Summary: The Income-tax Appellate Tribunal has clarified that consideration received on the buy-back of vested but unexercised stock options is taxable as long-term capital gains, and not as a salary perquisite, providing significant relief to employees participating in the ESOP liquidity programme.
Employee stock option (popularly known as ESOPs) buy-back programmes have increasingly emerged as a preferred liquidity mechanism for start-ups and multinational groups, enabling employees to monetise their equity-linked incentives without having to wait for a public listing (“IPO”) or any other exit event. However, such transactions have consistently drawn scrutiny, particularly on whether the consideration that employees receive should be taxed as salary or as capital gains.
In a significant ruling,[1] the Bangalore Bench of the Income Tax Appellate Tribunal (“ITAT”) has ruled in favour of the employee. This decision carries significant implications for holders of unexercised vested stock options where the company repurchased such options. The ITAT allowed the appeal filed by an employee of Flipkart Internet Private Limited (“FIPL”) and held that the consideration received on the repurchase of vested but unexercised stock options by Flipkart Private Limited, Singapore (“FPLS”), should be taxed as long-term capital gains and not as a perquisite under Section 17(2)(vi) of the Income-tax Act, 1961 (“IT Act”).[2]
Facts
The Assessee, an individual employed with FIPL, a wholly owned step-down subsidiary of FPLS, was granted stock options under the Flipkart Stock Option Scheme, 2012 (“FSOP 2012”), through the financial years 2015–16 to 2019–20.
During Assessment Year 2020–21, FPLS undertook a buy-back of vested stock options, pursuant to offer letters dated August 18, 2019, and September 18, 2019. In connection therewith, FPLS repurchased the vested stock options held by the Assessee for an aggregate consideration. The Assessee treated the consideration received on this buy-back as arising from the transfer of a capital asset and accordingly offered the same to tax as long-term capital gains in the income-tax return filed for the relevant assessment year.
Subsequently, based on information received under the e-Verification Scheme, 2021, the Assessing Officer (“AO”) noted that the Assessee had offered the buy-back proceeds to tax as long-term capital gains and applied the tax rate of 20 per cent, instead of the higher slab rate otherwise applicable, and therefore, initiated the reassessment proceedings.
The AO placed reliance on the Form 16 issued to the Assessee, which disclosed the buy-back consideration as a perquisite taxable under Section 17(2) of the IT Act and reflected tax deduction at source under Section 192. The AO also referred to the FPLS’s offer letters, which stated that the repurchase consideration would be taxable as “Income from Salaries”. Accordingly, the AO concluded that the entire consideration arose from the Assessee’s employment and was, therefore, taxable as a perquisite under “Salaries.”
Upholding the AO’s findings, the Commissioner of Income-tax (Appeals) held that the stock options were granted by virtue of the Assessee’s employment with FIPL and that the repurchase consideration constituted a taxable perquisite under Section 17(2)(vi) of the IT Act. Aggrieved, by the said order, the Assessee appealed to the ITAT.
Issues and Arguments
The principal issue before the ITAT was whether the characterisation of the repurchase consideration received by the Assessee of vested but unexercised stock options was taxable as “Salaries” or “Capital Gains”.
The Revenue contended that the stock options were granted solely by virtue of the Assessee’s employment and that the repurchase consideration remained a perquisite taxable under Section 17(2)(vi) of the IT Act. It relied on Form 16 and Form 26AS, which reflected the amount as a perquisite under Sections 17(2) and 192 of the IT Act, and on the repurchase offer letters, which treated the buy-back consideration as taxable under “Income from Salaries”.
The Assessee contended that since the stock options under FSOP 2012 were never exercised and no shares were allotted. Therefore, the fundamental condition for Section 17(2)(vi) of the IT Act, namely issuance or transfer of a “specified security” or sweat equity shares, was not satisfied. The Assessee also argued that FPLS, from whom the consideration was received, was not his employer, and that the tax treatment in the offer letters was merely indicative and could not conclusively determine the receipt’s legal character. Accordingly, the unexercised options constituted a “capital asset” under Section 2(14) of the IT Act, and the consideration received on their transfer was rightly offered to tax as long-term capital gains.
Decision
The ITAT held that Section 17(2)(vi) of the IT Act taxes only the value of a “specified security” is allotted or transferred upon exercise of an ESOP, and not the stock option itself. Noting that the statutory valuation mechanism is linked to the date of exercise, the ITAT observed that, until exercise, an employee merely holds a right to acquire shares and no taxable perquisite arises. Relying on the ruling in CIT v. B.C. Srinivasa Setty,[3] the ITAT concluded that since the Assessee’s options were never exercised and no shares were allotted, no “specified security” came into existence. Accordingly, and the computation mechanism under Section 17(2)(vi) of the IT Act could not operate and the repurchase consideration could not be taxed as a perquisite.
