In the case of Akash Poddar v. ACIT[i], the Hon’ble Delhi High Court held that the settlement consideration received by the Assessee for a dispute of issuance of sweat equity shares is taxable under the head of ‘long term capital gains’ (‘LTCG’) and such settlement consideration received cannot be considered under the head of ‘salary,’ i.e., ‘profits in lieu of salary’ after the cessation of the employment of the Assessee.
Brief facts
Akash Poddar (‘Assessee’), an Indian resident, was employed as the chief operating officer at Tek Travels Private Limited (‘TTPL’) from 01.12.2007 to 24.08.2010. As outlined in his employment contract, he was entitled to receive sweat equity shares in addition to his annual salary.
The Assessee was not allotted or issued shares till 31.03.2010. On 08.06.2010, TTPL issued 50,000 sweat equity shares in his name and delivered the corresponding share certificates. On 24.08.2010, TTPL terminated the Assessee’s employment.
TTPL refused to recognise the Assessee as a shareholder and did not include the Assessee’s name in the register of members. In response, the Assessee filed a petition with the Company Law Board (‘CLB’) seeking directions for TTPL to register the 50,000 shares in his name.
During the pendency of the case before the CLB, the Assessee and TTPL entered into a settlement agreement on 23.01.2014. Under this agreement, the Assessee received Rs. 3,03,75,000 from TTPL in the financial year (F.Y.) 2013-14. He reported this amount as LTCG with a declared acquisition cost of ‘nil’ in his income tax returns for the year of receipt.
However, the assessing officer (‘AO’) treated this amount as salary income under s. 17(3)(iii) of the Income-tax Act, 1961 (‘Act’) vide order dated 30.12.2016 (‘IT Order’). The AO held that the settlement consideration should not be treated as LTCG and concluded that the settlement consideration was essentially ‘profits in lieu of salary’ received in a lump sum after the termination of employment.
Aggrieved by the IT Order, the Assessee appealed to the Commissioner of Income Tax (Appeals) (‘CIT(A)’). The CIT(A) vide order dated 21.02.2018 overturned the IT order and held that the settlement consideration received by the Assessee should be taxed as LTCG instead under the head of ‘salaries.’
However, the Income Tax Appellate Tribunal (‘ITAT’) took a different stance vide order dated 15.12.2022 (‘ITAT Order’) and taxed 15,000 of the sweat equity shares as capital gains and the remaining 35,000 shares as salary income. The Assessee challenged this decision before the High Court.
Observations
At the outset, the High Court addressed the appeal filed by the Assessee against the ITAT's decision and observed that the Assessee’s counsel argued that the settlement consideration should be treated as compensation for giving up a right to sue. However, the Assessee consistently maintained that the settlement was to be classified as capital gains. Given that the ITAT addressed the Respondent's challenge to this classification, the High Court refrained from further examining the ITAT's decision regarding the argument about relinquishing a right to sue.
The High Court additionally noted that the ITAT’s decision to bifurcate the settlement consideration into salary and capital gains was not suggested by either the Respondents or the Assessee's advocates, indicating that the ITAT independently arrived at this conclusion.
The High Court also noted that the Assessee’s ownership of the 50,000 sweat equity shares was undisputed. The dispute arose because TTPL declined to register the Assessee's name as a shareholder, prompting the Assessee to seek specific performance from the CLB.
Furthermore, upon examining the settlement agreement, the High Court observed that the consideration was provided in exchange for the Assessee relinquishing the right to seek and enforce the registration of the shares. Thus, it was directly related to the Assessee forfeiting the sweat equity shares claims.
The High Court observed that s. 17 of the Act defines ‘salary’ to include ‘perquisites’ and sweat equity is considered a perquisite. However, ‘profits in lieu of salary’ are dealt with separately in s. 17(3) of the Act. Based on this observation, the High Court noted that the ITAT erred.
The High Court further observed that the petition filed with the CLB was primarily concerned with registering the sweat equity shares and did not address the termination of the Assessee’s employment or its validity. Consequently, the High Court determined that the ITAT erred in linking the settlement payment to terminating the Assessee’s employment.
The High Court also emphasised that s. 17(3)(iii) of the Act should be interpreted in light of its surrounding context. The High Court observed that the ITAT's decision to bifurcate the settlement consideration into two parts—salary and capital gains—was unjustified. The High Court ruled that the settlement consideration should not be classified under the category of salary, specifically 'profits in lieu of salary.' Given these observations and the underlying facts, the High Court granted the appeal and overturned the ITAT’s decision.
Conclusion
The decision highlights the important distinction between taxable receipts under the heads ‘capital gains’ and ‘salaries,’ especially when amounts are received under a settlement agreement between an employer and employee and relate to issues pertaining to the period of employment.
An interesting aspect of this decision is that an argument was raised regarding the non-taxability of the receipts on the ground that such amounts represent consideration for giving up the right to sue, which may have been the correct position in law. However, the Court refused to go into this aspect because the Assessee had declared the amounts as capital gains, which was not a contention made before the ITAT. Therefore, the High Court limited itself to the contentions raised before the ITAT. This highlights the importance of taking all possible legal grounds at the adjudication/first appellate forums and the consequences that may arise if such legal arguments are not taken.
End Note
[i] [2024]165taxmann.com271(Delhi)
Please read the related case law analysis by our associate Huzaifa Salim here: Madras High Court: Discretionary ESOP Compensation is Taxable as Perquisite, which provides an in-depth examination of the tax implications of discretionary ESOP compensation under the ITA.
Authored by Aishwarya Pawar, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.