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Tax authorities cannot impose punitive levies on seven people who declared the proceeds from stock options as one-time income and not regular income, the Supreme Court ruled Tuesday.

The top court’s third petty bench overturned high court rulings that supported the National Tax Agency. The four justices unanimously ruled that the tax agency was “unfair or too harsh, and illegal” in imposing the punitive taxes on the plaintiffs for entering the income in a category with a lower tax rate.

The top court said the tax agency began to regard proceeds from stock options as a part of salary around 1998 but “failed to fully inform the public of the measure by at least around June 2002.”

The income involved was generated when the plaintiffs exercised stock options between 1997 and 2001.

The top court acted on appeals filed by seven former corporate executives against Tokyo High Court rulings that rejected their demands for revocation of the penalty tax. Punitive taxes ranging from 340,000 yen to 212.69 million yen were imposed.

Among the seven are former executives of Microsoft Corp.’s Japanese unit and the Japanese unit of the now-defunct Compaq Computer Corp.

Until 1998, the National Tax Agency assessed many cases of stock option proceeds as one-time income, which falls under a lower tax rate.

Courts have handed down different judgments on whether such proceeds are part of a salary or one-time income. However, the Supreme Court ruled in January 2005 that the proceeds are compensation for labor and subsequently part of a salary.

The plaintiffs had entered the stock option proceeds on their personal tax returns as one-time income, but the tax agency told them it was part of their salaries. They were ordered to pay the higher tax rate for the income and punitive taxes were imposed.

Tuesday’s Supreme Court ruling effectively nullifies the punitive taxes because of the tax agency’s failure to adequately publicize its assessment shift.

The General Law of National Taxes states the government will not impose additional taxes without reasonable grounds.

During the September litigation, the plaintiffs said the National Tax Agency categorized proceeds from the stock options as one-time income for years and failed to fully inform the public that it had changed its interpretation.

The tax agency claimed the plaintiffs had ample opportunity to learn about the change through a number of government and media publications, including newspapers.

The Commercial Code was revised in 1997 to allow companies to give their employees stock options. Stock options confer the right to buy shares at predetermined prices, which allows the holder to make a profit by selling the shares when the market price is higher than the purchase price.

Some preferential tax treatment is allowed on income gained from such options if certain conditions are met.

Most of the lawsuits over taxation of stock option proceeds involve employees at the Japanese units of foreign companies.

The plaintiffs welcomed the court’s decision.

Atsushi Shimizu, 67, a former auditor at the Japanese unit of Compaq Computer, said, “Although the National Tax Agency regarded the proceeds (from stock options) as one-time income for a long time, they changed their interpretation on the taxation rule so they can increase tax revenue, and then tried to impose punitive taxes retroactively.”

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