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Income Tax Appellate Tribunal, “A” BENCH, MUMBAI
AadoSa / O R D E R महावीर स िंह, न्याययक दस्य/ PER MAHAVIR SINGH, JM:
This appeal filed by the assessee is arising out of the Revision order passed by Pr. Commissioner of Income Tax, Mumbai [in short PCIT], vide order dated 17.11.2017. The Assessment was framed by the Asst. Commissioner of Income Tax, Circle-2(2)(1), Mumbai (in short ITAs No. 409/Mum/2018 ‘ACIT/ITO/ AO’) for the A.Y. 2011-12 vide order dated 25.05.2015 under section 143(3) of the Income Tax Act, 1961 (hereinafter ‘the Act’).
The only issue in this appeal of assessee is against the revision order passed by PCIT holding that the assessment order framed by AO under section 143(3) dated 25.05.2015 is erroneous and prejudicial to the interest of the Revenue on account of allowance of ESOP discount of ₹ 3,99,78,891/-. For this assessee has raised the following six effective grounds: - “1. On the facts and in the circumstances of the case and in law, the learned Principal Commissioner of income-tax-2 [CIT] erred in holding that the order passed u/s 143(3) of the Income-tax Act 1961 [“Act”] on 25.05.2015 is erroneous and prejudicial to the interest of revenue on account of allowance of ESOP discount of Rs.39 978,891/-.
2. On the facts and in the circumstances of the case and in law, the learned CIT erred in holding that discount is a notional loss on account of short receipt of share premium and hence is not allowable as an expense u/s 37 of the Income-tax Act, 1961.
3. On the facts and in the circumstances of the case and in law the learned CIT erred in holding that the Special Bench decision in case of Biocon Ltd vs DCIT does not apply to unlisted ITAs No. 409/Mum/2018 companies. The earned CIT further erred in disregarding other judicial precedents relied upon by the appellant.
4. On the facts and in the circumstances of the case and in law, the learned CIT erred in holding that FMV in respect of unlisted shares cannot be determined in doing so, he erred in disregarding the intrinsic value adopted by the appellant company.
5. On the facts and in the circumstances of the case and in law, the learned CIT erred in invoking provisions of Rule 11 UA which is not applicable to the appellant which is a company in which public is substantially interested.
On the facts and in the circumstances of the case and in Law the learned CIT erred in holding that expenditure on account of ESOP discount debited to Profit and Loss account amounted to Reserve and that Reserves do not qualify for deduction.”
Briefly stated facts are that the PCIT on going through the case records of the assessee noticed that the assessee filed its return of income for relevant AY 2011-12 on 30.11.2011 declaring total income at ₹ 83,60,95,684/- and also declared book profit at ₹ 367,06,91,997/-. The assessment was completed under section 143(3) r.w.s 144C(3) of the Act. The PCIT noticed from the assessment order framed under section ITAs No. 409/Mum/2018 14(3) of the Act dated 25.05.2015 that allowance of expenditure on ESOP charges caused prejudice to the interest of Revenue and the order of the AO is erroneous. Hence, he issued show cause notice dated 06.09.2016 and the relevant issue raised in the show cause notice (the show cause notice is reproduced in the order of PCIT) reads as under:-
i. It is noticed from Sr. No. 8 of the ‘Significant Accounting Polivies’ (Schedule-P of the annual accounts) that in respect to ‘Employees Stock Option Schemes’ (ESOP) granted by your company the excess of fairmarket value of the share over exercise price of the option is treated as discount and accounted as employees compensation cost over the vesting period. It is further noticed that for the assessment year under consideration, expenditure amounting to ₹ 3,99,78,891/- has been debited to P & L a/c on account of ESOP charges amortization. Issue of share below the market price does not result into incurring any expenditure, it results into short receipt of premium. ESOP expenses being capital in nature are not deductible. The similar view has been taken by the ITAT Delhi in the case of Ranbaxy Laboratories Ltd. Vs. ACIT 124 TTJ 771. However, in the assessment order, the Assessing Officer did not disallow the said expenses. This has made the assessment order ITAs No. 409/Mum/2018 erroneous in so far as it is prejudicial to the interest of Revenue. ii. it is noticed from Sr. N 1 of ‘Notes forming part of Accounts’ that during the year under consideration not a single option has been exercised and therefore, the expenses debited to profit and loss account were not to be allowed being contingent in nature. However, in the assessment order, the Assessing Officer did not disallow the said expenses. This has made the assessment order erroneous in so far as it is prejudicial to the interest of revenue.
