The Supreme Court has ruled that the benefit given to the staff of a company under the employees' stock option scheme cannot be considered as taxable income and the company was not obliged to deduct tax at source.

The court thus dismissed the appeal of the Commissioner of Income Tax, Bangalore against the judgment of the Karnataka high court which had ruled in favour of Infosys Technologies.

The company had created Technologies Employees Welfare Trust and allotted 7.5 lakh (750,000) warrants at Rs 1 each. Such warrants could be used after a five-year lock-in period to obtain shares. The plan was floated because of buy-back problems where employees left their jobs for one reason or the other. The stock exchange was informed that the shares were non-transferable.

The tax authorities, however, determined that the total amount paid by the employees while exercising their option was Rs 6.64 crore (Rs 66.4 million) whereas the market value of those shares was Rs 171 crore (Rs 1.71 billion). The difference was treated as 'perquisite value' on which TDS was charged at 30 per cent.

The company was treated as a defaulter for not deducting the perquisite value of Rs 165 crore (Rs 1.65 billion). The tax tribunal and the high court, however, held in favour of Infosys [Get Quote] when it moved the courts.

Dismissing the appeal of the tax authorities, the Supreme Court bench headed by Justice S H Kapadia ruled that the company was not bound to deduct tax on the amount earned by its employees from exercise of stock option granted to them through the trust.

"Warrant is a right without obligation to buy. Therefore, perquisite cannot be said to accrue at the time when the warrants were granted," the judgment explained.

The employee could resign, and there was no certainty that his option would be exercised after the lock-in period. "The benefit if any which arose on the date when the option stood exercised was only a notional benefit whose value was unascertainable."

The change in law introduced in the Finance Act in 2000 was not retrospective, the court asserted. The benefit was prospective and unless a benefit was in the nature of income it was not taxable. There was no legislative support to consider the benefit given in this case to the employees as income chargeable under the head 'salaries', the judgment concluded.