2020 (11) TMI 779 - HC - Income Tax

ESOP share-issue discount treated as employee pay u/s37(1), deductible over vesting period; tax authority appeal dismissed

Whether ESOP discount is deductible under s.37(1) was the dominant issue. The HC held that 'expenditure' includes loss; issuing shares at a discount, with ... Discount on issue of ESOP - allowable deduction in computing the income under the head profits and gains of the business or not? - whether tribunal was right in holding that difference between market price of the shares at the time of grant of option and offer price amounts to discount and the same has to be treated as remuneration to the employees for their continuity of service? - as per revenue employees will not get any right in the shares till completion of the period prescribed and the expenditure claimed is contingent - HELD THAT:- 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) - 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. Tribunal therefore has rightly held that incurring of the expenditure by the assessee entitles him for deduction under Section 37(1) of the Act subject to fulfillment of the condition. Deduction of discount on ESOP over the vesting period is in accordance with the accounting in the books of accounts, which has been prepared in accordance with Securities And Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999. The decisions relied upon by the revenue in Gajapathy Naidu [1964 (4) TMI 6 - SUPREME COURT], Morvi Industries [1971 (10) TMI 5 - SUPREME COURT] and Keshav Mills Ltd. [1953 (1) TMI 5 - SUPREME COURT] 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 accounts. We are in respectful agreement with the view taken in PVP Ventures Ltd. [2012 (7) TMI 696 - MADRAS HIGH COURT] And Lemon Tree Hotels Ltd. [2015 (11) TMI 404 - DELHI HIGH COURT] Also for Assessment Year 2009-10 onwards the Assessing Officer has permitted the deduction of ESOP expenses and in view of law laid down in Radhasoami Satsang [1991 (11) TMI 2 - SUPREME COURT] the revenue cannot be permitted to take a different stand with regard to the Assessment Year in question. - Decided against revenue. Issues Involved:1. Deductibility of ESOP discounts under Section 37 of the Income Tax Act, 1961.2. Classification of the difference between market price and offer price of shares as remuneration.3. Contingent nature of ESOP-related expenditure and its eligibility for deduction.Detailed Analysis:Issue 1: Deductibility of ESOP Discounts under Section 37 of the Income Tax Act, 1961The primary issue was whether the discount on the issue of Employee Stock Option Plans (ESOP) is an allowable deduction in computing business income under Section 37 of the Income Tax Act, 1961. The tribunal held that the difference between the market price and the face value at which shares are allotted is part of remuneration to employees for their continuity of service and is allowable as an expenditure under Section 37. The High Court agreed, noting that Section 37(1) permits deduction for expenditure laid out or expended and does not require a cash payout. The court emphasized that the issuance of shares at a discount, where the assessee absorbs the difference between the issue price and the market value, constitutes an incurred expenditure for the purposes of Section 37(1). This expenditure is aimed at securing consistent employee services, not wasting capital, thus qualifying as a deductible business expense.Issue 2: Classification of the Difference Between Market Price and Offer Price of Shares as RemunerationThe tribunal concluded that the difference between the market price of shares at the time of granting the option and the offer price amounts to a discount, which should be treated as remuneration to employees. The High Court upheld this view, explaining that the ESOPs vest over a period (in this case, four years), and employees gain a definite right to a portion of the shares each year. This vesting creates a business liability that is permissible as a deduction, even if the liability is quantified and discharged in the future. The court cited Supreme Court decisions in Bharat Earth Movers and Rotork Controls India, affirming that such discounts are not contingent liabilities but ascertained ones.Issue 3: Contingent Nature of ESOP-Related Expenditure and Its Eligibility for DeductionThe revenue argued that the ESOP expenses were neither incurred nor accrued during the relevant assessment year and were contingent, not crystallized liabilities. The High Court rejected this argument, stating that the ESOP expenditure is an ascertained liability, not contingent. The court noted that the deduction of ESOP discounts over the vesting period aligns with accounting practices under SEBI guidelines. The court also dismissed the revenue's reliance on the Infosys Technologies case, clarifying that it dealt with non-deduction of tax at source and not the allowability of expenses in the employer's hands. The court concluded that the assessee's practice of debiting ESOP discounts as expenditure in its books was appropriate under the mercantile system of accounting.Conclusion:The High Court dismissed the revenue's appeal, affirming the tribunal's decision that the ESOP-related expenses are allowable deductions under Section 37 of the Income Tax Act. The court emphasized that the ESOP discounts represent a definite business liability and are not contingent, thereby supporting the assessee's claim for deduction. The court also highlighted the consistency in the assessee's accounting practices and the acceptance of similar deductions in subsequent assessment years.