ESOP Shares of Non-Residents: Can Exercise-Date FMV Be the Cost Even When the Perquisite Is Not Taxed in India?

Mumbai ITAT examines the interplay between Sections 17(2)(vi) and 49(2AA) in cross-border ESOP taxation

Background

Employee Stock Option Plans (ESOPs) can give rise to taxation at two distinct stages — first, when the option is exercised and the benefit may constitute a salary perquisite, and subsequently, when the resulting shares are transferred and capital gains are computed.

For globally mobile employees, an additional complexity arises where the employee renders services outside India and the ESOP perquisite is consequently not chargeable to tax in India.

This raises an important question:

If the ESOP perquisite was not taxed in India, can the employee nevertheless adopt the exercise-date fair market value (FMV) as the cost of acquisition while computing capital gains on the subsequent sale of shares in India?

The Mumbai ITAT recently examined this issue in Rajesh R. Hemrajani v. ITO (International Tax).

The Case

Case: Rajesh R. Hemrajani v. ITO (International Tax)
Appeal: ITA No. 1284/Mum/2025
Assessment Year: 2019-20
Bench: Mumbai ITAT – “I” Bench
Date of Order: 31 July 2026

The assessee was employed with the UK branch of L&T Infotech Ltd. and was a non-resident during the relevant year. As part of his remuneration package, he had been granted 7,700 ESOPs in respect of shares of the Indian listed company at an exercise price of Re.1 per share.

Facts of the Case

The ESOPs were to vest in five equal tranches of 20% each.

During the relevant year, the assessee exercised the first tranche of 1,540 vested options on 3 September 2018, paying the stipulated exercise price of Re.1 per share. The shares were subsequently credited to his demat account.

The assessee thereafter sold the 1,540 shares through the recognised stock exchange for aggregate consideration of ₹25,99,863.

For determining the perquisite value, the assessee considered the FMV on the exercise date. The opening market price was ₹1,734 and the closing market price was ₹1,773.15, resulting in an average FMV of approximately ₹1,753.58 per share.

While computing capital gains, the assessee adopted this exercise-date FMV as the cost of acquisition under Section 49(2AA) and consequently reported an aggregate short-term capital loss of ₹1,00,650.

Where Did the Dispute Arise?

The Assessing Officer did not accept the FMV as the cost of acquisition.

The Revenue's case, in substance, was that since the ESOP perquisite was not taxable in India, the FMV could not be regarded as having been “taken into account” for purposes of Section 17(2)(vi).

Accordingly, the AO sought to adopt the actual exercise price paid by the assessee rather than the exercise-date FMV as the cost of acquisition.

The DRP substantially agreed with this approach. It noted that although the assessee had paid tax in the UK on the perquisite value, no tax had been paid in India on that perquisite.

Following the DRP directions, the AO ultimately made an addition of ₹29,59,332 as unexplained short-term capital gains, as recorded in the Tribunal's order.

The Central Question

The controversy essentially turned on the interpretation of Section 49(2AA).

The question was:

Does Section 49(2AA) require the ESOP perquisite to have actually been subjected to tax in India before the FMV determined under Section 17(2)(vi) can be adopted as the cost of acquisition?

The distinction between computation of a perquisite and its ultimate chargeability to tax in India became central to the Tribunal's analysis.

Assessee's Position

The assessee contended that Section 49(2AA) determines the cost of acquisition of specified securities or sweat equity shares by reference to the FMV which has been taken into account for the purposes of Section 17(2)(vi).

According to the assessee, the provision does not say that the perquisite must actually have been taxed in India.

The FMV had been determined under the statutory mechanism applicable to ESOPs, and the same FMV should consequently constitute the cost base when the resulting shares were subsequently sold.

The assessee also pointed out that the perquisite value had been subjected to tax in the UK as part of his salary. The AO had recorded this factual position and had not disputed it.

Revenue's Position

The Revenue supported the AO's computation based upon the actual exercise price.

It relied upon decisions concerning taxation of salary and perquisites in the hands of non-residents and argued that, since the perquisite was not taxed in India, the assessee could not claim the exercise-date FMV as cost under Section 49(2AA).

