ANAROCK PROPERTY CONSULTANTS PRIVATE LIMITED,MUMBAI vs. PRINCIPAL COMMISSIONER OF INCOME TAX-6 MUMBAI, MUMBAI

The brief facts of the case are that the assessee had filed its return by declaring an income of Rs. 32,98,86,310/-. The assessee's case was selected for complete scrutiny under CASS to examine issues related to business expenses, refund claims, and depreciation claims. Accordingly, the notices under section 143(2) and 142(1) of the Act were duly issued. The Ld. AO completed the assessment with additions related to disallowance of bad debt amounting to Rs. 11,89,27,141/- and disallowance of provision for doubtful reversal amounting to Rs. 1,26,88,951/-. After completion of the assessment, the Ld. PCIT, in exercise of his revisional jurisdiction under section 263 of the Act, issued a notice to the assessee proposing to treat the impugned assessment order as erroneous insofar as it was prejudicial to the interests of the revenue. In the said notice, the Ld. PCIT observed that the Ld. AO had not carried out any verification with regard to the expenditure of Rs.5,30,72,141/- claimed by the assessee in its Profit and Loss Account towards the Employees' Stock Option Scheme ("ESOP"). The Ld. PCIT further observed that the aforesaid expenditure was not allowable under section 37 of the Act and that the same had neither been added back nor examined or verified by the Ld. AO during the course of the assessment proceedings. Accordingly, by invoking Explanation 2 to section 263 of the Act, the Ld. PCIT considered the impugned assessment order to be erroneous insofar as it was prejudicial to the interests of the revenue. In response to the notice issued under section 263 of the Act, the assessee duly furnished its explanation before the Ld. PCIT vide letter dated 16.12.2025. However, after considering the submissions of the assessee, the Ld. PCIT invoked the provisions of section 263 of the Act, held the impugned assessment order to be erroneous insofar as it was prejudicial to the interests of the revenue, and set aside the assessment order with a direction for de novo examination and verification of the issue. Being aggrieved by the revisional order, the assessee has preferred the present appeal before us.

The Ld. AR argued and filed a paper book comprising pages 1 to 97 which has been placed on record. The AR contended that the notice was duly issued by the Ld. PCIT u/s. 263 is erroneous on the ground that during the issuance of the notice the Ld. PCIT had duly finalised his own observations that the assessment order is erroneous. The observation noted by the Ld. PCIT in the alleged notice is reproduced as below:

The Ld. AR contended that the Profit and Loss Account and the financial statements of the assessee, annexed at APB pages 21 to 43, were duly available before and examined by the Ld. AO during the course of the assessment proceedings. It was submitted that various queries raised by the Ld. AO emanated from the said financial statements. Though the Ld. AO had admittedly not raised any specific query with regard to the ESOP expenditure in the notice issued under section 142(1) of the Act, specific queries were raised in respect of sub-brokerage expenses and other items appearing in close proximity to the impugned ESOP expenditure in the Profit and Loss Account. The Ld. AR, therefore, submitted that it could reasonably be inferred that the Ld. AO, while examining the financial statements, had also noticed the ESOP expenditure and did not consider it necessary to make any disallowance, the allowability of such expenditure being, according to the Ld. AR, a settled issue in favour of the assessee.

The Ld. AR further contended that the allowability of ESOP expenditure under section 37 of the Act is no longer res integra and has been considered in favour of the assessee by various Coordinate Benches of the Tribunal as well as by the Hon'ble High Courts. The Ld. AR submitted that the issue was considered by the Special Bench of the Tribunal in Biocon Ltd, reported in 35 taxmann.com 335 (Bangalore - Trib.) (SB) wherein the claim of ESOP expenditure was considered allowable. The said decision was subsequently affirmed by the Hon'ble Karnataka High Court vide judgment dated 11.11.2020, reported in 121 taxmann.com 351 (Karnataka).

