2023 (7) TMI 1583 - AT - Income Tax

ITAT allows ESOP expense deductions under section 37(1), sets aside revision order following Biocon precedent

ITAT Mumbai allowed the assessee's appeal against PCIT's revision order u/s 263 regarding ESOP expense deductions. The tribunal held that AO's order ... Revision u/s 263 - deduction for amortized Employee Stock Option Plan (ESOP) expenses - PCIT formed a view that the aforesaid expenses were not allowable as deduction u/s 37(1) - HELD THAT:- Special Bench of the Tribunal in the case of Biocon Ltd. [2013 (8) TMI 629 - ITAT BANGALORE] while holding that the deduction under Section 37(1) of the Act is allowable for ESOP expenses. We hold that the order passed by the AO cannot be regarded as erroneous or prejudicial to the interest of the Revenue. Further, in any case, it cannot be denied that the view taken by the AO was a plausible view and therefore, PCIT would not be justified in exercising powers of revision u/s 263 of the Act. We also note that the PCIT was cognizant of the fact that the decision in the case of Biocon Limited [2013 (8) TMI 629 - ITAT BANGALORE] has been confirmed by the Hon’ble High Court of Karnataka [2020 (11) TMI 779 - KARNATAKA HIGH COURT] and the issue is now pending the Hon’ble Supreme Court. Despite that, the Ld. PCIT had, possibly to keep the issue alive, exercised the powers of revision under Section 263 of the Act by invoking provision of Explanation 2 to Section 263(1) of the Act to contend that the claim for ESOP expenses has been allowed without proper enquiry/verification by the Assessing Officer. In this regard, we note that, firstly, all the relevant facts were already on record and therefore, the question of further enquiry/verification did not arise. Secondly, on perusal of contents of the notice under Section 263(1) of the Act, as reproduced in paragraph 2 of the order impugned, we find that the Ld. PCIT had issued notice under Section 263(1) of the Act on forming a view that proper inquiry/verification as warranted in the facts and circumstances of the case - which falls within the ambit of Explanation 2(a) to Section 263(1) of the Act, was not conducted. Therefore, in our view, the Assessment Order cannot be set aside on the ground that the same has been passed allowing deduction under Section 37(1) of the Act without inquiring into the claim - which falls within the ambit of Explanation 2(b) to Section 263(1) of the Act without confronting the Appellant. For this reason also the order passed by the Ld. PCIT cannot be sustained. Assessee appeal allowed. The core legal questions considered by the Tribunal in this appeal concern the validity and correctness of the revision order passed under Section 263 of the Income Tax Act, 1961, which set aside the original assessment order. The primary issues include:1. Whether the Principal Commissioner of Income Tax (PCIT) was justified in invoking Section 263 of the Act to revise the assessment order on the ground that it was erroneous and prejudicial to the interest of the Revenue.2. Whether the Employee Stock Option Plan (ESOP) expenses debited by the appellant to the Profit and Loss Statement qualify as allowable business expenditure under Section 37(1) of the Income Tax Act.3. Whether the PCIT erred in disregarding binding judicial precedents, particularly the Special Bench decision on ESOP expenses, thereby violating principles of judicial discipline.4. Whether the ESOP expenses represent an actual liability or expense, or merely a short receipt of share premium, and the consequent tax treatment thereof.Issue-wise Detailed Analysis1. Legality and correctness of revision under Section 263 of the ActLegal framework and precedents: Section 263 empowers the PCIT to revise an assessment order if it is found to be erroneous and prejudicial to the interest of the Revenue. Explanation 2 to Section 263(1) clarifies that an order is erroneous if it is passed without making inquiries or verification which ought to have been made.Court's interpretation and reasoning: The PCIT set aside the assessment order on the ground that the Assessing Officer (AO) failed to conduct proper inquiry or verification regarding the allowability of ESOP expenses, rendering the order erroneous and prejudicial. The PCIT relied on the Supreme Court decision in Indian Molasses Co. (P.) Ltd. v. CIT, which held that no expenditure is incurred when shares are issued at a concessional rate, and on the Tribunal's decision in Ranbaxy Laboratories Ltd., which treated ESOP expenses as short receipt of share premium rather than allowable expenditure.Key evidence and findings: The