TaxTMI 
TaxTMI 
2013 (8) TMI 629
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....l matrix from the assessment year 2003-2004, which is the first year under reference and for which the leading orders have been passed by the authorities below. Both the sides have also broadly chosen to make submissions with reference to the facts, findings and conclusions drawn in the orders for the assessment year 2003-2004 in which the assessee claimed deduction on account of Employees Compensation under Employees Stock Option Plan (hereinafter called 'the ESOP') for the first time. 3. Briefly stated the facts of the case are that the assessee is engaged in the manufacture of Enzymes and Pharmaceutical ingredients. It formulated the 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 Income-tax Act, 1961 (hereinafter called 'the Act') representing discount under the ESOP 2000. In the assessment completed u/s 143(3), the Assessing Officer (hereinafter also called 'the AO') disallowed the said c....
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....regard to the decision of the special bench on the question reproduced above. 5. Reverting to the question of law posted before us, the facts for the assessment year 2003-2004 are that the assessee-company floated ESOP 2000 under which it granted option of shares with face value of Rs. 10 at the same rate by claiming that the market price of such shares was Rs. 919, thereby claiming the total discount per option at Rs. 909. During the previous year relevant to the assessment year 2003- 04, the appellant company granted 71,510 options to its employees. The difference between the alleged market price and the exercise price, at Rs. 909 per option totaling Rs. 6.52 crore was claimed as compensation to the employees to be spread over the vesting period of four years. A deduction of Rs. 3.38 crore was claimed for the assessment year 2003-2004 on the strength of the SEBI Guidelines. It was argued that the claim for deduction was in conformity with the accounting treatment prescribed as per the Schedule I of the Guidelines. The assessee claimed that the employee stock option compensation expense of Rs. 3.38 crore was deductible u/s 37(1) of the Act as all the requisite conditions were s....
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....a for the appellant- assessee; Shri Rohit Jain for the Intervener, M/s. Bharti Airtel ; Shri Sachin Kumar B.P. for the Intervener, M/s. Advinus Therapeatics Limited ; and Shri K.R.Pradeep for the Intervener, M/s. NDTV Media Limited, (all the four counsel are hereinafter collectively referred to as 'the ld. AR'). We have also heard Shri S.K.Ambastha, the ld. CIT representing the Revenue. The moot question is as to whether the Discounted premium on ESOP also called as the Discount on issue of ESOP or the Employee stock option compensation expense or the Employees compensation expense or simply the Discount etc., is an allowable deduction in the computation the income under the head "Profits and gains of business or profession"? This larger question can be answered in the following three steps, viz., I. Whether any deduction of such discount is allowable ? II. If yes, then when and how much? III. Subsequent adjustment to discount 8. We will take up these three steps one by one for consideration and decision. I. WHETHER ANY DEDUCTION OF SUCH DISCOUNT IS ALLOWABLE ? 9.1. The crux of the arguments put forth by the ld. AR is that discount under ESOP is ....
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.... learned AR submitted that it is not a case of any short receipt of share premium but that of compensation given to employees. He supported the admissibility of deduction of the amount of discount on the strength of the order passed by the Chennai bench of the tribunal in the case of SSI Limited (supra) granting deduction of such discount by treating it as an employee cost. He submitted that the above view taken by the Chennai Bench has been approved by the Hon'ble Madras High Court in CIT v. PVP Ventures Limited vide its judgment dated 19.06.2012. The learned AR argued that PVP Ventures (supra) is a solitary judgment rendered by any High Court on the issue and hence the same needs to be followed in preference to any contrary Tribunal order. It was also pointed out that the Chennai bench's view has been subsequently followed by the Chandigarh Bench of the Tribunal in ACIT v. Spray Engineering Devices Limited ITA No.701/Chd/2009 vide its order dated 22.06.2012. 9.2.3. Let us examine the facts of the case of Ranbaxy Laboratories Limited (supra), which has been strongly relied by the learned Departmental Representative. It deals with a situation in which the assessee granted stock ....
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....es at the time of the grant of option and the offer price. In order to be eligible for acquiring the shares under the ESOP, the concerned employees are obliged to render services to the company during the vesting period as given in the scheme. On the completion of the vesting period in the service of the company, such options vest with the employees. The options are then exercised by the employees by making application to the employer for the issue of shares against the options vested in them. The gap between the completion of vesting period and the time for exercising the options is usually negligible. The company, on the exercise of option by the employees, allots shares to them who can then freely sell such shares in the open market subject to the terms of the ESOP. Thus it can be seen that it is during the vesting period that the options granted to the employees vest with them. This period commences with the grant of option and terminates when the options so granted vest in the employees after serving the company for the agreed period. By granting the options, the company gets a sort of assurance from its employee for rendering uninterrupted services during the vesting period a....
