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2015 (11) TMI 867
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....3 for assessment year 2007-08 as the lead case. The effective ground of appeal raised in all these appeals pertains to disallowance of ESOP (Employee Stock Option) expenses claimed by the assessee company as revenue expenditure. 3. The Brief facts of the case are that the assessee company filed its return of income for the assessment year 2007-08 declaring loss of Rs. 24,51,11,643/- and the assessment was completed by the assessing officer(hereinafter called "the AO") vide orders dated 24th November 2009 passed u/s 143(3) of Income Tax Act,1961(Hereinafter called "the Act") accepting the loss claimed by the assessee company. The assessment was re-opened u/s 147 of the Act read with section 148 of the Act on the ground that the assessee company has claimed an amount of Rs. 81,93,150/- as ESOP expenses which is actually the difference between the fair market value of the shares allotted to the employees and the price at which shares are allotted to employees and the same were claimed as revenue expenses by the assessee company. In the view of the AO, the said expenses are notional expenditure which can not be allowed as deduction under the Act as the same is not revenue expenditur....
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....Earth Movers v. CIT (2000) 245 ITR 428(SC) where by it has been held by Apex Court that provision made for leave encashment is an allowable expenditure. g) The assessee company also relied upon the decision of SSI Ltd. V. DCIT (2004) 85 TTJ 1049(Chen. Trib.) where the Chennai Tribunal allowed the claim of the tax payer under the similar facts. h) The assessee company submitted that Chandigarh Bench of Tribunal has allowed deduction with respect to issue of sweat equity shares at predetermined price for consideration other than cash. i) The liability for ESOP has accrued and arisen during the assessment year and it has been debited to Profit and Loss A/c and is an allowable expenditure. j) These ESOP expenses are taxable as perquisite in the hands of the employees u/s 17(2)(vi) of the Act read with section 115WB(1)(d) of the Act and hence the same are allowable expenses in the hands of the assesse company. k) The ESOP expenses are not capital as there is no increase in the capital base of the company which is Rs. 3,46,75,325 as at 31-03-2006 and also as at 31-03-2007. 6. The AO did not accepted the contentions of the assessee company and held that these are notiona....
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.... leave encashment and relied upon Hon'ble Supreme Court decision in Bharat Earth Movers v. CIT (2000) 245 ITR 428(SC) whereby Apex Court has held that provision made for leave encashment is an allowable expenditure. g) The assessee company also relied upon the decision of SSI Ltd. V. DCIT (2004) 85 TTJ 1049(Chen. Trib.) where the Chennai Tribunal allowed the claim of the tax payer under the similar facts. h) The assessee company submitted that Chandigarh Bench of Tribunal has allowed deduction with respect to issue of sweat equity shares at predetermined price for consideration other than cash. i) The liability for ESOP has accrued and arisen during the assessment year and it has been debited to Profit and Loss A/c and is an allowable expenditure. j) These ESOP expenses are taxable as perquisite in the hands of the employees u/s 17(2)(vi) of the Act read with section 115WB(1)(d) of the Act and hence the same are allowable expenses in the hands of the assesse company. k) The ESOP expenses are not capital as there is no increase in the capital base of the company which is Rs. 3,46,75,325 as at 31-03-2006 and also as at 31-03-2007. l) The assessee company also re....
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.... crystallized upon the grant of options to the employees and thereafter the option is with employees to exercise such grant and on which the assessee company had no control. e) The liability of the assessee company under ESOP can be measured with reasonable certainty under the mercantile method of accounting as per guidelines issued by the SEBI and is definite liability and an allowable expenditure. f) The liability under the an ESOP is easily comparable with provision made for leave encashment and relied upon Hon'ble Supreme Court decision in Bharat Earth Movers v. CIT (2000) 245 ITR 428(SC) had held that provision made for leave encashment is an allowable expenditure. g) The assessee company also relied upon the decision of SSI Ltd. V. DCIT (2004) 85 TTJ 1049(Chen. Trib.) where the Chennai Tribunal allowed the claim of the tax payer under the similar facts. h) The assessee company submitted that Chandigarh Bench of Tribunal has allowed deduction with respect to issue sweat equity shares at predetermined price for consideration other than cash. i) The liability for ESOP has accrued and arisen during the assessment year and it has been debited to Profit and Loss ....
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....achin 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 nothing but employees cost incurred by the assessee for which deductio....
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....t 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 S.S.I. Ltd. (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 Ltd. [2012] 211 Taxman 554/23 taxmann.com 286. The learned AR argued that PVP Ventures Ltd. (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 Asstt. CIT v. Spray Engineering Devices Ltd. [2012] 23 taxmann.com 267/53 SOT 70 (URO). 9.2.3 Let us examine the facts of the case of Ranbaxy Laboratories Ltd. (supra), which has been strongly relied by the learned Departmental Representative. It deals with a situation in which the assessee granted stock option to its employees. The shares were to ....
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....on 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 and as a quid pro quo it undertakes ....
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.... 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 for their....
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....s or profession'." When we read the 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 fulfilment 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 d....
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....der by contending that the entitlement to ESOP depends upon the fulfilment of several conditions laid down under the scheme. It is only when all such 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 ....
