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Facts
The revenue challenged the deletion of an addition of Rs. 4,06,00,000/- made by the Assessing Officer (AO) on account of ESOP expenses claimed by the assessee. The AO disallowed the claim, holding that the expenditure was contingent and not incurred. The CIT(A) deleted the addition, relying on High Court and ITAT decisions.
Held
The Tribunal held that the discount on ESOPs, representing employee compensation cost, is an ascertained liability and an allowable business expenditure under Section 37(1) of the Income Tax Act, 1961. They relied on the decision in CIT vs. Biocon Ltd.
Key Issues
Whether the discount on ESOPs, treated as employee compensation, is an allowable business expenditure under Section 37(1) of the Income Tax Act, 1961, or a capital expenditure that has not crystallized.
Sections Cited
37(1), 143(2), 142(1), 143(3), 2(15A), 17(2)(iiia)
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Income Tax Appellate Tribunal, “A” BENCH, MUMBAI
Before: SHRI OM PRAKASH KANT, AM
O R D E R Per Kavitha Rajagopal, J M: These appeals have been filed by the revenue, challenging the order of the learned Commissioner of Income Tax (Appeals), 48, Mumbai (‘ld. CIT(A)’ for short), passed u/s.250 of the Income Tax Act, 1961 (‘the Act'), pertaining to the Assessment Year (‘A.Y.’ for short) 2021-22 and 2022-23. 2. As the facts are identical, we hereby pass a consolidated order by taking as a lead case. (A.Y. 2021-22) 3. The revenue has raised the following grounds of appeal:
1. & 473/Mum/2025 (A.Y. 2021-22 & 2022-23) Avanse Financial Services Ltd. 1. "Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) is justified in directing the AG to delete the addition of R. Rs. 4,06,00,000/- made u/s 3 7(1) of the IT Act, 1961 on account of expenditure claimed by the assessee on ESOP without appreciating the facts that the issue of shares was not crystallized till the due date on which employees exercise the option and any expenditure debited during vesting period remains contingent in nature?" 2. "Whether on the facts and circumstances of the case and in law, the Ld. CIT (A) is justified in directing the AG to delete the addition of Rs. 4,06,00,000/- made u/s 37(1) of the IT Act, 1961 on account of expenditure claimed by the assessee on ESOP without appreciating the fact that while implementing the ESOP, the company did not follow the generic vesting schedule of ESOP and thereby defeated the very purpose of the ESOP Scheme?" 3. "Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) is justified in directing the AG to delete the addition of Rs. 4,06,00,000/- u/s 3 7(1) of the IT Act, 1961 on account of expenditure claimed by the assessee on ESOP by relying upon decision of decision of Hon'ble ITAT's 'D' Bench, Mumbai in the case of MIs. Motilal Oswal Securities Ltd. without appreciating the fact that the decision of Hon'ble ITAT has already been challenged before H6n'ble Bombay High Court and the issue has not reached to its finality?"
Brief facts of the case are that the assessee is a RBI registered non-deposit accepting non-banking financial company which is engaged in lending money by way of loans, advance with or without security and to solicit and procure insurance business as corporate agent and systematically important Non deposit taking Non-Banking Financial Company. The assessee had filed its return of income dated 11.03.2022, declaring total income at Rs. 69,91,15,319/- and the assessee’s case was selected for scrutiny and notices u/s. 143(2) and 142(1) of the Act were duly issued and served upon the assessee. The learned Assessing Officer ('ld. A.O.' for short) observed that the assessee has debited an amount of Rs. 4,06,00,000/- towards ESOP expenses in its profit and loss account which according to the ld. AO is that the shares did not crystalize during the year under consideration and that the expenditure incurred of the same was merely contingent in nature and not eligible for claiming the same as revenue & 473/Mum/2025 (A.Y. 2021-22 & 2022-23) Avanse Financial Services Ltd. expenditure. Further, the ld. AO held that the assessee does not incur any expenditure merely on issuing ESOP to the employees. The ld. AO disallowed the ESOP expenses amounting to Rs. 4,06,00,000/- and added the same to the total income of the assessee. The ld. AO passed the assessment order u/s. 143(3) of the Act dated 16.12.2022, declaring total income at Rs. 73,97,15,319/-.
