JYOTI STRUCTURES LTD,MUMBAI vs. DCIT CEN CIR 41, MUMBAI

This is an appeal filed by the assessee. The relevant assessment year is 2006-07. The appeal is directed against the order of the Commissioner of Income Tax (Appeals)-49 [in short ‘CIT(A)’], Mumbai and arises out of the assessment completed u/s 143(3) r.w.s. 153A of the Income Tax Act 1961, (the ‘Act’).

The grounds of appeal

The Learned CIT (A) has erred in holding that the expenditure on ESOS cannot be considered as expenditure at all by wrongly applying the decision of the Hon'ble Supreme Court as laid down in the case of EMICO –KCP Ltd. [2000] 109 TAXMAN 151 (SC) to the facts of the Appellant's case. 4. The Learned CIT (A) has erred in not appreciating that the facts as laid down by the Hon'ble Supreme Court as well as the ratio of the Hon'ble Delhi High Court as laid down in the case of EMICO-KCP Ltd. are not applicable to the facts and the issue in the Appellant's case. 5. The Learned CIT (A) has erred in not appreciating the case law quoted to him regarding the allowably of the ESOS expenditure. 3. Briefly stated, the facts of the case are that during the course of assessment proceedings, the Assessing Officer (AO) found from clause 17(a) of Form No. 3CD that the auditors have mentioned that an amount of Rs.1,62,49,300/- being Employee Compensation Expense is capital expenditure, however, the assessee-company has reduced the said amount from the competition of its business income. In response to a query raised by the AO, the assessee filed a reply vide letter dated 08.10.2013 stating that the original return of income was filed declaring total income of Rs.28,41,85,172/-. However, in the light of amendment to section 115WB and based on legal advice, the assessee claimed the said Employees Stock Purchase Scheme (ESOP) expenditure of Rs.1,62,49,300/- as business expenditure. Before the AO, the assessee relied on the order of the Bangalore Tribunal reported in 42 Jyoti Structures Ltd. taxmann.com 168 (Bangalore-Trib) in the case of Novo Nordisk India (P) Ltd. v. Deputy Commission of Income Tax, Circle-12(2), Bangalore. Also it was stated before the AO that this position of law is confirmed from the proviso to section 17(2)(iii) as it stood for the relevant year which specifically exempted ESOP benefit from being treated as perquisite though it was an expenditure of the employer. However, the AO was not convinced with the above explanation of the assessee and observed that the amendment to section 115WB of the Act is w.e.f. 01.04.2008 and hence, not applicable to AY 2006-07. Further, the AO relied on the Explanatory Circular on Fringe Benefit Tax arising on allotment or transfer of specified securities or sweat equity shares (Circular no. 9/2007). He made a specific reference to question No. 16, of the above circular which reads as under: “Q.16: Whether the fringe benefit arising on account of shares allotted or transferred under the ESOP is allowed as deduction in calculating the taxable income of the employer company? Ans: In case where the employer purchases the shares and then subsequently transfers such shares to its employees, the expenditure so incurred is allowable as deduction in computing the taxable income of the employer company. However, if the shares are allotted to the employees from the share capital of the company, no deduction is allowable in computing the taxable income of the company since no expenditure has been incurred by it. In the above question although answering with regards to question arising on fringe benefit tax, it has been duly mentioned that any fringe benefit arising on account of ESOP is not allowable as a deduction/expenditure in the hands of the company.”

Aggrieved by the order of the AO, the assessee filed an appeal before the Ld. CIT(A). During the course of appellate proceedings, the assessee filed before him a copy of ESOS of the assessee. The assessee also submitted a copy of the computation of ESOS expenditure, which is based on the market closing price of 05.09.2005 at Rs.295.25, the exercise price of Rs.85 and the number of options granted for 234,800 shares. Referring to the decision in Biocon Ltd. v. DCIT (2013) 144 ITD 21 (Bangalore-Trib) (SB), the Ld. CIT(A) observed that in the above order, Jyoti Structures Ltd. Special Bench have not considered the decision of the Hon’ble Supreme Court in the case of Eimco KCP Ltd. v. CIT (2000) 242 ITR 659(SC). The Ld. CIT(A) was of the opinion that the decision in the above case squarely applies to the facts of the present case. Then he agreed with the AO that the case of M/s Novo Nordisk India (P) Ltd. is not applicable to the facts of the case. Thus, the Ld. CIT(A) confirmed the disallowance of Rs.1,62,49,300/- made by the AO.

Before us, the Ld. counsel of the assessee files a Paper Book (P/B) containing the decision in DCIT v. Kotak Mahindra Bank Ltd. (2018) 89 taxmann.com 223 (Mumbai-Trib), Biocon Ltd. (supra), CIT v. M/s PVP Ventures Ltd. (2012) 23 taxmann.com 286 (Madras), CIT v. Lemon Tree Hotels Ltd. (ITA No. 107/2015) by Delhi High Court and Eimco KCP Ltd. (supra).

On the other hand, the Ld. DR relies on the decision in Eimco KCP Ltd. (supra) and the order of the Tribunal in Ranbaxy Laboratories (supra).

