Stock Appreciation Rights (SARs) are recognised globally as one of the most popular instruments of stock-based compensation. SARs are alternatives adopted for implementing equity-based compensation plans like an employee stock option or employee stock purchase. SARs can be structured as either ‘equity settled’ or ‘cash settled’. As a concept, SARs contemplate passing on of appreciation in the value of a certain number of equity shares to employees.
The Income Tax Act, 1961 (IT Act) did not have any specific provision to tax such income; specific provisions were introduced in 1999 to provide for taxation of benefits provided by an employer to its employees under share benefit rewards. From 1999 onwards, Section 17(2) of the IT Act specifies the payments that come within the ambit of ‘salary’ and ‘perquisites’, and covers benefits available to employees therefrom.
For the period prior to 1999, the issue of taxability of amounts received from various employee benefit programmes, including amounts received from the redemption of SARs, was always under dispute. The special bench of the Mumbai Income Tax Appellate Tribunal (ITAT) in the case of Sumit Bhattacharya held that the amount received on redemption of SARs should be taxable as salary because it was an employment related benefit, in the nature of deferred wages, bonuses or incentives received as a fruit of employment. However, the issue remained inconclusive and litigious. The Supreme Court (SC) appears to have settled this issue in the case of Bharat V. Patel, wherein it has been held that the amount received on account of SARs redemption prior to amendment to section 17(2) would not be taxed as salaries.