All you need to know about Stock Appreciation Rights (SAR) Taxation

Across the world many corporations, particularly multinational organizations, now favour ESOP (employee stock ownership plan) as a preferred mode of employee compensation. Unlike the regular salary that the employee draws periodically, this is an in-kind benefit that allows the employee to own a part of the company (in the form of stock ownership) either while undertaking employment or as part of regular reimbursement. This gives the employee a personal interest in the business and maintains the corporate culture in the company.

Similar to the ESOP, many corporations also award their employees SAR or Stock Appreciation Rights. These may be declared from time to time as incentives or as bonus. Usually the employee is allocated stock options of the company (at current market value) and can be redeemed anytime after a year (till the period of employment or within any other term specifically mentioned). This means that the amount of appreciation of a specific number of shares of the company are passed on to the employee and not the equity itself.

It is important that employees holding SAR understand the income tax rates applicable on these stocks options at the time of redemption. Unfortunately, though, till very recently there has not been much clarity on the issue. The Income Tax Act of 1961 does not specify the tax levy on any such stock options provided to the employee. At the time, such compensation modes were not very popular either. Some provisions were added to the IT Act in 1999 which attempted to cover the share benefit rewards provided to an employee, but this too did not fully clarity the issue of tax liabilities on the redemption of SARs. The prevalent Income Tax return form often failed to reflect these benefits and their appropriate taxes. The matter has disputed at various tribunals over the years. In 2008 the Mumbai Income-Tax Appellate Tribunal (ITAT) ruled that income from SARs would be taxable as salary at the time of redemption. Recently, however, the matter had been referred to the apex court for adjudication.

Earlier this year, in the Addl. Commissioner of Income Tax vs. Bharat V. Patel, the Supreme Court finally provided much-needed clarity on the matter. While the ITAT's ruling was upheld in case of all SARs which were redeemed after 1 April 2000, the court also ruled that prior to the amendment the 1999 amendment of the IT Act (1961) SARs were not legally defined as perquisites or perks due to employment. Till this amendment, SARs were not considered salary under Section 17(2)(iii).  If an income is not defined it cannot be taxed appropriately. This means that any SARs redeemed prior to the enforcement of this amendment would be taxed only under the provisions of the Capital Gains Tax.