Supreme Court Clarifies Taxability of Stock Appreciation Rights (SARs) in Income Tax Act: Addl. Commissioner of Income Tax vs. Bharat V. Patel (24 April 2018)

Introduction

Date of the Judgment: 24 April 2018

Citation: (2018) INSC 342

Judges: R.K. Agrawal, J. and Abhay Manohar Sapre, J.

When an employee receives benefits from their employer, how should these benefits be taxed? The Supreme Court of India addressed this question in a case concerning Stock Appreciation Rights (SARs). The core issue was whether the money received by an employee upon redemption of SARs should be taxed as a perquisite (a benefit related to employment) or as capital gains (profit from the sale of an asset).

The Supreme Court, in this case, examined the taxability of amounts received by an employee on the redemption of Stock Appreciation Rights (SARs). The court had to decide whether such amounts should be taxed as a perquisite under Section 17(2) of the Income Tax Act, 1961, or as capital gains. The judgment was delivered by a two-judge bench comprising Justice R.K. Agrawal and Justice Abhay Manohar Sapre.

Case Background

The respondent, Mr. Bharat V. Patel, was the Chairman and Managing Director of Procter and Gamble (P&G), India. He filed his income tax return for the Assessment Year 1998-99, declaring a total income of Rs 40,13,820. The Assessing Officer, however, determined his total income to be Rs 7,23,11,013, which included an amount received by Mr. Patel on the redemption of Stock Appreciation Rights (SARs).

The SARs were issued to Mr. Patel by P&G, USA, between 1991 and 1996, without any payment from him. These SARs were redeemed on 15 October 1997, and Mr. Patel received Rs 6,80,40,724. Mr. Patel claimed this amount as an exemption from income tax. The Assessing Officer treated this amount as a perquisite and hence taxable under the Income Tax Act, 1961.

Mr. Patel appealed the assessment order to the Commissioner of Income Tax (Appeals), who dismissed his appeal. He then appealed to the Income Tax Appellate Tribunal (the Tribunal), which partly allowed his appeal. Both Mr. Patel and the Revenue (the Income Tax Department) filed cross-appeals before the High Court of Gujarat at Ahmedabad.

The Assessing Officer, while giving effect to the Tribunal’s order, treated the amount of Rs 6,80,40,649 as capital gains on the transfer/redemption of shares and held Mr. Patel liable to pay tax on capital gains. Mr. Patel appealed this order to the CIT (Appeals), which was upheld in favor of the Assessing Officer. Mr. Patel then appealed to the Tribunal, which dismissed his appeal.

The High Court allowed Mr. Patel’s appeal and dismissed the Revenue’s appeal, holding that the amount received on redemption of SARs should be treated as capital gains but no capital gains arose as there was no cost of acquisition. The Revenue then appealed to the Supreme Court.

Timeline

Course of Proceedings

The Assessing Officer initially determined the respondent’s income to be Rs 7,23,11,013, which included the amount received on redemption of SARs. The Commissioner of Income Tax (Appeals) upheld the Assessing Officer’s order. The Income Tax Appellate Tribunal (Tribunal) partly allowed the respondent’s appeal.

Following the Tribunal’s order, the Assessing Officer treated the amount received on redemption of SARs as capital gains. The Commissioner of Income Tax (Appeals) again upheld the Assessing Officer’s order. The Tribunal dismissed the respondent’s subsequent appeal. The High Court of Gujarat at Ahmedabad allowed the appeal of the respondent and dismissed the appeal of the Revenue.

Legal Framework

The case revolves around the interpretation of key provisions of the Income Tax Act, 1961. The primary sections under consideration are:

• Section 17(2) of the Income Tax Act, 1961: This section defines the term “perquisite.” The relevant part, Section 17(2)(iii), states that “*the value of any benefit or amenity granted or provided free of cost or at concessional rate by an employer to an employee*” is a perquisite.
• Section 28(iv) of the Income Tax Act, 1961: This section deals with profits and gains of business or profession. It states that “*the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession*” is chargeable to income tax under the head “Profits and gains of business or profession.”
• Section 17(2)(iiia) of the Income Tax Act, 1961: This clause, introduced by the Finance Act, 1999, and later omitted, defined the value of specified securities allotted or transferred by an employer to an employee. It stated that “*the value of any specified security allotted or transferred, directly or indirectly, by any person free of cost or at concessional rate, to an individual who is or has been in employment of that person*” is a perquisite. The explanation to this clause defined cost, specified securities, sweat equity shares and value.

