Compensation received for diminution in value of stock options is a capital receipt, not taxable

In the case of Manjeet Singh Chawla, the Karnataka High Court held that the compensation awarded to an employee due to the diminution in value of stock options is not chargeable to tax as salary or capital gains under the Income-tax Act, 1961.

The Karnataka High Court relied on the Delhi High Court’s decision in the case of Sanjay Baweja and distinguished the Madras High Court’s ruling in the case of Nishithkumar Mukeshkumar Mehta, which involved an identical transaction relating to other employees of the same employer.

The taxpayer contended that section 56(2)(viia) was introduced as an anti-abuse provision. The legislative history links section 56(2)(viia) to section 56(2)(vii)—which clearly applies only to capital assets. Accordingly, section 56(2)(viia) should not apply to genuine business transactions involving trading stock.

The Mumbai Bench of the Tribunal accepted the taxpayer’s interpretation, relying on legislative intent, CBDT circulars, and judicial precedents.