PCIT noted that the appellant debited Rs. 73,55,180/- as ESOP expenses under Section 37(1), but contended that this was not an actual expenditure but a mere appropriation of profits to share premium account, which remains part of the company's funds.Application of law to facts: The PCIT concluded that the AO's acceptance of the ESOP expenses without proper verification was erroneous and prejudicial, thus justifying revision.Treatment of competing arguments: The appellant challenged the revision order, arguing that the ESOP expenses fulfilled the requirements of Section 37(1) and were accounted for in accordance with accepted accounting norms and judicial precedents, including a Special Bench decision on ESOP expenses.Conclusion: The Tribunal found that the PCIT's reliance on Indian Molasses and Ranbaxy was misplaced because these decisions had been considered and distinguished by the Special Bench in Biocon Ltd. (Special Bench), which held that ESOP expenses are allowable under Section 37(1). Further, the Tribunal held that the AO's order was a plausible view and thus not erroneous under Section 263.2. Allowability of ESOP expenses under Section 37(1) of the Income Tax ActLegal framework and precedents: Section 37(1) allows deduction of any expenditure (not being capital expenditure or personal expenses) laid out wholly and exclusively for business purposes. The Supreme Court in Indian Molasses defined 'expenditure' as something 'paid out or away,' implying actual outflow of money or assets.The Special Bench of the Tribunal in Biocon Ltd. examined whether the ESOP discount qualifies as an allowable expenditure. It analyzed the definition of 'expenditure' in conjunction with Section 43(2) (defining 'paid' to include 'incurred' expenditure) and the Expenditure Act, 1957 (defining 'expenditure' as money spent or liability incurred).Court's interpretation and reasoning: The Special Bench held that although no cash outflow occurs when shares are issued at a discount, the company incurs a liability to issue shares at a discounted price in exchange for employee services, which constitutes an expenditure under Section 37(1). The Bench also referred to the Supreme Court decision in CIT v. Woodward Governor India (P.) Ltd., which recognized that 'expenditure' under Section 37(1) may include 'loss' even if no actual payment is made.Key evidence and findings: The Tribunal noted that the appellant's ESOP expenses were accounted for as per accepted accounting standards and represented an equity-based incentive to employees, thus fulfilling the conditions of business expenditure.Application of law to facts: The Tribunal applied the Special Bench's reasoning to reject the PCIT's view that ESOP expenses are not allowable under Section 37(1). It emphasized that the AO's acceptance of the claim was consistent with binding judicial precedent and accounting principles.Treatment of competing arguments: The PCIT argued that ESOP expenses were merely short receipt of share premium and not actual expenditure, relying on Indian Molasses and Ranbaxy. The Tribunal distinguished these decisions on the basis that the Special Bench in Biocon had considered and overruled their applicability to ESOP expenses. The Tribunal also rejected the PCIT's contention that the AO failed to make proper inquiries, noting that all relevant facts were on record and no further verification was warranted.Conclusion: The Tribunal held that ESOP expenses are allowable business expenditure under Section 37(1), and the AO's order accepting the claim was neither erroneous nor prejudicial to the Revenue.3. Adherence to judicial discipline and binding precedentsLegal framework and precedents: The principle of judicial discipline requires lower authorities to follow binding decisions of higher courts or Special Benches unless set aside or stayed. The Special Bench decision in Biocon Ltd. was binding on the issue of ESOP expenses.Court's interpretation and reasoning: The Tribunal observed that the PCIT disregarded the binding Special Bench decision and instead relied on earlier decisions that had been considered and distinguished by the Special Bench. The Tribunal also noted that the Special Bench decision had been upheld by the Karnataka High Court and was pending before the Supreme Court.Key evidence and findings: The Tribunal referred to the decision in DCIT v. Kotak Mahindra Bank Ltd., where the Mumbai Bench of the Tribunal upheld the Special Bench's view and criticized the AO for not following it despite the absence of any stay or reversal by a higher court.Application of law to facts: The Tribunal concluded that the PCIT's revision order violated the principle of judicial discipline by ignoring binding precedent without any valid reason.Treatment of competing arguments: The PCIT contended that the issue was sub judice before the Supreme Court and thus required further verification. The Tribunal rejected this, stating that the existence of a pending appeal does not justify ignoring binding precedent or revising an assessment order without fresh material or inquiry.Conclusion: The Tribunal held that the PCIT's order was unsustainable as it failed to respect binding judicial pronouncements and relied on a view already rejected by the Special Bench and upheld by the High Court.4. Nature of ESOP expenses: actual liability or short receipt of share premiumLegal framework and precedents: The PCIT's position was that ESOP expenses represent a short receipt of share premium, which is a capital receipt and not an allowable business expenditure.Court's interpretation and reasoning: The Tribunal, relying on the Special Bench decision, held that the obligation to issue shares at a discount creates a liability which qualifies as expenditure under Section 37(1). The Tribunal emphasized that the absence of cash outflow does not negate the existence of expenditure if a liability is incurred.Key evidence and findings: The appellant's accounting treatment and the Special Bench's analysis supported the view that ESOP expenses are an ascertained liability and a cost of employee services, not merely a shortfall in capital receipt.Application of law to facts: The Tribunal applied this reasoning to reject the PCIT's characterization of ESOP expenses as short receipt of share premium and upheld the AO's acceptance of the claim.Treatment of competing arguments: The PCIT's reliance on Indian Molasses and Ranbaxy was countered by the Special Bench's detailed analysis and the subsequent judicial endorsement of that view.Conclusion: The Tribunal concluded that ESOP expenses represent an actual business expenditure and are allowable under Section 37(1).Significant Holdings'The word 'expenditure' has not been defined in the Act. However, sec. 2(h) of the Expenditure Act, 1957 defines 'expenditure' as: 'Any sum of money or money's worth spent or disbursed or for the spending or disbursing of which a liability has been incurred by an assessee......'. When section 43(2) of the Act is read in conjunction with section 37(1), the meaning of the term 'expenditure' turns out to be the same as is there in the afore quoted part of the definition under section 2(h) of the Expenditure Act, 1957, viz., not only 'paying out' but also 'incurring'. Coming back to our context, it is seen that by undertaking to issue shares at discounted premium, the company does not pay anything to its employees but incurs obligation of issuing shares at a discounted price on a future date in lieu of their services, which is nothing but an expenditure u/s 37(1) of the Act.''The word 'expenditure' as used in section 37 made in the circumstances of a particular case, covers an amount which is really a 'loss' even though the said amount has not gone out from the pocket of the assessee.''The order passed by the Assessing Officer cannot be regarded as erroneous or prejudicial to the interest of the Revenue. Further, in any case, it cannot be denied that the view taken by the Assessing Officer was a plausible view and therefore, the Ld. PCIT would not be justified in exercising powers of revision under Section 263 of the Act.''The PCIT's order disregarding the binding Special Bench decision and relying on earlier decisions without any fresh material or inquiry is unsustainable and violates the principle of judicial discipline.''The issue of ESOP expenses is pending before the Hon'ble Supreme Court but the existence of a pending appeal does not justify ignoring binding precedent or revising an assessment order without fresh material or inquiry.'Final determinations:- The revision order under Section 263 of the Act setting aside the assessment order was quashed as the assessment order was not erroneous or prejudicial to the Revenue.- ESOP expenses debited by the appellant are allowable business expenditure under Section 37(1) of the Income Tax Act.- The Assessing Officer's acceptance of the ESOP expenses claim was a plausible and legally tenable view supported by binding judicial precedents.- The PCIT's invocation of Section 263 was improper as it ignored binding Special Bench decisions and failed to establish any lack of inquiry or verification by the AO.- The assessment order dated 28/01/2021 is reinstated and the appeal of the appellant is allowed.