The Court also considered the concept of “capital gains,” which refers to profits from the sale of property or investments. These gains are taxed in the year the capital asset is transferred.

Arguments

Arguments by the Revenue:

• The Revenue argued that the amount received on redemption of SARs should be treated as a perquisite under Section 17(2)(iii) of the Income Tax Act, 1961, and taxed as income from “Salaries.”
• The Revenue contended that since there was an employer-employee relationship between P&G, USA and the Respondent, the benefit derived from the SARs should be considered as a perquisite.
• The Revenue relied on the case of Sumit Bhattacharya vs. ACIT Circle 16(1), Mumbai [2008] 112 ITD 1 (MUM.) (SB) to support their argument that the amount received on redemption of SARs should be taxed under the head “Salaries.”
• The Revenue also argued that the amendment brought in by Section 17(2) of the IT Act was clarificatory, hence, retrospective in nature.
• The Revenue also argued that the case of the Respondent shall come within the ambit of the Section 28(iv) of the IT Act.

Arguments by the Respondent:

• The Respondent argued that the amount received on redemption of SARs should be treated as capital gains, not as a perquisite under Section 17(2)(iii) or Section 28(iv) of the Income Tax Act, 1961.
• The Respondent submitted that the capital gains could not be said to have arisen as there was no cost of acquisition involved from the side of the Respondent.
• The Respondent contended that such an amount could have been taxed under the provisions of Clause (iiia) of Section 17(2) of the IT Act, but since that clause was not in effect at the time of the transaction, it could not be applied.
• The Respondent relied on the case of Commissioner of Income Tax vs. Infosys Technologies Ltd., [2008] 297 ITR 167 (SC), to argue that the issue was no longer res integra.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. Whether in the present facts and circumstances of the case, any interference by this Court is required with the impugned decision of the High Court?

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

The Court analyzed the authorities presented by both sides. The Court distinguished the case of Sumit Bhattacharya vs. ACIT Circle 16(1), Mumbai [2008] 112 ITD 1 (MUM.) (SB)* stating that it was not applicable in the present circumstances. The Court followed the ratio of Commissioner of Income Tax vs. Infosys Technologies Ltd., [2008] 297 ITR 167 (SC)* stating that unless a benefit is made taxable, it cannot be regarded as income. The Court also followed the ratio of Commissioner of Income-Tax, Bangalore vs B.C. Srinivasa Setty [(1981) 128 ITR 294 (SC)]* that the charging section and computation provision under the 1961 Act constituted an integrated code. The Court interpreted Section 17(2), Section 28(iv) and Section 17(2)(iiia) of the Income Tax Act, 1961. The Court distinguished the applicability of Circular No. 710 dated 24.07.1995 issued by the CBDT stating that it was not applicable to the case of SARs.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the principle that a receipt must be made taxable before it can be treated as income. The Court emphasized that it cannot interpret the law in a way that brings an individual within the ambit of the Income Tax Act to pay tax when they are not otherwise liable. The Court noted that the amendment brought in by the Finance Act, 1999, by inserting clause (iiia) in Section 17(2) of the IT Act, was not retrospective in nature and hence, not applicable to the present case. The Court also held that the case of the Respondent would not fall under the ambit of Section 28(iv) of the IT Act. The Court also noted that the circular issued by the CBDT was not applicable to the facts of the present case.

The Court also noted that the amendment brought in by the Finance Act, 1999, by inserting clause (iiia) in Section 17(2) of the IT Act, was not retrospective in nature and hence, not applicable to the present case. The Court also held that the case of the Respondent would not fall under the ambit of Section 28(iv) of the IT Act. The Court also noted that the circular issued by the CBDT was not applicable to the facts of the present case.

