Introduction:

ESOPs are structured as rights, not obligations, granted by companies to employees to purchase shares at a future date at a pre-agreed price. These rights vest over time and can be exercised upon meeting certain conditions. The life cycle of an ESOP generally involves the following stages:

1. Grant: The option is granted to the employee.

2. Vesting: The employee earns the right to exercise the options over a vesting period.

3. Exercise: The employee purchases shares at the exercise price.

4. Allotment: The Company allots the shares to the employee.

5. Sale: The employee sells the shares, triggering potential capital gains.

Under the Indian taxation regime, ESOPs are taxed at two key stages:

• At the time of exercise, where the difference between the fair market value (FMV) and the exercise price is taxed as a perquisite under Section 17(2)(vi).

• Upon sale, where any gain is taxed under the head capital gains.

However, when corporate events like demergers, spin-offs, or strategic realignments occur, the value of unexercised options may fluctuate drastically even before the employees can benefit from them- and that’s where the tax complexities enter. This creates a unique challenge for the tax system, which is built on realization-based taxation principles, not hypothetical or notional events.

Manjeet Singh Chawla vs. DCIT [TS-806-HC-2025(KAR. H.C.)]

Whether one-time voluntary compensation awarded to employees on account of diminution in the value of unexercised stock options is a capital receipt?

Issue Involed

Whether one-time voluntary compensation awarded to employees on account of diminution in the value of unexercised stock options is a capital receipt?

Facts of the Case

• Manjeet Singh Chawla (the assessee) was an employee of Flip kart Internet Private Limited (FIPL) an Indian subsidiary of Flip kart Marketplace Private Ltd. (FMPL) which was a step-down subsidiary of Flip kart Private Limited, Singapore (FPS). Assessee was granted stock options of FPS.
• In a significant restructuring exercise in 2022, Flip kart Singapore (FPS), the holding entity for Flip kart India and Phone Pe, completed a spin-off that separated Phone Pe as an independent entity. While this move was intended to unlock value and create independent growth trajectories for the businesses, it had a depreciative effect on the share value of FPS, impacting the value of ESOPs granted by Flip kart to Indian employees. Recognizing this loss, Flip kart Singapore made a voluntary, one-time payment to employees.

Arguments of the Appellant (Assessee)

Employees contended that the payment was a capital receipt, not chargeable under any head of income. They sought Nil TDS certificates under Section 197, anticipating that the payment would not attract tax.

Arguments of the Respondent (Revenue)

Receipt of any stock options under ESOP or any ESOP related monetary compensation by the assessee was inherently income and taxable as a perquisite under Section 17(2)(vi) of the Act, being linked to the ESOPs. The payment should be treated the same as tax treatment of ESOPs as compensation was linked to a reduction in the value of stock options, thus taxable under the head of ‘Salaries’. 

Decision of the Court

The said payment was:

• Non-contractual: There was no legal obligation to make the payment.

• Non-recurring: It was a one-time compensatory measure.

• Non-transfer-related: The ESOPs were not exercised, sold, or transferred.

Importantly, recipients continued to hold their unexercised ESOPs, which meant that no real transaction had occurred in terms of exercising or liquidating stock options. The payment merely attempted to compensate for unrealized economic value.

In the instant case, although some stock options were vested, the assessee had neither exercised the options, nor transferred/sold any shares. Since the computation of an ‘perquisite’ for ESOPs under Section 17(2)(vi) of the Act is inextricably linked to actual exercise and allotment of shares, the machinery for computation failed, hence, the one-time voluntary compensation cannot be taxed as ‘perquisites’ under Section 17(2)(vi) of the Act.

Also, the cost of acquisition of stock options by the assessee cannot be determined, and therefore, Section 48 of the Act cannot be applied; similarly, Section 45 of the Act is not applicable. Accordingly, computation mechanism under capital gains provisions cannot be applied and thus the charging provisions also fail.

Final Thoughts

The Flip kart- Phone Pe episode serves as a case study on the intersection of tax law, equity compensation, and corporate restructuring. It highlights how well-intentioned corporate actions can result in unintended tax exposure unless the legal and fiscal ecosystem evolves in parallel. As India grows into a global start up hub, ESOP related tax controversies will only increase. While judicial interpretations will play a role, what’s urgently needed is clarity from the tax administration, especially in borderline cases involving notional losses and voluntary compensation. Clarity in ESOP taxation, particularly in cross-border and restructuring contexts, is essential for ensuring fairness, reducing litigation, and fostering a predictable business environment.