The Karnataka HC recently in the case of Manjeet Singh Chawla vs. Deputy Commissioner of TDS on June 2, 2025, held that one-time voluntary compensation awarded to employees for the diminution in the value of their unexercised stock options (both vested and unvested) is a capital receipt.  The same is not chargeable to tax as salary or capital gain under the Income Tax Act, 1961 (the Act).  

Facts of the Case

  • Manjeet Singh Chawla (the assessee) was an employee of Flipkart Internet Private Limited (FIPL) an Indian subsidiary of Flipkart Marketplace Private Ltd (FMPL). FMPL was a step-down subsidiary of Flipkart Private Limited, Singapore (FPS) which also held shares in multiple other subsidiaries. 
  • Assessee was granted stock options of FPS under the group Flipkart Stock Option Plan (FSOPs) with a vesting schedule of 4 years – some of which had vested (but not exercised) while others remained unvested till the year under consideration.  
  • FPS divested its stake from one of its subsidiary PhonePe, Singapore, leading to diminution in the value of the stock options held by employees. To compensate for the diminished value of the stock options, FPS announced a one-time compensatory payment to all option holders, including the assessee (Manjeet). The assessee received a sum of ₹71,01,004 as one-time compensation. Even after the receipt of FPS Compensation, the assessee being an ESOP holders continue to retain all ESOPs and the right to receive the same number of shares of FPS subject to vesting and exercise. 
  • Assessee had applied for a ‘Nil Tax Deduction Certificate’ under Section 197 of the Act, relying on the Delhi High Court in the case of Sanjay Baweja1 (another employee of FPS) claiming that the sum received as one-time compensation is not liable to be taxed being capital receipt. The revenue rejected the application on the ground that the compensation received from FPS was taxable as perquisite and as capital gains arising on transfer of stock options exercised under ESOP.  
  • Aggrieved by the Revenue order, the assessee filed a writ petition before the Karnataka High Court.  

Revenue contention

  • 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. 
  • There was a deemed/implied allotment of shares, and the compensation paid to the assessee was part of the FMV of the shares issued under ESOP, to which the taxpayer is entitled after the vesting period when he exercises the options. Therefore, the payment was part of the perquisite value due to the assessee and thus taxable under the head of ‘Salaries’. 
  • Reliance was placed on the Madras High Court decision in Nishithkumar Mehta2 case (another employee of FPS) wherein it was held that such one-time compensation for diminution in value of stock options will qualify as perquisite and would be liable to be taxed under the head ‘Income from Salaries’.
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High Court Decision

The Karnataka HC allowed the assessee’s writ petition and quashed the order of the Income Tax department which had rejected the application for a ‘Nil’ TDS certificate under Section 197 of the Act. The HC directed the Income Tax department to issue a certificate holding that the compensation received was in nature of capital receipt, not eligible for tax. In arriving the above decision, the HC has discussed as under: 

  1. One-time voluntary compensation was for the reduction in value of stock options which formed part of the profit-making structure of the assessee i.e. his employment and therefore capital in nature and therefore not amenable to tax.
  2. Stock Options confers a right and not an obligation to purchase the underlying shares. On vesting the option, the holder acquires the right to exercise the option and get the allotment of shares. The Karnataka HC further noted that under the Income Tax Act, ESOPs are taxed at only two stages:
    • At Exercise of options – As a ‘perquisite’ under Section 17(2)(vi) of the Act at the time the ESOP holder exercises the vested option. The taxable value is the difference between the Fair Market Value (FMV) of the shares on the date of exercise and the exercise price paid by the ESOP holder.
    • At the time of sale of such shares – As ‘capital gains’ under Section 45 shares acquired upon exercise are sold.

    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.

  3. 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. 
  4. Karnataka HC relied on SC in case of CIT Vs. D. P. Sandu Bros Chembur (P.) Ltd. (2005) (142 Taxmann 713) wherein it has been held that if the capital receipt is not chargeable to tax under head Capital Gains, then the same cannot be taxed under any other head of income. 
  5. Given that the compensation received by the assessee did not constitute to taxable income, the HC held that withholding provisions were not applicable.
  6. The Karnataka HC distinguished the Madras HC in the case of Nishithkumar Mukeshkumar Mehta on the following grounds:
    • The decision erroneously concluded that the compensation could be taxed as salary or perquisite, as this was not contested by either party before the Hon’ble Madras High Court.
    • The definition of ‘capital asset’ under Section 2(14) of the Act is extremely wide and covers ‘property’ of all kinds. The Hon’ble Madras High Court misconstrued Explanation-1 to Section 2(14) of the Act which clarifies that ‘property’ includes “any rights in, or in relation to an Indian company, including rights of management or control or any other rights whatsoever”. The Madras High Court failed to appreciate that Explanation-1 cannot lead to a conclusion that rights in shares of a foreign company could not be considered a ‘property’ for qualifying as a ‘capital asset’.
    • The Hon’ble Madras High Court erroneously held that (i) ESOPs are not a source of revenue and not capable of generating revenue, and (ii) ESOPs are actionable claim not capable of generating revenue. Further, the Hon’ble Madras High Court ignored the fact that there was a permanent loss of revenue generating source. Such reasoning fails to appreciate that the options held by the petitioner are ‘capital assets’ which are an income earning source, and it is a settled principle of law that the compensation/windfall awarded in lieu of diminishing of profit-making structure would be a ‘capital receipt’ as relied upon in Sanjay Baweja case.
    • The HC failed to recognize that as the taxpayer in this case has not exercised the options and accordingly perquisite provisions could not be invoked and in absence of the computation mechanism, no tax could be levied.
  7. The Karnataka HC relied on the Delhi HC in the case of Sanjay Baweja which involved similar transaction relating to another employee of FPS and HC noted that the said judgement has not been challenged by the Revenue and had attained finality making binding upon the revenue. 
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Conclusion

The High Court rulings reaffirm that one-time compensation received by employees for diminution in the value of stock options may constitute a capital receipt, particularly where such options are not exercised. The characterization of the payment—capital or revenue—must be determined from the perspective of the recipient, not merely the payer. Further, such compensation does not automatically qualify as ‘salary’ or ‘perquisite’ under Section 17 of the Income Tax Act, especially in the absence of exercise. 

However, with conflicting views among the Delhi, Karnataka, and Madras High Courts, the issue remains unsettled and litigious. Until the Supreme Court delivers final clarity, both employers and employees should tread cautiously regarding tax treatment and withholding obligations for ESOP-linked compensations, particularly those awarded before exercising. 

Authored by:
Megha Gala | Direct Tax