The DRP had similarly distinguished an earlier decision relied upon by the assessee on the ground that, in that case, the relevant amounts had suffered tax, whereas the present assessee had not paid tax in India on the ESOP perquisite.

What Did the Mumbai ITAT Hold?

The Tribunal rejected the Revenue's interpretation.

It examined the language of Section 49(2AA), particularly the expression referring to the:

“fair market value which has been taken into account for the purposes of section 17(2)(vi)”

The Tribunal observed that the provision refers to the FMV entering into the determination of the value of the perquisite in accordance with Section 17(2)(vi) read with Rule 3.

Significantly, Section 49(2AA) does not stipulate that the resulting perquisite must actually have been subjected to tax in India or included in the assessee's total income in India.

Computation and Chargeability Operate in Different Fields

This is, in our view, the central proposition emerging from the ruling.

The Tribunal distinguished between:

Computation of the ESOP perquisite

and

Chargeability of that perquisite to tax in India.

The FMV mechanism under Section 17(2)(vi) read with Rule 3 determines the value of the perquisite.

Whether that perquisite is ultimately chargeable to tax in India in the hands of a particular non-resident employee is a separate question governed by the charging and source provisions and, where applicable, treaty considerations.

The Tribunal expressly observed that these two aspects “operate in different fields.”

Therefore, the absence of Indian taxation of the salary perquisite did not, by itself, alter the statutory cost mechanism contained in Section 49(2AA).

Can an Additional Condition Be Read Into Section 49(2AA)?

The Tribunal answered this in the negative.

It held that reading Section 49(2AA) as requiring the perquisite to have actually suffered tax in India would amount to supplying words that the Legislature had not incorporated into the provision.

Where the statutory language is plain, an additional condition cannot be inserted through interpretation.

This aspect of the ruling goes beyond merely resolving an ESOP computation dispute. It reflects a broader principle of statutory interpretation:

A tax provision should be applied according to the conditions Parliament has prescribed, rather than conditions that may appear implicit from the Revenue's understanding of the legislative scheme.

FMV Itself Was Not in Dispute

Another important factual aspect should not be overlooked.

The AO did not dispute the FMV determined by the assessee.

The Tribunal recorded that the AO himself proceeded on the basis that the FMV adopted by the assessee had been determined in accordance with Rule 3(8)(ii) of the Income-tax Rules.

Accordingly, there was no controversy before the Tribunal regarding determination of FMV on the date of exercise.

The controversy was therefore confined to whether such FMV could become the cost under Section 49(2AA) when the corresponding perquisite was not taxed in India.

What About the Earlier Judicial Precedents?

The Revenue relied upon decisions dealing with taxation of salary and perquisites of non-residents.

The Tribunal distinguished those authorities.

It observed that those cases principally concerned residential status or chargeability of salary/perquisite under Sections 5 and 9.

They did not directly examine the scope of Section 49(2AA) for determining the cost of acquisition of ESOP shares.

The Tribunal also considered Ramamurthy Sridharan v. ACIT.

It declined to read that decision as laying down an absolute proposition that Section 49(2AA) becomes available only when the ESOP perquisite has actually suffered tax in India.

Instead, the Tribunal independently interpreted the statutory language and refused to introduce such an additional condition.

The Two-Stage ESOP Tax Framework

The decision can be understood through a simple two-stage framework:

The Tribunal's ruling indicates that the taxability of Stage 1 in India does not itself rewrite the statutory cost mechanism applicable at Stage 2.

This distinction assumes particular importance for employees whose ESOPs straddle more than one tax jurisdiction.

SSB Perspective

The significance of the decision lies in its treatment of a recurring issue in cross-border employee equity compensation.

1. “Not taxable in India” does not necessarily mean “ignore the FMV”

The Revenue's position effectively equated absence of Indian perquisite taxation with absence of an FMV-based cost.

The Tribunal rejected that equation.

Section 49(2AA) looks to the FMV determined for purposes of Section 17(2)(vi); it does not expressly make the cost conditional upon actual Indian taxation of the corresponding perquisite.

