One-Time ESOP Compensation: Capital Receipt or Taxable Perquisite?
1. Situation:
i. Suppose, an employer pays a one-time discretionary compensation to employees due to a reduction in value of ESOPs, without the ESOPs being exercised. Due to company restructuring or adverse market movement, the value of options fell and so the employer decided to pay a one time compensation to the employees.
ii. The moot point is whether such a compensation is:
A non-taxable capital receipt, or
A taxable perquisite under Section 17(2)(vi) of the Income-tax Act?
2. What is Sec 17(2)(vi) – Perquisites
i. “Perquisite” includes—
“(vi) the value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer or former employer, free of cost or at a concessional rate to the assessee…”
ii. Key requirements:
The security must be allotted or transferred.
Trigger point is exercise, not just grant.
3. Karnataka HC judgement:
i. Karnataka HC in a very recent case of Manjeet Singh Chawla v. DCIT. W.P. No. 20212 of 2023 (T-IT) (Karnataka High Court) [02-06-2025] held that such a payment is a capital receipt and not a taxable perquisite.
Reasoning:
a. Section 17(2)(vi) applies only when specified securities are allotted or transferred upon exercise of the option.
b. Since the ESOPs were never exercised, no “perquisite” arose.
c. The payment was made to compensate for loss of potential capital appreciation, not in the nature of salary.
d. The employer had no TDS obligation under Section 192.
4. Delhi HC judgement:
Delhi HC in the case of Sanjay Baweja [W.P.(C) 11155/2023 (Delhi HC) has similarly held that the amount received is a non-taxable capital receipt.
Reasoning:
a. Section 17(2)(vi) triggers only upon exercise of ESOPs.
b. Compensation paid in respect of unexercised options cannot be treated as a perquisite.
c. The right under ESOP is a contingent capital right.
5. Divergent view by Madras HC:
However Madras HC in the case of Nishithkumar Mukeshkumar Mehta v. Deputy Commissioner of Income (165 taxmann 386 (Madras) held that such a payment is taxable as a perquisite under Section 17(2)(vi).
Reasoning:
a. The expression “transferred directly or indirectly” in Section 17(2)(vi) is wide enough to cover compensation for unexercised options.
b. Even without exercise, economic benefit flowed to the employee.
c. Payment had a nexus to employment and ESOP scheme, hence falls under “salary” head.
6. Conclusion:
i. The Karnataka and Delhi High Courts have adopted a narrow and literal interpretation of Section 17(2)(vi), treating such payments as capital receipts not chargeable to tax and outside the scope of TDS under Section 192.
ii. The Madras High Court, however, has taken a broader, purposive approach, classifying the compensation as a perquisite arising from employment.
iii. Given this clear judicial divergence, the issue is ripe for Supreme Court resolution, or CBDT clarification to ensure consistent tax treatment
The copy of the order is as under:
