Tax appellate body allows ESOP expenditure as revenue deduction u/s 37(1), dismisses Revenue's disallowance appeal

The ITAT Mumbai upheld the order of the CIT(A) allowing deduction of expenditure incurred under the ESOP scheme as revenue expenditure u/s 37(1). It noted that in the assessee's own cases for earlier assessment years, similar ESOP expenditure had been consistently held to be revenue in nature, and no change in facts or law had been demonstrated by the Revenue. Relying on this consistent view and tribunal precedent on ESOP-related discounts, the ITAT found the AO's disallowance unjustified and dismissed the Revenue's appeal in entirety.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether expenditure claimed in respect of an Employee Stock Option Plan (ESOP) is capital or revenue in nature and consequently allowable as a deduction under section 37(1) of the Income-tax Act, 1961.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Characterisation of ESOP expenditure as capital or revenue and its deductibility under section 37(1)

Legal framework (as discussed)

2.1 The dispute centres on section 37(1) of the Income-tax Act, 1961, dealing with allowability of business expenditure not specifically covered elsewhere, and on the question whether ESOP-related expenditure constitutes capital expenditure or revenue expenditure.

2.2 The Tribunal considered earlier decisions of Co-ordinate Benches in the assessee's own cases for several preceding assessment years, and the Special Bench decision in Biocon Limited, wherein ESOP discount was treated as a revenue expenditure allowable under section 37(1).

Interpretation and reasoning

2.3 The Assessing Officer treated the ESOP expenditure as capital in nature on the ground that it related to issue of shares, involved change in capital structure, and did not represent a real, out-of-pocket business expense, but an opportunity cost connected with capital restructuring.

2.4 The first appellate authority, after examining the factual position and judicial precedents, held that the issue of allowability of ESOP expenditure was no longer res integra for the assessee, as Co-ordinate Benches of the Tribunal in multiple earlier assessment years had consistently held that ESOP-related expenditure is revenue in nature and allowable under section 37(1) on identical facts.

2.5 The Tribunal verified the orders of the Co-ordinate Benches in the assessee's own cases for prior years and found that the ESOP expenditure had repeatedly been allowed as a revenue deduction under section 37(1), and that there was no change either in the material facts or in the applicable legal position for the year under consideration.

2.6 The Tribunal also took note of the reliance placed on the Special Bench decision in Biocon Limited, which had upheld the allowability of ESOP discount as revenue expenditure. The mere pendency of a Special Leave Petition against the related High Court decision before the Supreme Court was held not to displace the binding nature of the Special Bench decision and the consistent Co-ordinate Bench view, in the absence of any contrary binding judgment.

2.7 On confrontation, the departmental representative could not point out any distinguishing feature in facts or law for the assessment year in question, nor any contrary decision overruling the earlier Co-ordinate Bench or Special Bench views.

Conclusions

2.8 The Tribunal held that the ESOP-related expenditure in question is revenue in nature and allowable as a deduction under section 37(1).

2.9 The disallowance made by the Assessing Officer, and sought to be restored by the revenue on grounds that the expenditure is capital in nature or not a real business outlay, was found to be unjustified and was not interfered with, the order of the first appellate authority allowing the deduction being upheld.

2.10 All grounds raised by the revenue on this issue were dismissed, and the appeal was rejected in entirety.

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