2. ESOP analysis should separate the two taxable events

Advisers should avoid treating ESOP taxation as one continuous event.

The following questions need separate examination:

At exercise: Where is the employment perquisite taxable?

At sale: What is the statutory cost of the shares, and where is the resulting capital gain taxable?

The answer to the first question does not necessarily determine the answer to the second.

3. The ruling is particularly relevant for globally mobile employees

Employees may receive ESOP grants while working in one jurisdiction, vest over periods involving multiple jurisdictions, exercise while resident abroad and subsequently sell shares of an Indian company.

The Mumbai ITAT decision highlights why the grant, vesting, exercise and sale stages should each be mapped separately before determining the Indian tax consequences.

4. Documentation remains important

The ruling should not be understood as permitting an arbitrary FMV claim.

In the present case, the FMV was determined using the prescribed mechanism and was not disputed by the AO.

For cross-border ESOP cases, records relating to the grant, vesting schedule, exercise, exercise-date FMV, foreign salary taxation and subsequent share sale therefore remain important.

5. The ruling should not be overstated

The decision does not establish that every foreign ESOP arrangement automatically receives an FMV cost in India.

The ruling concerns the interpretation of Section 49(2AA) in the context of the facts before the Tribunal, including ESOPs relating to shares of an Indian listed company and an undisputed FMV determined under the prescribed mechanism.

The precise terms of the employee stock plan and the applicable Indian statutory provisions must therefore be examined in each case.

Practical Takeaways

For NRIs, globally mobile employees and employers dealing with ESOPs, the ruling suggests the following review approach:

First: Identify the employee's residential status and work location during the relevant vesting/exercise period.

Second: Determine whether and where the ESOP benefit has been taxed as salary/perquisite.

Third: Independently determine the FMV under Section 17(2)(vi) read with the applicable Rule 3 mechanism.

Fourth: At the subsequent sale stage, examine Section 49(2AA) independently for determining the cost of acquisition.

Fifth: Do not automatically substitute the nominal exercise price merely because the perquisite was not chargeable to tax in India.

Sixth: Maintain documentary evidence of the ESOP grant, vesting, exercise, FMV computation, foreign tax treatment, demat credit and subsequent sale.

Conclusion

The Mumbai ITAT decision in Rajesh R. Hemrajani provides an important interpretation of Section 49(2AA) in the context of cross-border ESOPs.

The Tribunal has distinguished the determination of an ESOP perquisite from its ultimate chargeability to tax in India.

Where FMV has been determined for purposes of Section 17(2)(vi) in accordance with the prescribed mechanism, Section 49(2AA) does not impose an additional requirement that the perquisite must first have actually suffered tax in India before such FMV can constitute the cost of acquisition.

The larger takeaway may therefore be expressed as follows:

In cross-border ESOP taxation, the taxability of the perquisite and the determination of cost for subsequent capital gains are connected — but they are not the same question.

Case Reference

Rajesh R. Hemrajani v. ITO (International Tax)
ITA No. 1284/Mum/2025
Assessment Year 2019-20
Income Tax Appellate Tribunal, Mumbai – “I” Bench
Order dated 31 July 2026

The Tribunal allowed the assessee's claim on the substantive ESOP/capital-gains issue. The authorities' precedents concerning taxation of salary/perquisites were distinguished as not directly addressing the interpretation of Section 49(2AA).

Publication Details

Publication: SSB Tax Insights
Reference: SSB-TI-2026-004
Published by: SSB & Associates, Chartered Accountants
Author: SSB Editorial Team
Reviewed by: CA C S Sreenivas
Publication Date: 24th August 2026

Disclaimer

This publication is intended solely for general information and knowledge sharing and should not be construed as professional advice or opinion. The analysis is based on the facts and findings recorded in the judicial decision referred to above. Tax consequences of ESOPs, particularly in cross-border situations, depend upon the terms of the relevant employee stock option plan, residential status, place and period of employment, applicable domestic law, tax treaty provisions and other facts of each case. Readers should examine the applicable law and obtain appropriate professional advice before acting on the basis of this publication.

SSB & Associates
Chartered Accountants