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.... In holding so, the Hon'ble Apex Court observed that : "the law is settled : if a business liability has definitely arisen in the accounting year, the deduction should be allowed 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" sha....
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....y of the discount on incurring of liability on the rendition of service by the employees. The factum of the employees becoming entitled to exercise options at the end of the vesting period and it is only then that the actual 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' becaus....
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....er ESOP as a benefit provided by the employer to its employees during the course of service. If the legislature considers such discounted premium to the employees as a fringe benefit or 'any consideration for employment', it is not open to argue contrary. Once it is held as a consideration 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 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....
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....lement is earned. It means that 25 options vest with the employee at the end of each year on his rendering service for the respective year. If during the interregnum, he leaves the service, say after one year, he will still remain entitled to exercise option for 25 shares at the discounted premium at the time of exercise of option. In 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 directl....
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....duction of discount during the years of vesting of options. In that case the vesting period was three years and the assessment order was passed u/s 143(3), inter alia, allowing deduction of Rs. 66.82 lakh under the head "Staff welfare expenses" on account of amortization of discounted value of option over a period of three years. The CIT revised 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....
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....unt under ESOP. 11.1.2 We have noticed above that the company incurs a definite liability during the vesting period, but its proper quantification is not possible at that stage as the actual amount of employees cost to the company, can be finally determined at the time of the exercise of option or when the options remain unvested or lapse at the end of the exercise period. It is at this later stage that 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....
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....shall be taxable in the previous year in which such option is exercised by such individual. Such clause (iiia) was subsequently deleted with effect from 1st April, 2001. After certain changes to the relevant provisions in this regard, the position which now stands is that the discount on ESOP is taxable as perquisite u/s 17(2)(vi) for : 'the value of any specified security or sweat equity shares allotted or transferred, directly 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 o....
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.... in correctly visualizing the likely market price of shares at the time of exercise of option by the employees, which, in turn, would reflect the correct employees cost. Since the definite liability is incurred during the vesting period, it has to be quantified on some logical basis. It is this market price at the time of the grant of options which is considered for working out the amount of discount during the vesting period. But, since actual amount of employees cost can be precisely determined only 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 Market value per share 110 Option price 10 Employees compensation or Discount ....
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....oportionate discount on unvesting/lapsing of options at the appropriate time on the basis of the SEBI Guidelines. If this contention is correct, it would mean that the first two stages have been rightly given effect to. But the appellant assessee does not appear to have made any downward adjustment to the amount of discount at the time of exercise of option by the employees 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 fo....
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....either in a specific or a general manner. These can be specific by making a clear cut provision in respect of deductibility of a particular item of expense or taxation of a particular item of income. General provisions are those which set out the overall principles to govern the deductibility or taxability of unspecified items. For example, the definition of 'income' u/s 2(24) has been given by 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 fulfil the requisite conditions, gain deductibility under section 37(1). To put it in simple w....
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....ry is made about a hypothetical income, which does not materialise.' 11.2.7 It follows that accounting principles have absolutely no role to play in the matter of determination of total income under the Act. If an accounting principle is referred to by the higher judiciary, then there is an underlying presumption that such accounting principle is in conformity with and not in conflict with the taxation principle. The essence of the matter is that taxation principles 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. (supra), was also take....
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....ery reference by the Chennai Bench of the Tribunal in SSI Limited (supra) to the SEBI Guidelines is indicative of the fact that it dealt with a year during which the options were vesting with the employees and the company claimed discount during the vesting period. The Hon'ble Madras High Court in the case of PVP Ventures Ltd. (supra) has upheld the view taken by the Chennai Bench in the case of S.S.I. Ltd. (supra). The granting of the binding force to the SEBI Guidelines by the Hon'ble Madras High Court should be viewed 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....
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....vant to the assessment year 2003-2004 and as such there was no question of the listing of its shares and having some market price at the time of grant of options. Ordinarily, the amount of discount on premium which is written off over the vesting period represents the market price of the shares listed on the stock exchange on the date of grant of option as reduced by the price at which option is given to the employees. However, presently there is no availability of any market price of such shares on the date of grant of option as the company came to be listed on a stock 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 claim....
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....en claimed in the instant year. Two letters granting options to Shri Murali Krishnan K.N. and Neville Bain have been randomly filed which are dated 2nd April, 2002. If the options are granted on 2nd April, 2002, then 25% of the total option shall vest in the employees at the end of the first year from this date, which date would be 1st April, 2003. As such, the amount would become deductible in the previous year relevant to assessment year 2004-2005 and not 2003-2004. The ld. AR contended that though these letters are dated 2nd April, 2002, but in fact the options were granted on 1st April, 2002. The correct date of grant and vesting needs to be verified at the AO's end. d. The ld. AR has stated that the amount of discount claimed as deduction in the earlier years in respect of unvesting/lapsing options has been reversed at the relevant time. There is no finding either in the assessment or the impugned order in this regard. This fact should also be verified by the AO to ensure that the overall expenditure booked by the company is restricted only to the extent of the exercised options." The Hon'ble Special Bench in the case of Biocon Limited(supra) has held that ....