2017 (2) TMI 1399 - HC - Income Tax

Court upholds Tribunal decision on claimed expenditure, clarifies ESOP deduction rules.

The court dismissed the Revenue's appeal regarding the claimed expenditure under section 37 for the assessment year 2007-08, upholding the Income-tax ... Deductibility of ESOP discount as business expenditure under section 37(1) - incurrence and timing of liability under mercantile system of accounting - ascertained versus contingent liability in ESOPs - statutory recognition of ESOP discount as consideration for employment (fringe benefit) - application of precedents on allowance of liability despite difficulty of quantificationDeductibility of ESOP discount as business expenditure under section 37(1) - incurrence and timing of liability under mercantile system of accounting - ascertained versus contingent liability in ESOPs - application of precedents on allowance of liability despite difficulty of quantification - Expenditure by way of discount on shares under ESOP is an allowable deduction and was correctly treated as an ascertained business liability for the relevant assessment year. - HELD THAT: - The court accepted the reasoning of the Income-tax Appellate Tribunal which followed the Special Bench in Biocon and earlier authorities. The legislative recognition of ESOP discount as a consideration for employment (fringe benefit) indicates that such discount is an expenditure. Applying the mercantile system of accounting and the principles in the cited precedents, a business liability that has definitely arisen in an accounting year is deductible in that year even if precise quantification is difficult and discharge may occur later. Lapses or non-exercise of some options do not render the liability contingent at the macro level because such options are generally available for re-grant or allocation among the employee pool; any necessary reversal can be made in a later year. Having regard to these authorities and the earlier related decision of this Court, no substantial question of law arises in respect of the same items of expenditure considered for the assessment years in issue. [Paras 5]Appeal dismissed; no substantial question of law arises and the deduction treatment of the ESOP-related expenditure is upheld for the assessment year in question.Final Conclusion: The Revenue's appeal is dismissed. The Tribunal's view that the discount on ESOPs is an allowable business expenditure (being an ascertained liability under mercantile accounting and capable of deduction in the relevant year) is supported and no substantial question of law is made out. Issues:1. Whether the expenditure claimed by the assessee under section 37 was taxable for the assessment year 2007-08.2. Whether the Income-tax Appellate Tribunal's approach was correct in restoring the matter to the file of the Assessing Officer for re-adjudication.3. Whether the discount on shares under the Employees Stock Option Plan (ESOP) is an allowable deduction under section 37(1).4. When and how much amount of deduction should be granted for the discount under ESOP.Issue 1:The Revenue appealed against the assessee's expenditure claimed under section 37 for the assessment year 2007-08. The Income-tax Appellate Tribunal's decision in favor of the assessee was based on the Special Bench ruling in Biocon Limited v. Deputy CIT. The court had previously refused to entertain a similar appeal for the previous assessment year 2006-07. The Revenue contended that the reliance on CIT v. Lemon Tree Hotels Ltd. was not justified, and the appeal was rejected on the ground of delay. The court had affirmed the Tribunal's decision in favor of the assessee in the Lemon Tree case, and the Income-tax Appellate Tribunal's order was consistent with this decision. Thus, the court found no substantial question of law in this issue.Issue 2:The Income-tax Appellate Tribunal had restored the matter to the Assessing Officer for re-adjudication. The court found that the Tribunal's decision was in line with the Lemon Tree case and that no substantial question of law arose in this regard. The court upheld the Tribunal's approach and dismissed the Revenue's appeal.Issue 3:The court referred to the ruling in CIT v. PVP Ventures Ltd. where the Madras High Court held that the expenditure on shares issued under ESOP was an ascertained liability and not a contingent liability. The court also discussed the Special Bench ruling in Biocon, which elaborately examined ESOPs and the liability on the rendition of service by employees. The court concluded that the discount on shares under ESOP is an allowable deduction under section 37(1) as it is considered a fringe benefit provided by the employer to its employees.Issue 4:Regarding the timing and amount of deduction for the discount under ESOP, the court explained that under a mercantile system of accounting, an expense becomes deductible when the liability to pay arises, even if the actual payment occurs later. The court cited the Supreme Court's mandate that if a business liability has arisen in an accounting year, the deduction should be allowed in that year. The deduction for an expense is allowable on incurring the liability, even if its quantification is difficult at that stage. The court emphasized the importance of distinguishing between a liability not incurred and a liability incurred but difficult to quantify. The court dismissed the appeal, considering the previous order and finding no question of law arising.In conclusion, the court dismissed the appeal as it found no substantial question of law in the issues raised by the Revenue, affirming the decisions of the Income-tax Appellate Tribunal and previous court orders.