Fact:Law Ratio

Logical Reasoning:

The Supreme Court considered whether the amount received on redemption of SARs could be taxed under Section 17(2)(iii) or Section 28(iv) of the Income Tax Act, 1961. The Court held that the amount could not be taxed as a perquisite under Section 17(2)(iii) because it was not a benefit provided by the employer. The Court also held that the amount could not be taxed under Section 28(iv) because it did not arise from business or profession. The Court noted that the amount could have been taxed under Section 17(2)(iiia), but this provision was not in effect at the time of the transaction. The Court concluded that the amount was not taxable under the existing provisions of the Income Tax Act, 1961.

The Court rejected the Revenue’s argument that the amendment brought in by Section 17(2) of the IT Act was clarificatory and hence retrospective in nature. The Court held that the amendment was not clarificatory and not retrospective. The Court also rejected the Revenue’s argument that the case of the Respondent would fall under the ambit of Section 28(iv) of the IT Act. The Court held that the applicability of Section 28(iv) is confined only to the case where there is any business or profession related transaction involved.

The Court also considered the circular issued by the CBDT and held that it was not applicable to the facts of the present case.

The Court quoted from the judgment in Commissioner of Income Tax vs. Infosys Technologies Ltd., [2008] 297 ITR 167 (SC), stating, “Unless the benefit is made taxable, it cannot be regarded as income.” The Court also stated, “It is a fundamental principle of law that a receipt under the IT Act must be made taxable before it can be treated as income.” The Court further stated, “Courts cannot construe the law in such a way that brings an individual within the ambit of Income Tax Act to pay tax who otherwise is not liable to pay.”

There was no minority opinion in this case.

Key Takeaways

• The Supreme Court clarified that amounts received on redemption of Stock Appreciation Rights (SARs) before 01.04.2000 cannot be taxed as a perquisite under Section 17(2)(iii) of the Income Tax Act, 1961.
• The Court held that such amounts also cannot be taxed under Section 28(iv) of the Income Tax Act, 1961.
• The Court emphasized that amendments to tax laws are not to be applied retrospectively unless expressly stated by the legislature.
• The Court reiterated that a receipt must be made taxable before it can be treated as income.

Directions

The Supreme Court dismissed the appeals filed by the Revenue and directed the parties to bear their own costs.

Specific Amendments Analysis

The judgment specifically discusses the amendment brought in by the Finance Act, 1999, which introduced Clause (iiia) in Section 17(2) of the Income Tax Act, 1961. This clause was intended to bring benefits transferred by employers to employees within the ambit of the Income Tax Act. However, the Court held that this amendment was not retrospective and therefore did not apply to the case at hand, as the transaction occurred before the amendment came into effect.

Development of Law

The ratio decidendi of this case is that unless a benefit is specifically made taxable by law, it cannot be considered as income. The Supreme Court upheld the principle that tax laws should be construed strictly and that individuals cannot be subjected to tax liability unless there is a clear statutory provision. This judgment clarifies that the amendment brought in by the Finance Act, 1999, by inserting clause (iiia) in Section 17(2) of the IT Act, was not retrospective in nature and hence, not applicable to the present case. This case also clarifies that the case of the Respondent would not fall under the ambit of Section 28(iv) of the IT Act.

Conclusion

In conclusion, the Supreme Court dismissed the appeals filed by the Revenue, upholding the High Court’s decision. The Court clarified that the amount received by the respondent on redemption of Stock Appreciation Rights (SARs) prior to 01.04.2000 was not taxable under the existing provisions of the Income Tax Act, 1961. The Court emphasized that tax laws must be interpreted strictly and that a benefit must be made taxable before it can be treated as income. The Court also held that the amendment brought in by the Finance Act, 1999, by inserting clause (iiia) in Section 17(2) of the IT Act, was not retrospective in nature and hence, not applicable to the present case.