The assessee replied to the above show cause notice and stated that the issue is covered by the decision of Special Bench of this Tribunal i.e. Bangalore ITAT in the case of Biocon Ltd. vs. DCIT [2013] 35 taxmann.com 335 (Bangalore - Trib.) (SB), wherein it is held that the discount on premium under ESOP is simply one of the modes of compensating the employees for their services and is a part of their remuneration and it is nothing but the employee’s cost incurred by the assessee company. It was held that by undertaking to issue shares at discounted price, the company does not pay anything to its employees, but incurs obligation of issuing shares at discounted price on a future date in lieu of their services. Finally, it was held that the same is an expenditure under section 37(1) of the Act and it cannot be held to be contingent liability. It was contended by the learned Counsel before us also that the main thrust of PCIT is that it is nothing but contingent ITAs No. 409/Mum/2018 liability. The learned Counsel drew our attention to the findings of PCIT, which are as under: - “6.1 The assessee has claimed that ESOP discount debited to Profit and Loss account over the vesting period is in accordance with Securities and Exchange Board of India ('SEBI') Guidelines, which provide for treatment of difference between Fair Market Value ('FMV') and Exercise price on the grant date as ESOP discount. It is observed that as per the Guidance Note issued by Institute of Chartered Accounts of India (ICAI) and SEBI the main objective to issue an ESOP share is to remunerate the employee for, his past services, for making available intellectual property rights to the employer. However, due to the issue of ESOP the rights of the existing shareholders get diluted and therefore there is a need to compensate such dilution by creating an artificial reserve. The only resource available with any company is the corporate profits. Hence the ICAI and SEBI have suggested to create such reserve from the current profits earned by the company. The methodology to be adopted as suggested by ICAI and SEBI to compute the quantum of reserve is the ITAs No. 409/Mum/2018 difference between market value as computed under SEBI rules on the date of grant and the price at which the shares are issued to the employees in order to compensate the payout obligation which might arise on ESOP shares either at buyback or at liquidation. Thus, the aforesaid guidelines provide for creation of 'reserve' for compensating the existing shareholders. Under Income- tax Act, if any reserve is created, the deduction for creating the expense is not allowed unless provided under the specific provisions of the Act. By creation of reserve, no money is changing hands. It is a settled principle of law that no person can make profit from himself. Similarly, no expense can be said to have been incurred if payment is not made to any other party. Accounting entry to create a reserve cannot be allowed as expense. Moreover, the guidelines issued by SEBI with regard to ESOP were not applicable to the assessee as it applied to listed companies only.
6.2 The assessee has claimed that in the decision in the case of Biocon vs DCIT 144 ITR 21 the Special Bench of the Bangalore ITAT has held the discount on premium under ESOP is simply one of the modes of compensating the employees for their services and is a part of their remuneration and an expenditure under ITAs No. 409/Mum/2018 section 37(1). In this regard, it is observed that the decision of the Special Bench of the ITAT is in the case of listed companies and the assessee was an unlisted company at the time of ESOP scheme. Further, the Special Bench its decision has, inter alia, referred to the SEBI guidelines. These guidelines were not applicable in the case of assessee company as it was not a listed company during the assessment year under consideration. Therefore, the aforesaid decision is distinguishable or, facts.
6.3 Further, reliance has been placed by the assessee on the different judicial decisions wherein ESOP cost is an allowable expense under the Income-tax Act. The decisions were perused. It is observed that the decisions are in respect of listed companies where market price at the time of vesting of shares under ESOP scheme were available in public domain, whereas the assessee was an unlisted company and market price was not available in public domain. In fact, there is no market where shares of an unlisted can be sold and fair market price can be determined.
6.4 Moreover, the ESOP expense debited to P&L is notional in nature since the assessee ITAs No. 409/Mum/2018 has neither laid out or expended any amount while choosing to receive alleged lesser securities premium. Since the receipt of securities premium is not chargeable to tax being a capital receipt any short collection of securities premium should also be considered as capital outlay and cannot be allowed as expenditure.
6.5 It is further observed that in unlisted company it is impossible to find out the market price of shares unless the share is listed. Further, from the details furnished by the assessee during the current revisionary proceedings u/s 263, it is observed during the assessment year under consideration, that strike price of shares of Rs. 10/- (allotted/proposed to be allotted to employees) was kept at par and fair market price of the same was taken by the assessee at Rs.
Accordingly, the difference amount of Rs. 3,99,78,891/- was debited to profit and loss account as discount on account of ESOP. On being asked, the assessee furnished the valuation of market price of the share recovering letter dated 14.11.2017. From the details filed it is observed that the assessee has not determined the fair market price by following the method prescribed under Rule 11UA(b) and has ITAs No. 409/Mum/2018 based its valuation of market price on relative valuation using two separate multiples: - Enterprise Value to Revenue multiple and market capitalization to Net Profit, based on the data of other companies. It indicates that the determination of market price and subsequent discount is on estimate basis and was thus not allowable as expense. There can be a possibility that the market price of the shares may be less than the market price estimated by the assessee company. Even later, the shares were issued to public in 2016 was at lesser price that is Rs. 710/- per equity shares. Therefore, the amount of 'discount' debited by the company on account of ESOP was unsubstantiated and, hence, not allowable as expense.