The Ld. AR further contended that admittedly the Ld. AO had not examined the alleged ESOP expense. It could be reasonable inferred that the Ld. AO was aware about the legal implication of the alleged expenses, which had already been duly considered and adjudicated by different judicial authorities. The Ld. AR further respectfully relied upon the order of the Coordinate Bench of the ITAT, Mumbai, in the case of Shri Ratan Tata Trust vs. DCIT, reported in (2020) 122 taxmann.com 273 (Mumbai - Trib.) where the identical issue was considered by the bench. The relevant observations of the Bench in paragraph 22 are reproduced below:

The Ld. AR argued and specifically mentioned that the proceeding under section 263 was duly initiated by the Ld. PCIT on the basis of an objection raised by the “Revenue Audit”. On the basis of these audit observations, the Ld. PCIT has initiated proceedings under section 263 of the Act. Therefore, the initiation of proceedings under section 263, relying upon the audit objection is unjustifiable and arbitrary. The Ld. AR contended that an identical issue was duly considered and adjudicated by the Coordinate Bench of ITAT, Mumbai in the case of Zensar Technologies Limited vs. PCIT, ITA No. 3439/Mum/2025, date of pronouncement 12.02.2026. The relevant observations of the Bench in paragraphs 15 and 16 are reproduced below:

The Ld. DR argued and contended that, during the course of the impugned assessment proceedings, the Ld. AO had issued a notice under section 142(1) of the Act; however, no specific enquiry or verification was carried out with regard to the ESOP expenditure claimed by the assessee under section 37 of the Act. According to the Ld. DR, in the absence of any enquiry or verification by the Ld. AO, the genuineness and allowability of the expenditure claimed towards ESOP remained unexamined. Therefore, the Ld. PCIT was justified in invoking the revisional jurisdiction under section 263 of the Act on account of the failure of the Ld. AO to make the requisite enquiry and verification in respect of the ESOP expenditure claimed by the assessee. In support of his contention, the Ld. DR relied upon the order of the Coordinate Bench of the ITAT, Mumbai, in the case of Livelong Insurance Brokers Limited, ITA No. 2864/Mum/2025, pronounced on 17.06.2025. The Ld. DR invited our attention to the relevant observations contained in paragraphs 11 and 13 of the said order, which are reproduced hereunder:

The Ld. DR further contended that the Ld. PCIT had made a clear observation in the impugned revisional order that the Ld. AO had not examined the entire expenses. So, exercising the jurisdiction of the ld. PCIT as per Explanation 2 to section 263 is justified. Since there was no verification of the said expense, the assessment order was rightly treated as erroneous and prejudicial to the interests of the revenue. The Ld. DR invited our attention to paragraph 6 to 8 of the impugned revisional order, which is reproduced below:

The submissions of the assessee have been carefully perused and contention of the assessee that assessment order is not erroneous as the AO has madeappropriate enquiry on the ESOPs related issue during assessment is found to be unacceptable. During assessment, vide notices u/s 142(1) of the Act, the AO has called for various details from the assessee. However, details related to ESOPs of Rs.5,30,72,141/- have not been called for. Even, the assessee company in its submissions filed during revision proceedings has not contended that details of ESOPs were asked for during assessment proceedings. Mere availability of audited financial statements during assessment does not confirm that enquiry has been conducted on this issue of ESOPs by the AO. The AO should have conducted enquiry on this issue during assessment proceedings before coming to a conclusion. However, AO has not enquired upon this matter.

In view of the above, I am of the considered opinion that the assessment order passed by the Assessing Officer under section u/s. 143(3) r.w.s. 144B of the Act dated 13.03.2024 is erroneous in so far as it is prejudicial to the interest of revenue. Accordingly, the said assessment order passed by the Assessing Officer is set aside on the matter of above discussed issue, and the AO is directed to make a detailed enquiry in this matter and reassess the income in accordance with law, after giving an opportunity of being heard to the assessee.”