We have heard the rival submissions and perused the relevant materials on record. The reasons for our decisions are given below. We begin with the decision in the case of Eimco KCP Ltd. (supra) relied on by the Ld. DR. In that case the assessee was a company registered under the Indian Companies Act. It was incorporated in the year 1965. Two companies, Eimco, an American company and KCP Ltd., an Indian company, promoted the assessee. The authorized capital of Jyoti Structures Ltd. Rs.1,00,00,000/- consisting of 10,00,000 equity shares of Rs.10 each. Each of them agreed to subscribe Rs.4,70,000/- out of which each would have to pay initially a sum of Rs.2,80,000/- towards its contribution. Towards its share, Eimco contributed technical knowhow. It valued the knowhow, etc. at a sum of Rs.2,35,000/- and paid the balance in cash as its contribution. The board of directors of the assessee allotted equity shares of Rs.2,35,000/- being the value of the knowhow, to Eimco by resolution passed on April 29, 1968. In the assessment year 1969-70, the appellant claimed deduction of Rs.2,35,000/- as revenue expenditure paid to Eimco towards consideration for supply of technical knowhow. The ITO treated that amount as a capital expenditure and allowed 1/14th of the said amount as allowable expenditure u/s 35A of the Act. The appellant challenged that order before the Appellate Assistant Commissioner on the ground that the whole expenditure ought to have been allowed as revenue expenditure. While so, the Commissioner of Income Tax in exercise of his power u/s 263(1) of the Act revised the said order of the ITO dated March 25, 1970, holding that the amount in question could not be treated as expenditure and that granting 1/14th of the said amount as capital expenditure u/s 35A was erroneous and prejudicial to the interest of the revenue and thus set aside the same. Thereafter, the Appellate Assistant Commissioner dismissed the appeal and directed that 1/14th amount be added back as income of the assessee. Against both the orders, the appellant filed appeals before the ITAT. The Tribunal on December 12, 1975, allowed the appeals of the appellant taking the view that the said amount was revenue expenditure of the Jyoti Structures Ltd. appellant. On a reference, the High Court held that the Commissioner of Income Tax had jurisdiction to pass the order in revision and that the sum paid by the assessee-company to the foreign collaborator did not constitute revenue expenditure. On appeal by the assessee, the Hon’ble Supreme Court held that the Commissioner of Income Tax could interfere, acting u/s 263 of the Act, with the order of the ITO on a point which was directly in appeal before the Appellate Assistant Commissioner. In the instant case, the ESOS expenditure was calculated and debited to the profit & loss account as per SEBI Guidelines. The issue here is whether the discount on share allotted by the assessee to its employess under ESOP scheme out of its share capital is an allowable expenditure u/s 37 of the Act. Thus the case of the assessee in the instant appeal is distinguishable from the above decision relied on by the Ld. Counsel. 7.1 In the case of Biocon Ltd. (supra), relied on by the Ld. Counsel and distinguished by the Ld. DR, the assessee is engaged in the manufacture of enzymes and pharmaceutical ingredients. It formulated the Employees Stock Option Plan (ESOP) 2000. A trust was set up under the name and style of “Biocon India Limited Employees Welfare Trust” for giving effect to the ESOP 2000 and another ESOP 2004 which was launched subsequently but during one of the years under consideration. The assessee claimed deduction of Rs.3,38,63,779/- as ‘Employee Compensation Cost’ u/s 37 of the Act, representing discount under ESOP 2000. In the assessment completed u/s 143(3), the AO disallowed the Jyoti Structures Ltd. 37(1). He further held that the Securities and Exchange Board of India (Employee Stock Option Scheme & Employee Stock Purchase Scheme) Guidelines, 1999 (hereinafter called ‘the SEBI Guidelines’) on which the assessee had placed reliance in support of the deduction, would not apply as these cannot supersede the taxing principles. The AO did not accept the contention of the assessee of the supremacy of the accounting principles and SEBI Guidelines for the purposes of computation of total income on the ground that it was a contingent liability. On reference to the Special Bench by the Division Bench, on question allowability of discount on issue of stock option as an expenditure u/s 37(1), the Tribunal held that: “In the present case, the assessee-company was closely held company in the previous year relevant to the assessment year 2003-04 and such there was no question of listing of its shares and having some market price at the time of grant of options. Ordinarily, the amount of discount on premium which is written off over the vesting period represents the market price of the shares listed on the stock exchange on the date of grant of option as reduced by the price at which option is given to the employees. However, since there was no availability of any market price of such shares on the date of grant of option as the company came to be listed on a stock exchange in a subsequent year, the assessee-company took the market price of the share on the date of grant of option at Rs.919. No material worth the name was placed on record to indicate as to how a share with face value of Rs.10 had been valued at Rs.919 for claiming deduction towards discount at Rs.909 per share. This aspect of Jyoti Structures Ltd. Rs.919 per share needs to be examined by the Assessing Officer.” The Special Bench further held that where liability in respect of ESOP is incurred at end of each year, which is quantified at the end of vesting period when employees become entitled to exercise options, discount on ESOP is an ascertained liability and not a contingent liability. Further, it held that discount on ESOP being a general expense, is an allowable deduction u/s 37(1) during years of vesting on basis of percentage of vesting during such period, subject to upward or downward adjustment at time of exercise of option. While deciding the allowability of cost of ESOP, the Special Bench in the above case has distinguished the decision in Ranbaxy Laboratories Ltd. (supra). 7.2 Also in the case of M/s PVP Ventures Ltd. (supra), the Hon’ble Madras High Court at para 29 held: “29 As far as the Employees Stock Option Plan is concerned, as rightly pointed out by the Tribunal, the assessee had to follow SEBI direction and by following such direction, the assessee claimed the ascertained amount as liability for deduction. We do not find that their exists any error to disturb the order of the Tribunal and in turn the Assessing Authority.” 7.3 In the case of Lemon Tree Hotel Ltd. (supra), the Hon’ble Delhi High Court following the decision in PVP Ventures Ltd. (supra) held that cost of ESOP could be debited to the profit and loss account.