Aggrieved the assessee was in appeal before the first appellate authority, who vide order dated 22.11.2024 deleted the impugned addition/disallowance by relying on the decision of the Hon'ble High Court of Karnataka in the case of CIT v. Biocon Ltd. [2020] 121 taxmann.com 351 (Kar HC) and the decision of the coordinate bench in the case of M/s. Motilal Oswal Securities Ltd dated 18.08.2023.
The revenue is in appeal before us, challenging the impugned order of the ld. CIT(A).
We have heard the rival submissions and perused the materials available on record. It is observed that the assessee has granted 34,27,772 stock option to eligible employees and had adopted a fair value based method of accounting and determined compensation cost for its stock-based compensation scheme and the fair value was calculated by applying Black Scholes Value model as valued by an independent valuer and arrived at an expenditure of Rs. 4,06,00,000/- which was debited to the P & L account of the assessee under 'Employee benefit expenses’ which is the difference between the fair value of the shares at the time of the grant and the offer price amortized over the vesting period. It is observed that during the assessment proceeding, the ld. AO disallowed the ESOP expenses claimed by the assessee amounting to Rs. 4,06,00,000/- on the ground & 473/Mum/2025 (A.Y. 2021-22 & 2022-23) Avanse Financial Services Ltd. that the issue of share has not been crystalized till the due date on which the employee exercises the option and the expenditure claimed is merely contingent in nature and the same would amount to capital expenditure as opposed to a revenue expenditure claimed by the assessee. The assessee had claimed the same as business expenditure u/s. 37(1) of the Act which amounts to employee compensation cost incurred for its business purpose which is in the nature of remuneration liable for deduction u/s. 37(1) of the Act as business expenditure.
8. The ld. DR for the revenue contended that it is merely contingent liability and has not crystalized during the year under consideration. The ld. DR further stated that the assessee has not incurred any expenditure in issuing the ESOP to the employees and relied on the order of the lower authorities.
9. The learned Authorised Representative ('ld. AR' for short) for the assessee contended that the discount on issue of ESOP was not contingent liability but ascertained liability, where the deduction of discount was claimed over the vesting period. The ld. AR relied on the decision of the Special Bench of the Tribunal in the case of Biocon Ltd. vs. DCIT [2013] 35 taxmann.com 335 (Bangalore - Trib.) (SB) which was upheld by the Hon'ble Karnataka High Court in CIT v. Biocon Ltd. (supra) which held that the discount on ESOP being the difference in the fair value of the share at the time of the grant and the offer price amortized over the vesting period as business expenditure u/s. 37(1) of the Act. The ld. AR also relied on the various other decisions in support of the assessee’s contentions.
& 473/Mum/2025 (A.Y. 2021-22 & 2022-23) Avanse Financial Services Ltd.
10. On the above factual matrix of the case, the only moot issue to be adjudicated is whether the expenditure claimed by the assessee towards ESOP would be a revenue expenditure allowable u/s. 37(1) of the Act or is a capital expenditure which has not crystalized during the year under consideration. It is a settled proposition of law, wherein the Special Bench case of the Tribunal in Biocon Ltd. (supra) has decided this issue in favour of the assessee by holding the same to be business expenditure u/s. 37(1) of the Act in terms of the difference amount between the market value and face value at which shares are allotted which is in the nature of remuneration paid to the employees on certain terms and conditions. The revenue’s contentions is that the expenditure has neither incurred nor accrued during the assessment year and is contingent in nature and the same is merely hypothetical and notional expenditure claimed by the assessee. Further, the revenue’s contention is that in mercantile system of accounting, expenditures are allowable only when the same has been incurred for claiming deduction u/s. 37(1) of the Act. It is trite to reproduce Section 37(1) of the Act for ease of reference: 37. (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the asses see), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession". Explanation 1. — For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure. Explanation 2.—For the removal of doubts, it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession.
