by the assessee from PGU, on redemption of his stock appreciation rights, cannot be taxed under the head ‘income from salaries’. This argument rests on the assumption that taxability under the head ‘income from salaries’ is confined to what is received by an employee from his employer.
This proposition, is no longer legally sustainable.
The Supreme Court’s five judge bench judgment in the case of Justice Deoki Nandan Agarwal Vs Union of India had observed.
“ It is contended qua fourth question that, in any event, a judge of the High Court and the Supreme Court has no employer and, therefore, what he receives is not salary; accordingly, what he receives as remuneration is not taxable under the ‘salary’ under the Income Tax Act. To our mind, there is a misconception here. It is true that High Court and Supreme Court judges have no employer, but that, ipso facto, does not mean that they do not receive ‘salaries’….. It is not possible to hold that what judges receives are not ‘salaries’ or that such salaries are not taxable as income under the head of ‘salary’…….
As held by the five judge bench in the above case, a High Court or Supreme Court judge has no employer, and yet the salary received by the Hon’ble judges, is taxable under the head ‘income from salaries’. When there is no employer, as admittedly is the position in this case, there cannot be any question of anything flowing from employer to the employee, and yet the salaries received by the Hon’ble judges was held to be taxable under the head 'income from salaries’. The theory of compensation for services rendered flowing from employer to the employee being since qua non for taxability under the head ‘Income from salaries’ is thus no longer valid. What is material is that the amount received by the assessee should be in the nature of salaries.
As for the connotation of the expression ‘salary’ the Tribunal quoted the Stroud’s Judicial Dictionary, which defines ‘salary’ as recompense or consideration given to a person for his pains bestowed upon another man’s business’ and observed that it is not even assessee’s case that the stock appreciation right that he has received are no in the nature of ‘recompense or consideration’ given to him for anything other than his employment. The only defence for its non taxability under the head ‘Income from salaries’ is that the stock appreciation rights are not received from the employer, and, therefore, the same cannot be taxed under the head ‘income from salaried’. This plea, is not sustainable in law.
As follows from the Supreme Court judgment in the Justice Deoki Nandan Agarwal ’s case, what is to be taxed under the head ‘income from salaries’ is whatever constitutes ‘salary’. The expression ‘salary’ though not specifically defined under the Act, is the reward or consideration for services rendered by a person in employment. The assessee’s receipts of whatever nature, in connection with his employment, are, therefore, to be treated ‘salaries’.
Though it is only academic, now in this case, can Tribunal change the heading of income?
The Tribunal held that even if the amount received by the assessee on redemption of share appreciation right is held to be not taxable under the head ‘income from salaries’ this fact, by itself would not take the same outside the ambit of taxable income, since, in such an eventuality, the said amount will be taxable under the head ‘income from other sources’. Even if it is held that amount in question is received from a person other than the employer of the assessee, and that in order for an income to be taxed under the head ‘income from salaries it is a condition precedent that the salary, benefit or the consideration must flow from employer to the employee, the amount received by the assessee on redemption of stock appreciation rights will still be taxable – though under the head ‘Income from other sources’. The plea raised by the assessee that the amount in question cannot be taxed as ‘income from salaries’ is thus irrelevant.
Finally the Tribunal held,
1. the assessee was indeed liable to tax in respect of the amount of Rs. 4,79,13,851 received on redemption of stock appreciation right.
2. The taxability of this amount is under the head ‘income from salaries’
3. Even if assessee’s plea that the amount in question is received from a person other than the de jure employer, even if it was to be accepted, would not have any material difference to the taxability per se, because in such an event, this amount would have been taxed under the head ‘income from other sources’.