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....er words, such discounted premium on shares is a substitute to giving direct incentive in cash for availing the services of the employees. There is no difference in two situations viz., one, when the company issues shares to public at market price and a part of the premium is given to the employees in lieu of their services and two, when the shares are directly issued to employees at a reduced rate. In both the situations, the employees stand compensated for their effort. If under the first situation, the company, say, on receipt of premium amounting to Rs. 100 from issue of shares to public, gives Rs. 60 as incentive to its employees, such incentive of Rs. 60 would be remuneration to employees and hence deductible. In the same way, if the company, instead, issues shares to its employees at a premium of Rs. 40, the discounted premium of Rs. 60, being the difference between Rs. 100 and Rs. 40, is again nothing but a different mode of awarding remuneration to employees for their continued services. In both the cases, the object is to compensate employees to the tune of Rs. 60. It follows that the discount on premium under ESOP is simply one of the modes of compensating the employees ....
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....e definition of the word "paid" u/s 43(2) in juxtaposition to section 37(1), the position which emerges is that it is not only paying of expenditure but also incurring of the expenditure which entails deduction u/s 37(1) subject to the fulfillment of other conditions. At this juncture, it is imperative to note that 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 aforequoted 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. ....
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.... conditions are fulfilled and the employees render services during the vesting period that the question of any ascertained liability can arise. He submitted that during the entire vesting period, it is only a contingent liability and no deduction is admissible under the provisions of the Act for a contingent liability. The options so granted may lapse during the vesting period itself by reason of termination of employment or some of the employees may not choose to exercise the option even after rendering the services during the vesting period. It was, therefore, argued that the discount is nothing but a contingent liability during the vesting period not calling for any deduction. In the opposition, the learned AR submitted that the amount of discount claimed by the assessee as deduction is not a contingent liability but an ascertained liability. He stated that in the ESOP 2000, there is a vesting period of four years, which means that the options to the extent of 25% of the total grant would vest with the eligible employees at the end of first year after rendering unhindered service for one year and it would go on till the completion of four years. 9.3.2. It is a trite law and t....
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....owed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain." From the above enunciation of law by the Hon'ble Supreme Court, it is manifest that a definite business liability arising in an accounting year qualifies for deduction even though the liability may have to be quantified and discharged at a future date. We consider it our earnest duty to mention that the legislature has inserted clause (f) to section 43B by providing that "any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee" shall be allowed as deduction in computing the income of the previous year in which such sum is actually paid. With this legislative amendment, the application of the ratio decidendi in....
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....ual amount of discount would be determined, is akin to the quantification of the precise liability taking place at a future date, thereby not disturbing the otherwise liability which stood incurred at the end of the each year on availing the services. 9.3.6. As regards the contention of the ld. DR about the contingent liability arising on account of the options lapsing during the vesting period or the employees not choosing to exercise the option, we find that normally it is provided in the schemes of ESOP that the vested options that lapse due to non-exercise and/or unvested options that get cancelled due to resignation of the employees or otherwise, would be available for grant at a future date or would be available for being re-granted at a future date. If we consider it at micro level qua each individual employee, it may sound contingent, but if view it at macro level qua the group of employees as a whole, it loses the tag of 'contingent' because such lapsing options are up for grabs to the other eligible employees. In any case, if some of the options remain unvested or are not exercised, the discount hitherto claimed as deduction is required to be reversed and offered for t....
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....onsideration for employment, the natural corollary which follows is that such discount i) is an expenditure; ii) such expenditure is on account of an ascertained (not contingent) liability ; and iii) it cannot be treated as a short capital receipt. In view of the foregoing discussion, we are of the considered opinion that discount on shares under the ESOP is an allowable deduction. II. IF YES, THEN WHEN AND HOW MUCH? 10.1. Having seen that the discount under ESOP is a deductible expenditure u/s 37(1), the next question is that 'when' and for 'how much' amount should the deduction be granted ? 10.2. The assessee is a limited company and hence h it is obliged to maintain its accounts on mercantile basis. Under such system of accounting, an item of income becomes taxable when a right to receive it is finally acquired notwithstanding the fact that when such income is actually received. Even if such income is actually received in a later year, its taxability would not be evaded for the year in which right to receive was finally acquired. In the same manner, an expense becomes deductible when liability to pay arises irrespective of its actual discharge. The incurring of liabilit....