& 473/Mum/2025 (A.Y. 2021-22 & 2022-23) Avanse Financial Services Ltd. Explanation 3.—For the removal of doubts, it is hereby clarified that the expression "expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law" under Explanation 1, shall include and shall be deemed to have always included the expenditure incurred by an assessee, — (i) for any purpose which is an offence under, or which is prohibited by, any law for the time being in force, in India or outside India; or (ii) to provide any benefit or perquisite, in whatever form, to a person, whether or not carrying on a business or exercising a profession, and acceptance of such benefit or perquisite by such person is in violation of any law or rule or regulation or guideline, as the case may be, for the time being in force, governing the conduct of such person; or (iii) to compound an offence under any law for the time being in force, in India or 17[outside India; or (iv) to settle proceedings initiated in relation to contravention under such law as may be notified by the Central Government in the Official Gazette in this behalf].
On a bare perusal of the said provision, it is observed that any expenditure other than expenditures specified in Section 30 to 36 and excluding capital expenditure or personal expenses, which is incurred wholly and exclusively for the purpose of the business or profession of the assessee is allowed for deduction while computing the profit and gains of business or profession. The mandate of this provision is, it has to be expended only for the purpose of the business of the assessee so as to be eligible u/s. 37(1) of the Act.
The issue in hand is squarely covered by the decision of the Hon’ble High Court of Karnataka in the case of Biocon Ltd. (supra) which upheld the finding of the special bench of the tribunal in Biocon Ltd. vs. DCIT (supra). The relevant extract of the decision of the Hon’ble High Court is cited herein under for ease of reference: “6. We have considered the submissions made by learned counsel for the parties and have perused the record. The singular issue, which arises for consideration in this appeal is whether the tribunal is correct in holding that discount on the issue of ESOPs i.e., difference between the grant price and the market price on the shares as on the date of grant of options is allowable as a deduction under section 37 of the Act. Before proceeding further, it is apposite to take note of section 37(1) of the Act, which reads as under: Section 37(1) says that any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal & 473/Mum/2025 (A.Y. 2021-22 & 2022-23) Avanse Financial Services Ltd. expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head, "Profits and Gains of Business or Profession".
7. Thus, from perusal of section 37(1) of the Act, it is evident that the aforesaid provision permits deduction for the expenditure laid out or expended and does not contain a requirement that there has to be a pay out. If an expenditure has been incurred, provision of section 37(1) of the Act would be attracted. It is also pertinent to note that section 37 does not envisage incurrence of expenditure in cash.
Section 2(15A) of the Companies Act, 1956 defines 'employees stock option' to mean option given to the whole time directors, officers or the employees of the company, which gives such directors, officers or employees, the benefit or right to purchase or subscribe at a future rate the securities offered by a company at a free determined price. In an ESOP a company undertakes to issue shares to its employees at a future date at a price lower than the current market price. The employees are given stock options at discount and the same amount of discount represents the difference between market price of shares at the time of grant of option and the offer price. In order to be eligible for acquiring shares under the scheme, the employees are under an obligation to render their services to the company during the vesting period as provided in the scheme. On completion of the vesting period in the service of the company, the option vest with the employees.
In the instant case, the ESOPs vest in an employee over a period of four years i.e., at the rate of 25%, which means at the end of first year, the employee has a definite right to 25% of the shares and the assessee is bound to allow the vesting of 25% of the options. It is well settled in law that if a business liability has arisen in the accounting year, the same is permissible as deduction, even though, liability may have to quantify and discharged at a future date. On exercise of option by an employee, the actual amount of benefit has to be determined is only a quantification of liability, which takes place at a future date. The tribunal has therefore, rightly placed reliance on decisions of the Supreme Court in Bharat Movers supra and Rotork Controls India P. Ltd., supra and has recorded a finding that discount on issue of ESOPs is not a contingent liability but is an ascertained liability.
