NRI moved to Dubai and exercised Indian bank ESOPs worth Rs 1.56 crore: Know why ITAT ruled they are taxable in India

An employee of a private sector bank who moved to Dubai and later exercised employee stock ownership plan (ESOP) options worth around Rs 1.56 crore could not escape income tax in India. The Income Tax Appellate Tribunal (ITAT), Mumbai, ruled that the benefits were taxable in India as they were linked to services rendered before the employee moved abroad. The tribunal held that becoming a non-resident at the time of exercising stock options does not change the country in which the underlying income accrued. The ruling relates to assessment years 2013-14 and 2014-15. The tribunal dismissed the employee's appeals against the tax department's decision to treat the ESOP benefits as taxable income in India.

How did the employee receive ESOPs worth Rs 1.56 crore? According to the case details, the employee was working with a private sector bank in Mumbai when he was granted options for 18,500 shares on June 27, 2007, at an exercise price of Rs 219.74 per share. He moved to the bank's representative office in Dubai on October 1, 2007. Subsequently, 50 percent of the options vested on June 27, 2008, while the remaining 50 percent vested on June 27, 2009. The employee exercised these options during assessment years 2013-14 and 2014-15, when he was a non-resident in India. The difference between the market price of the shares and the exercise price resulted in an ESOP perquisite value of Rs 72.77 lakh in AY 2013-14 and Rs 83.59 lakh in AY 2014-15.

The combined value stood at approximately Rs 1.56 crore. The employer deducted tax at source of Rs 22.48 lakh on the ESOP perquisite for AY 2013-14. However, while filing his income tax return, the employee claimed relief of Rs 20.44 lakh under Section 90 of the Income Tax Act, 1961, arguing that the ESOP income was not taxable in India. Why did the employee claim tax exemption? The employee argued that under Section 5(2) of the Income Tax Act, a non-resident is taxable in India only on income received, accruing or arising in India. Since he had been working in Dubai when the options vested and were exercised, he contended that the ESOP benefits arose from services rendered outside India.

He also relied on Article 15 of the India-UAE Double Taxation Avoidance Agreement (DTAA), arguing that salary and similar employment-related remuneration earned by a UAE resident should be taxable only in the UAE, provided the employment was exercised there. However, the assessing officer rejected the claim, observing that the ESOPs had been granted in 2007 in consideration of services rendered in India. The Commissioner of Income Tax (Appeals) also upheld the decision. Why did ITAT rule that ESOP income was taxable in India? The Mumbai tribunal held that the taxability of ESOP benefits cannot be determined solely by looking at when the employee exercised the options.

Relying on the Supreme Court's judgment in E D Sassoon & Co Ltd v. CIT (1954), the tribunal observed that income accrual and actual receipt are two different events. It held that the employee's right to receive the ESOP benefit had accrued in 2007, when the options were granted for services rendered in India. Section 17(2)(vi) determines when the ESOP perquisite becomes taxable, generally at the time of exercise. However, this provision does not change where the income originally accrued, the tribunal said. On the DTAA argument, the tribunal accepted that ESOPs qualify as 'other similar remuneration' under Article 15.

However, it said the treaty benefit depends on where the underlying employment was exercised. The tribunal observed that ESOP benefits linked to services rendered in the UAE could receive treaty protection even if exercised after the employee returned to India. However, the same protection cannot be claimed for ESOPs earned through services rendered in India. What should NRIs keep in mind while exercising ESOPs? According to Divya Bhanushali, Chartered Accountant and Head of Product at TaxBuddy, taxpayers dealing with ESOPs should examine the grant date, vesting schedule and the location where employment services were rendered.

Simply exercising stock options after becoming an NRI does not automatically make the resulting perquisite exempt from Indian income tax. "For employees who have worked in more than one country, the grant and vesting details, deputation documents and employment records become important while determining the tax treatment of ESOP benefits," Bhanushali said. Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.