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.... that case, the benefit which would have accrued to him at the end of the second, third and fourth years would stand forfeited. Thus it becomes abundantly clear that an employee becomes entitled to the shares at a discounted premium over the vesting period depending upon the length of service provided by him to the company. In all such schemes, it is at the end of the vesting period that option is exercisable albeit the proportionate right to option is acquired by rendering service at the end of each year. 10.4. Similar is the position from the stand point of the company. An obligation falls upon the company to allot shares at the time of exercise of option depending upon the length of service rendered by the employee during the vesting period. The incurring of liability towards the discounted premium, being compensation to employee, is directly linked with the span of service put in by the employee. In the above illustration, when 25 out of 100 shares vest in the employee after rendering one year's service, the company also incurs equal obligation at the end of the first year for which it becomes entitled to rightfully claim deduction u/s 37(1) of the Act. Similarly at the end ....
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.... such order by directing the A.O. to disallow ESOP expenditure of Rs. 66.82 lakh. When the matter came up before the Tribunal, it was held that the expenditure in that behalf was an ascertained liability and not contingent upon happening of certain events. It was further noticed that the assessee claimed deduction of such discount on ESOP by following the SEBI Guidelines. As the expenditure itself was an ascertained liability, the Tribunal held that the same to be deductible. 10.7. Before proceeding further it would be befitting to take stock of the nutshell of the SEBI Guidelines in this regard. These Guidelines provide for granting of deduction on account of discount on issue of options during the vesting period. It has been so explained with the help of an example in Schedule I to the Guidelines. For the sake of simplicity, we are taking an instance under which an option of share with face value of Rs. 10 is given under ESOP to employees at the option price of Rs. 10 as against the market price of such shares at Rs. 110 on that date. Further suppose that the vesting period is four years with equal vesting @ 25% at the end of each year. Total discount comes to Rs. 100 (Rs. 110....
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....hat the provisional amount of discount on ESOP, initially quantified on the basis of market price at the time of grant of options, needs to be suitably adjusted with the actual amount of discount. 11.1.3. As regards the adjustment of discount when the options remain unvested or lapse at the end of the exercise period, it is but natural that there is no employee cost to that extent and hence there can be no deduction of discount qua such part of unvested or lapsing options. But, as the amount was claimed as deduction by the company during the period starting with the date of grant till the happening of this event, such discount needs to be reversed and taken as income. It is so because logically when the options have not eventually vested in the employees, to that extent, the company has incurred no employee cost. And if there is no cost to the company, the tentative amount of deduction earlier claimed on the basis of the market price at the time of grant of option ceases to be admissible and hence needs to be reversed. The ld. AR stated that the discount in respect of the unvested/lapsing options has been reversed on the happening of such events and the overall employee cost has....
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....y or indirectly, by the employer, or former employer, free of cost or at concessional rate to the assessee'. Clause (c) of Explanation to section 17(2)(vi) provides that : ' the value of any specified security or sweat equity shares shall be the fair market value of the specified security or sweat equity shares, as the case may be, on the date on which the option is exercised by the assessee as reduced by the amount actually paid by, or recovered from, the assessee in respect of such security or shares'. Two things surface from the above provisions. First, that the perquisite arises on the 'allotment' of shares and second, the value of such perquisite is to be computed by considering the fair market value of the shares on 'the date on which the option is exercised' by the assessee as reduced by the amount actually paid. The position that such amount was or was not taxable during some of the years in the hands of the employees is not relevant in considering the occasion and the amount of benefit accruing to the employee under ESOP. Any exemption or the deductibility of an allowance or benefit to employee from taxation does not obliterate the benefit itself. It simply means that the ....
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....nly at the time of the exercise of option by the employees, the provisional amount of discount availed as deduction during the vesting period needs to be adjusted in the light of the actual discount on the basis of the market price of the shares at the time of exercise of options. It can be done by making suitable northwards or southwards adjustment at the time of exercise of option. This can be explained with the following example with the assumption of vesting period of four years and the benefit vesting at 25% each at the end of 1st to 4th years:- At the time of granting option At the time of exercise of option Situation I Situation II Situation III Market value per share 110 110 130 90 Option price 10 10 10 10 Employees compensation or Discount 100 100 120 80 11.1.7. From the above table it can be noticed that the market price of the shares at the time of grant of option was Rs. 110 against the option price of Rs. 10, which resulted in discount at Rs. 100. With the vesting period of four years with the equal vesting, the company can rightly claim deduction at the rate of Rs. 25 each at the end....