From perusal of section 37(1), which has been referred to supra, it is evident that an assessee is entitled to claim deduction under the aforesaid provision if the expenditure has been incurred. The expression 'expenditure' will also include a loss and therefore, issuance of shares at a discount where the assessee absorbs the difference between the price at which it is issued and the market value of the shares would also be expenditure incurred for the purposes of section 37(1) of the Act. The primary object of the aforesaid exercise is not to waste capital but to earn profits by securing consistent services of the employees and therefore, the same cannot be construed as short receipt of capital. The tribunal therefore, in paragraphs 9.2.7 and 9.2.8 has rightly held that incurring of the expenditure by the assessee entitles him for deduction under section 37(1) of the Act subject to fulfilment of the condition.
11. The deduction of discount on ESOP over the vesting period is in accordance with the accounting in the books of account, which has been prepared in accordance with Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999.
& 473/Mum/2025 (A.Y. 2021-22 & 2022-23) Avanse Financial Services Ltd.
12. So far as reliance place by the revenue in the case of Infosys Technologies Ltd.(supra) is concerned, it is noteworthy that in the aforesaid decision, the Supreme Court was dealing with a proceeding under section 201 of the Act for non-deduction of tax at source and it was held that there was no cash inflow to the employees. The aforesaid decision is of no assistance to decide the issue of allowability of expenses in the hands of the employer. It is also pertinent to mention here that in the decision rendered by the Supreme Court in the aforesaid case, the Assessment Years in question was 1997-98 to 1999-2000 and at that time, the Act did not contain any specific provisions to tax the benefits on ESOPs. Section 17(2)(iiia) was inserted by Finance Act, 1999 with effect from 1-4-2000. Therefore, it is evident that law recognizes a real benefit in the hands of the employees. For the aforementioned reasons, the decision rendered in the case of Infosys Technologies is of no assistance to the revenue. The decisions relied upon by the revenue in A. Gajapathy Naidu,Morvi Industries Ltd. and Keshav Mills Ltd.(supra) support the case of assessee as the assessee has incurred a definite legal liability and on following the mercantile system of accounting, the discount on ESOPs has rightly been debited as expenditure in the books of account. We are in respectful agreement with the view taken in PVP Ventures Ltd. And Lemon Tree Hotels Ltd.'case (supra).
It is also pertinent to mention here that for Assessment Year 2009-10 onwards the Assessing Officer has permitted the deduction of ESOP expenses and in view of law laid down by Supreme Court in Radhasoami Satsang v. CIT, [1992] 60 Taxman 248/193 ITR 321, the revenue cannot be permitted to take a different stand with regard to the Assessment Year in question.
13. By respectfully following the above said decision, we deem it fit to hold that there is no infirmity in the order of ld. CIT(A) in deleting the addition of Rs. 4,06,00,000/- made u/s. 37(1) of the Act towards expenditure claimed by the assessee on ESOP. We hereby dismiss the grounds of appeal
raised by the revenue on the aforesaid observation.
14. In the result, the appeal filed by the revenue is dismissed.
(A.Y. 2022-23) 15. The findings recorded in shall apply mutatis mutandis to this appeal also.
& 473/Mum/2025 (A.Y. 2021-22 & 2022-23) Avanse Financial Services Ltd.
In the result, both the appeals filed by the revenue are dismissed. Order Pronounced under Rule 34(4) of the ITAT Rules by placing result on the notice board on.28.05.2025 Sd/- Sd/- (OM PRAKASH KANT) (KAVITHA RAJAGOPAL) ACCOUNTANT MEMBER JUDICIAL MEMBER Mumbai; Dated: 28.05.2025 Karishma J. Pawar (Stenographer) Copy of the Order forwarded to: 1. The Appellant 2. The Respondent 3. CIT- concerned 4. DR, ITAT, Mumbai 5. Guard File BY ORDER,