We have heard the rival submissions and considered the material available on record. The assessment was completed under complete scrutiny pursuant to selection under CASS. During the course of the assessment proceedings, the Ld. AO issued notices under section 142(1) of the Act and called for details and explanations in respect of various items of expenditure. It is, however, an admitted position that no specific query was raised or verification carried out by the Ld. AO with regard to the assessee's claim of ESOP expenditure amounting to Rs.5,30,72,141/- under section 37 of the Act. The Ld. PCIT, therefore, invoked Explanation 2 to section 263 of the Act and set aside the assessment order on this issue for fresh examination.

The contention of the Ld. AR is that the ESOP expenditure was duly reflected in the audited financial statements placed before the Ld. AO and that the Ld. AO had examined various other items appearing in the same financial statements. However, mere availability of the financial statements before the Ld. AO, by itself, may not establish that a conscious enquiry was made into the allowability of the ESOP expenditure. To this extent, the decision relied upon by the Ld. DR in Livelong Insurance Brokers Limited (supra) supports the proposition that where there is complete absence of enquiry on the issue of ESOP expenditure, Explanation 2 to section 263 may be attracted.

However, the matter does not rest merely upon the absence of enquiry by the Ld. AO. For exercise of jurisdiction under section 263 of the Act, the assessment order must be both erroneous and prejudicial to the interests of the revenue. In the present case, when the proceedings under section 263 were initiated, the assessee furnished its explanation and placed its claim regarding the allowability of ESOP expenditure before the Ld. PCIT. The legal position concerning the allowability of ESOP expenditure under section 37(1) had also been considered in Biocon Ltd. (supra), which was affirmed by the Hon'ble Karnataka High Court. The Coordinate Bench in ICICI Securities Limited (supra), while dealing with section 263 itself, has observed that, in view of the settled judicial position recognising ESOP expenditure as an allowable business expenditure, the action of the Assessing Officer in allowing such claim could not be regarded as erroneous and prejudicial to the interests of the Revenue.

At this stage, the principle enunciated by the Coordinate Bench in Shri Ratan Tata Trust (supra) assumes relevance. The Coordinate Bench has explained that mere absence of enquiry does not, in every case, necessarily justify restoration of the matter to the assessment stage. Where, on the material available before the revisional authority, it can be determined that even after the requisite enquiry no addition or disallowance would be warranted, no prejudice can be said to have been caused to the legitimate interests of the revenue. It is only where the absence of enquiry prevents a conclusive determination one way or the other that a remand for fresh enquiry may be warranted.

In the present case, the Ld. PCIT had the assessee's explanation before him during the revisional proceedings. Nevertheless, instead of examining the explanation and determining whether the claim was contrary to law or whether any prejudice had actually been caused to the revenue, the assessment order was set aside essentially on the ground that the Ld. AO had not carried out an enquiry into the ESOP expenditure. Thus, while there was admittedly no specific enquiry by the Ld. AO, the second statutory requirement, namely prejudice to the interests of the revenue, was also required to be independently examined in the light of the material and the legal position placed before the Ld. PCIT.

We have also considered the contention that the genesis of the revisional proceedings was a “Revenue Audit” objection. In Zensar Technologies Limited (supra), the Coordinate Bench held that where the exercise of revisional jurisdiction was not based upon the independent decision 13 of the PCIT but was materially influenced by an audit objection, such exercise of jurisdiction under section 263 could not be sustained. The applicability of this principle, however, necessarily depends upon whether the material on record establishes that the revisional action in the present case was in fact founded upon, or materially influenced by, the audit objection.

Considering the totality of the facts and circumstances and respectfully following the principles laid down in Shri Ratan Tata Trust (supra), we find that merely setting aside the assessment for a de novo enquiry on the ground of absence of enquiry by the Ld. AO, without first dealing with the assessee's explanation and examining whether the allowance of ESOP expenditure had actually resulted in prejudice to the interests of the revenue, does not satisfy the twin conditions for exercise of revisional jurisdiction under section 263 of the Act. Accordingly, the impugned revisional order passed under section 263 of the Act is set aside and the assessment order is restored. Consequently, the grounds raised by the assessee are allowed.

In the result, the appeal of the assessee bearing ITA No.4983/Mum/2026 is allowed.