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.... with the difference in the market price of the shares at the time of grant of option and price at the time of exercise of option. The argument seems to be that the SEBI Guidelines do not provide for such downward adjustment. It has been argued by the ld. AR that where the provisions of the Act specifically provide for treatment of a particular source of income in a particular manner, then the germane provision should be followed. If, however, there is no specific provision dealing with an issue in the Act, then the accounting principles should be adhered to while determining the total income of the assessee. In this regard, he relied on the judgment in the case of Challapalli Sugars Ltd.'s [supra] , wherein the Hon'ble Supreme Court has held that the interest payable on capital borrowed by the assessee for purchase of plant and machinery before the commencement of business should be capitalized on the basis of accepted accountancy rule. Similarly in the case of U.P. State Industrial Development Corporation (supra), the Hon'ble Apex Court held in the case of an underwriter that it would be right to consider the net investment, that is the purchase price less the underwriting commis....
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.... the Act in an inclusive manner. There have been enshrined clauses (i) to (xvi) dealing with the items specifically listed. However, the provision has been couched in such a way so as to include general items of receipts having character of income, even though not specifically mentioned. Similar is the position regarding deductions. Under the head 'Profits and gains of business or profession', there are sections granting deductions in respect of specific expenses or allowances. Similarly, there is section 37(1), which grants deduction for expenses not specifically set out in other sections, if the conditions stipulated in the section, are fulfilled. All other items of expenses, which fulfill the requisite conditions, gain deductibility under section 37(1). To put it in simple words, this section is a specific provision for granting deduction in respect of the unspecified or the general categories of expenses. Discount on ESOP is a general expense and hence covered by the specific provision of section 37. The contention of the ld. AR that there is no provision in the Act dealing with the deductibility of ESOP discount, is therefore, devoid of any merit. This concludes the question o....
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....nciples are to be followed. If an accounting principle is in conformity with the mandate of taxing principle and reference is made to such accounting principle while deciding the issue, it does not mean that the accounting principle has been followed. It simply means that the taxation principle has been followed and the accounting principle, which is in line with such taxation principle, has been simply taken note of. If however, an accounting principle runs counter to the taxation principle, then there is no prize for guessing that it is only the taxation principle which shall prevail. 11.2.8. The plea now raised before us by the ld. AR, relying on the case of Challapalli Sugars Ltd.'s case, was also taken up before the Hon'ble Supreme Court in the case of Tuticorin Alkalis (supra). Dealing with the same, the Hon'ble Supreme Court held that : "The question in Challapalli Sugars Ltd.'s case [1975] 98 ITR 167 (SC) was about computation of depreciation and development rebate under the Indian Income-tax Act, 1922. In order to calculate depreciation and development rebate it was necessary to find out "the actual cost" of the plant and machinery purchased by the company. This court h....
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....ed in the context of the issue before it, which was about the deductibility of discount during one of the vesting years. In the earlier part of this order, we have held that the deductibility of discount during the vesting period, as prescribed under the SEBI Guidelines, matches with the treatment under the mercantile system of accounting. To that extent, we also hold that the SEBI guidelines are applicable in the matter of deduction of discount. Neither there was any issue before the Hon'ble Madras High Court nor it dealt with a situation in which the market price of the shares at the time of exercise of option is more or less than the market price at the time of grant of option. It is a situation which has also not been dealt with by the Guidelines. Accordingly, the aforenoted taxation principle of granting deduction for the additional discount and reversing deduction for the short amount of discount at the time of exercise of option, needs to be scrupulously followed. 11.3. We, therefore, sum up the position that the discount under ESOP is in the nature of employees cost and is hence deductible during the vesting period w.r.t. the market price of shares at the time of grant o....
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....tock exchange in a subsequent year. On a pointed query, the ld. AR furnished the details of such claim by showing that it granted 71,510 options with discount of Rs. 909 per option making total discount at Rs. 6.50 crore. He stated that the face value of shares is at Rs. 10 against which the deduction for discounted premium over the vesting period has been claimed at Rs. 909, meaning thereby that the market price of the share on the date of grant of option was taken at Rs. 919. No material worth the name has been placed on record to indicate as to how a share with face value of Rs. 10 has been valued at Rs. 919 for claiming deduction towards discount at Rs. 909 per share. This aspect of valuation of shares at Rs. 919 per share needs to be examined by the Assessing Officer. b. We have held above that the deduction of the discounted premium is to be claimed over the vesting period. The assessee claimed deduction for discount amounting to Rs. 3.38 crore for the A.Y. 2003-04. On being called upon to furnish bifurcation of such claim, the assessee filed a chart showing its detail comprising of four amounts. First amount of Rs. 1.62 crore has been shown as the first tranche of 2....