6.6 The Supreme Court, in M/s McDowell and Co Ltd Vs Commercial Tax officer, 1985, (154 ITR 148(SC), held that for it is open for the tax authorities to go behind the transaction and examine the "substance" and not merely the "form". In the instant case the assessee being an unlisted company debited discount on account of ESOP when the market price of the share was not available.
6.7 In view of the aforesaid facts, it is held that the claim of assessee of expense of ITAs No. 409/Mum/2018 discount on account of ESOP was not allowable.
In view of the aforesaid facts and the provisions of law mentioned in the preceding paras, the assessment order dt 25.05.2015 passed by the Assessing Officer under section 143(3) read with section 144C(3) is held to be erroneous in so far as It is prejudicial to the interest of revenue. Accordingly, the assessment order is revised and the Assessing Officer is directed to disallow the claim of discount on ESOP of Rs. Rs 3,99,78,891/- and add the same to the total income of the assessee company. The assessment order will be modified by the A.O. to this extent.”
We find that this issue is covered by the decision of Tribunal in assessee’s own case for AY 2009-10 in wherein the Tribunal held as under: - “13. Now, we shall examine the issue on which the assessment order was cancelled and was directed to be passed afresh after giving proper opportunity to the assessee. We have seen that assessment order under section 143(3) was passed on 15 January 2014. The assessing officer issued notice under section 154 for rectification of the mistake in the assessment order, copy of which is placed on record vide ITAs No. 409/Mum/2018 page No.10 of Paper Book (PB). In the notice under section 154 the assessing officer mentioned that he has seen from significant accounting policies (Schedule-P of the annual accounts) in respect of ESOP granted by Assessee Company the excess of the fair value of share over exercise price of option is treated as discount and accounted as employee compensation cost over the vesting period. It was further mentioned that ( Sl No. 2 of the Notes of account) that the assessee had granted 25,31,159 options to its employee to issue shares of face value of Rs. 5/- each (with option price of Rs.25/- under I,II,& III series and Rs.10/- for IV-XVI and XVII-XVIII) outstanding at March 31st 2009 under different ESOP scheme. It is also mentioned in the notice that it was seen from the cash flow statement that an amount of Rs. 6,61,09,445/- was accounted as employee stock option amortization expenses which is obviously the discount amount treated as employee cost. Thus, from the perusal of the notice under section 154 it is clear that all the details related with ESOP discount were available with the assessing officer. The assessee file its reply vide reply dated 28.01.2015, copy of which is filed on record vide page No. 11 to 18 of PB. In the reply the assessee explained the legislative history ESOP ITAs No. 409/Mum/2018 and relied on the decision of Special Bench in Biocon Limited (supra), wherein it was held that discount on ESOP is an allowable deduction under section 37(1) during years of vesting on basis of percentage of vesting during such period, subject to adjustment at time of exercise of option. The ld AR for the assessee while making submissions submitted that after taking the reply of assessee and the details relating to the ESOP, the assessing officer has not conveyed his decision on proposed rectification and the contention of the assessee is deemed to be accepted as allowable expenses under the Act. The ld. DR for the revenue has not disputed the contention of the ld. AR for the assessee nor filed any material on record rejecting the contention of the assessee, which was conveyed by them to the assessing officer in reply to the notice under section 154 of the ACT.
Considering the factual matrix of the case we find that, though the assessing officer has not discussed the issue of ESOP at the time of original assessment proceedings, however, in the proceedings initiated under section 154 the assessing officer after examining the details of ESOP discount was satisfied and not disallowed it, being allowable expenses and the assessing officer has taken a possible view. Though, the ITAs No. 409/Mum/2018 assessing officer has not communicated his order, it should have been communicated to the assessee or the ld. PCIT ought to have confirmed from the assessing officer of his finding on proposed action initiated under section 154, before proceeding further in the matter. Hence, in our view the order passed by assessing officer is not erroneous and therefore the twin condition as enunciated under section 263 are not fulfilled. We are also of the view that no revision under section 263 was warranted, on the facts of present case, when the assessing officer on the basis of the material available before him initiated action under section 154 and after examining the issue made no disallowance and taken a possible view in accordance with the law. It is settled law that every loss of revenue as a consequence of a view taken by the Assessing Officer cannot be treated as prejudicial to the interest of the revenue. For example, when the Income-tax Officer adopted one of the courses permissible in law and it has resulted in loss of revenue; or where two views are possible and the Income- tax Officer has taken one view with which the Commissioner (PCIT) does not agree, it cannot be treated as an erroneous order prejudicial to the interest of the revenue, unless the view taken by the Income-tax Officer is unsustainable ITAs No. 409/Mum/2018 in law. In the result the grounds of appeal raised by assessee are allowed.”