A UK-based employee has won a significant tax dispute after the Mumbai bench of the Income Tax Appellate Tribunal (ITAT) ruled that the fair market value (FMV) of shares at the time of exercising employee stock option plan (ESOP) options can be treated as their cost of acquisition. According to reports from Mint, the case involved Rajesh R. Hemrajani, a non-resident and UK tax resident who was employed with the UK branch of L&T Infotech Ltd. Hemrajani had exercised 1,540 ESOPs at ₹1 per share and later sold the shares for about ₹25.99 lakh. The tribunal heard the case on May 13, 2026 and passed the judgement on July 31, 2026, with Chartered Accountant Dhruv Janssen representing Hemrajani.
As reported by Mint, Hemrajani treated the FMV of the shares on the exercise date, approximately ₹1,754 per share, as the cost of acquisition. This resulted in a short-term capital loss of around ₹1 lakh. The tax department disputed this treatment, arguing that the cost should instead be restricted to the actual exercise price of ₹1 per share. The ITAT Mumbai, however, allowed Hemrajani's appeal and directed the assessing officer to recompute the capital gains by adopting the FMV as the cost of acquisition. The tribunal emphasized that the actual amount paid by the employee does not, by itself, determine the cost of acquisition under section 49(2AA).
According to the ITAT order reported by Mint, the tribunal focused on the wording of section 49(2AA) of the Income-tax Act. The provision states that the cost of acquisition of specified securities or sweat equity shares acquired through an ESOP is the FMV that has been taken into account for the purposes of section 17(2)(vi). The ITAT held that the provision does not contain a requirement that the FMV must actually have been subjected to tax in India or included in the taxpayer's total income. The tribunal distinguished between determining the value of an ESOP perquisite and whether that perquisite is ultimately taxable in India. The tax tribunal further observed that making the benefit of Section 49(2AA) dependent upon the country in which the perquisite was taxed would introduce an additional condition that Parliament had not incorporated.
As reported by Mint, the tax department's position was that the ESOP benefit was not taxable in India because Hemrajani was a non-resident and the relevant employment services were rendered outside India. The assessing officer instead restricted the cost to the actual exercise price of ₹1 per share. The Dispute Resolution Panel subsequently upheld the department's position, principally on the ground that the perquisite had not suffered tax in India. The AO proposed an addition of ₹25.98 lakh as short term capital gains against the short term capital loss of ₹1 lakh offered by Hemrajani. However, the ITAT Mumbai disagreed with this approach and held that Hemrajani was entitled to adopt the fair market value of the shares on the exercise date as their cost of acquisition, irrespective of whether the related perquisite was taxable in India.
Hemrajani had also argued that denying the ESOP benefit solely because the perquisite had been taxed in the United Kingdom instead of India would result in discriminatory treatment and would be contrary to the non-discrimination provisions contained in Article 26 of the India-UK Double Taxation Avoidance Agreement. According to Mint, the tax tribunal noted that the decisions relied upon by the Income Tax Department primarily concerned the taxability of salary or perquisites in the hands of non-residents and did not directly address the determination of the cost of ESOP shares under section 49(2AA). They were therefore held to be distinguishable. Since relief was granted on the plain interpretation of the statutory provision, the tax tribunal did not consider it necessary to conclusively decide the taxpayer's alternative argument based on the non-discrimination clause in Article 26 of the India-UK DTAA.
