11 May 2016 EY Tax Alert Chennai Tribunal upholds salary taxation of SARs benefits received from foreign parent of employer Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert summarizes a recent ruling of the Chennai Income Tax Appellate Tribunal (Tribunal) in the case of Soundarrajan Parthasarathy and Kummathi Rameswar Reddy [1] (Taxpayers) on the issue of taxation of Stock Appreciation Rights (SARs) benefits received by employees of an Indian company (I Co) from a foreign parent based in the USA (US Co). The Tribunal held that the benefits were taxable as salary income in the hands of the employees for the following reasons: (a) The benefits are not in the nature of capital gains arising from transfer of any capital asset. (b) Although the benefits were not received directly from the employer (I Co), they were paid for services rendered to I Co as compensation, in addition to salary income, by the parent, US Co, which was interested in I Co s business. (c) Even though the SARs benefits vested when the employees were non-residents (NRs) and rendered services outside India, they were exercised when the employees were residents in India. [1] [TS-252-ITAT-2016]
Background Section 15 of the Indian Tax Laws (ITL) includes, inter alia, the following incomes as chargeable to tax under the head Income from Salary (Salary Income): Perquisite by way of 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 concessional rate to the employee. Profits in lieu of salary which, inter alia, include any payment due to or received by employees from an employer or a former employer (subject to certain exceptions). Under the ITL, an individual taxpayer is liable to global income taxation if he is a resident of India. However, if he is an NR or not ordinarily resident (NOR), taxation is restricted to incomes accrued or arising [2] in India or first received [3] in India. But, under source taxation rules, salary payable for services rendered in India is deemed to accrue or arise in India and, hence, taxable in India. As per the terms of the SARs, the Taxpayers were not offered any security or sweat equity shares, but, were given a right to receive cash equivalent of the appreciated value of certain specified number of securities of US Co. The rights vested in the Taxpayers when they were working outside India and were NRs. But, the Taxpayers exercised the rights when they were residents of India. I Co withheld tax on the SARs benefits by treating them as Salary Income. It appears that US Co also withheld taxes payable in the USA on the same benefits. However, while filing their returns of income, the Taxpayers claimed that the SARs benefits were not taxable as Salary Income. This claim was rejected by the Tax Authority. The First Appellate Authority confirmed the Tax Authority s action of taxing the SARs as Salary Income. Being aggrieved, the Taxpayers filed further appeal to the Tribunal. The ITL casts an obligation on the employer to withhold tax on income chargeable as Salary Income while making payment to its employees. Taxpayer s contentions The SARs benefits were not taxable as Salary Income on the following grounds: Facts SAR is a capital asset and, hence, realization of value of the SAR is taxable as capital gains. The Taxpayers were employees of I Co which was a subsidiary of US Co. US Co rolled out a SARs plan under which the Taxpayers, as employees of I Co, became eligible and received options under the plan. The SARs vested in the employees when they were NRs working outside India. The fact that they were exercised while being resident in India is not relevant. The SARs were given by US Co which was not the employer of the Taxpayers. Since there was no employer-employee relationship between the Taxpayers and US Co, the SARs cannot be treated as Salary Income of the Taxpayers. [2] Or deemed to accrue or arise [3] Or deemed to be received The SARs were already subjected to tax in the USA and, hence, taxation thereof in India would amount to double taxation of the same income.
Tax Authority s contentions US Co promoted the SARs scheme to promote its business and for commercial expediency. The Taxpayers accepted the offer and enriched themselves. The Tax Authority asserted salary taxation of the SARs benefits on the following grounds: SARs were taxable as perquisites, since they represented value of specified security allotted or transferred, directly or indirectly, by the employer, free of cost or at concessional value. The SARs benefits were conferred on the Taxpayers since they were employees of I Co which was a subsidiary of US Co. This constituted indirect grant of perquisite by the employer. No evidence was furnished by the Taxpayers in support of tax paid in the USA on the subject income and, hence, the benefits were fully taxable in India. Tribunal s ruling The Tribunal ruled in favor of the Tax Authority and upheld salary taxation on the following grounds: The SARs were in addition to salary for services rendered to I Co and, hence, they were taxable as salary, being benefit in lieu of salary for services rendered. SARs trigger taxation in India if the exercise happens when a taxpayer is resident in India The SARs benefits were conferred on the Taxpayers for services rendered to I Co. The Taxpayers exercised the SARs options when they were residents in India. Merely because the vesting happened when the Taxpayers were NRs and working outside India, does not relieve taxation at the time of the exercise, based on residency in India. The Taxpayers are entitled to the India- US Double Taxation Avoidance Agreement (DTAA) benefit if the SARs are subjected to US tax The Taxpayers did not produce any certificate to support their claim that the SARs had suffered taxation in the USA. SARs are not capital assets The SARs were given to the Taxpayers as compensation for services rendered to I Co. They did not represent transfer of capital asset or termination of any source of income. The Taxpayers were merely given the right to receive appreciation in value of shares in cash, and not shares itself. Hence, SARs did not represent capital assets. They were revenue receipt. This issue requires examination in light of the India-US DTAA on the basis of the certificate issued by the tax authorities in the USA. The Tribunal remitted the matter to the Tax Authority to examine whether the Taxpayers had paid tax on the SARs in the USA and to examine the taxability of the SARs based on the India-US DTAA. The SAR is taxable as Salary Income despite the absence of a direct employeremployee relationship with US Co SARs were given to employees who are connected, directly or indirectly, with US Co so as to motivate the employees to perform their best work. But for employment with I Co, the Taxpayers would not have received the benefits. The SARs benefitted I Co directly and US Co benefitted indirectly.
Comments Most of the issues dealt with in the present ruling have been covered by an earlier ruling of the Special Bench (SB) of the Mumbai Tribunal in the case of Sumit Bhattacharya [4]. The present ruling is in line with the ratio laid down by the SB, although no explicit reference has been made to the SB ruling. An additional issue dealt with in the present ruling that was not covered by the earlier SB ruling is taxation based on residency at the time of encashment of SARs. In case of an NR, if the SARs benefit is received outside India for services rendered outside India, it is possible to urge for pro rata exclusion from the scope of taxation in India. However, in the present case, the Taxpayers were residents (presumably not NORs) in India at the time of the exercise and, hence, the Tribunal held that the whole of the benefits were taxable in India. [4] [300 ITR (AT) 347 (MUM)(SB)]
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