The ITAT further held that vested but unexercised stock options constitute a “capital asset” under Section 2(14), relying on the judgments in Chittharanjan A. Dasannacharya v. CIT,[4] and Miss Dhun Dadabhoy Kapadia v. CIT.[5] The repurchase of such options constituted a “transfer” under Section 2(47), rendering the gains taxable as long-term capital gains under Section 45. The ITAT also relied on the judgment in Sanjay Baweja v. DCIT,[6] which held that the value of specified security cannot be determined for unexercised options and, therefore, the provision of salary was not triggered.
The ITAT also rejected the Revenue’s reliance on the indicative tax disclosures in the offer letters and the characterisation of the amount in Form 16 and tax withholding by the employer, holding that the true nature of a receipt must be determined by law and not by contractual descriptions or withholding positions. Accordingly, it also distinguished the judgment in Nishithkumar Mukeshkumar Mehta v. DCIT,[7] noting that the case arose in a materially different factual context involving compensation on account of a business divestment rather than the repurchase of stock options.
OUR ANALYSIS
The decision is an important development in the continuing debate around the taxation of employee stock options, particularly where vested ESOPs are bought back before exercise. Tax authorities have frequently sought to tax such receipts as “salary” based on the employer–employee relationship and their characterisation in offer letters, payroll records, or Form 16. Against this backdrop, the ruling provides valuable guidance for start-ups and multinational groups that commonly use stock option liquidity and buy-back programmes to provide employees with an exit opportunity before an IPO or any other liquidity event.
At the heart of the ruling is the principle that taxation under Section 17(2)(vi) of IT Act arises only upon the actual exercise of a stock option and the allotment of underlying shares. The ITAT reaffirmed that an unexercised option is merely a contingent right to acquire shares in the future and does not, by itself, trigger the taxation framework applicable to ESOP perquisites. Particularly noteworthy is the ITAT’s reliance on the integrated principle to observe that where the statutory mechanism for computing a taxable perquisite cannot operate, the corresponding charging provision also fails, providing a strong analytical foundation for cases involving the repurchase of options prior to exercise.
Equally significant is the ITAT’s approach to documentary evidence. The ruling clarifies that references in offer letters, employer tax disclosures, or TDS treatment adopted by an employer cannot conclusively determine the tax character of a receipt. Instead, the true nature of the transaction must be assessed independently under the law. This serves as an important reminder that employees are not bound by an employer’s tax withholding position if it is inconsistent with the legal characterisation of the amount received.
At the same time, the ruling is unlikely to be the final word on the subject, and it remains to be seen how the higher judicial forums will adjudicate the issue. Judicial views on the taxation of stock option related receipts and compensation payments have not been entirely consistent, and the ITAT itself was required to distinguish contrary authority of the Madras High Court on the basis of the facts before it. As a result, the decision should be viewed as a fact-specific precedent rather than a universally applicable principle. The Revenue may continue to contend, in appropriate cases, that amounts received on the repurchase of ESOPs are intrinsically linked to the employment relationship and are, therefore, taxable as profits in lieu of salary, particularly where the benefit derives solely from the recipient’s status as an employee rather than from an independent capital asset.
[1] Pramod Kumar Jain v. DCIT, ITA No. 3034/Bang/2025 (Income Tax Appellate Tribunal, Bangalore Bench).
[2] This judgment pertains to Assessment Year 2020–21 and was rendered under the provisions of the erstwhile provisions of the Indian tax laws. Accordingly, the analysis and conclusions discussed here are based on the provisions of the IT Act, whereas the Income-tax Act, 2025, only came into effect from April 1, 2026.
[3] CIT v. B.C. Srinivasa Setty, (1981) 128 ITR 294 (Supreme Court).
[4] Chittharanjan A. Dasannacharya v. CIT, (2020) 429 ITR 570 (Karnataka High Court).
[5] Miss Dhun Dadabhoy Kapadia v. CIT, (1967) 63 ITR 651 (Supreme Court).
[6] Although the Karnataka High Court in Manjeet Singh Chawla v. Deputy Commissioner of TDS (2025) 175 taxmann.com 778 relied on the Delhi High Court’s ruling in Sanjay Baweja v. DCIT, (2024) 163 taxmann.com 116, such reliance appears debatable given the materially different factual circumstances. Unlike in Sanjay Baweja’s case, where the taxpayer was a former employee when the consideration was received, the Assessee in the present case remained in employment, thereby strengthening the argument that the receipt retained its character as an employment-linked benefit.
[7] Nishithkumar Mukeshkumar Mehta v. DCIT, (2024) 165 taxmann.com 386 (Madras High Court).
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