2025 (7) TMI 893 - AT - Income Tax

Revision u/s 263 - deduction of the ESOP expenses - as per CIT order passed u/s.143(3) r.w.s 144B was erroneous and prejudicial to the interests of revenue - HELD THAT - The issue as regards the deductibility of ESOP expenses under section 37 of the Act is no longer res integra and has been decided in favour of the taxpayer as decided in Biocon Ltd. 2020 (11) TMI 779 - KARNATAKA HIGH COURT Also decided in Learning Mate Solutions Private Limited 2023 (7) TMI 1583 - ITAT MUMBAI reasoning given by the Ld. PCIT for forming the view that the deduction for ESOP Expenses was not allowable under Section 37(1) of the Act stands rejected by the Special Bench of the Tribunal innin the case of Biocon Ltd. 2013 (8) TMI 629 - ITAT BANGALORE Further in the case of DCIT Vs. Kotak Mahindra Bank Ltd. 2018 (1) TMI 320 - ITAT MUMBAI relied upon by the Ld. Authorised Representative for the Appellant during the course of hearing the Mumbai Bench of the Tribunal had made following observations while dismissing the appeal preferred by the Revenue against the order passed by CIT(A) deleting the addition of ESOP expenses. Thus the impugned order passed by the learned PCIT under section 263 of the Act is quashed and assessment order passed under section 143(3) read with section 144B of the Act is reinstated. Assessee appeal allowed.

Summary

The core legal questions considered in this appeal pertain primarily to the validity and correctness of the revisionary order passed under section 263 of the Income Tax Act, 1961 ("the Act") by the Principal Commissioner of Income Tax ("PCIT"), specifically:

1. Whether the order passed under section 263 of the Act was valid and within jurisdiction, or whether it amounted to an impermissible change of opinion or view by the PCIT.

2. Whether the assessment order passed under section 143(3) read with section 144B of the Act was erroneous and prejudicial to the interests of revenue, particularly on the issue of allowing deduction for Employee Stock Option Plan ("ESOP") expenses claimed under section 37(1) of the Act.

3. Whether the ESOP expenses debited by the assessee to the profit and loss account are allowable as deduction under section 37(1) of the Act or are to be treated as capital expenditure or notional expenditure disallowable for tax purposes.

4. Whether the AO conducted proper enquiry and verification regarding the ESOP expenses before passing the assessment order, and whether the PCIT was justified in setting aside the assessment order on the ground of lack of enquiry.

Issue-wise Detailed Analysis

1. Validity of Revisionary Order under Section 263 of the Act

Legal Framework and Precedents: Section 263 empowers the PCIT to revise an assessment order if it is found to be erroneous in so far as it is prejudicial to the interests of the revenue. However, it is well settled that this power cannot be exercised merely to substitute the opinion of the PCIT for that of the AO, especially where the AO has taken a plausible view after due enquiry. The Supreme Court has held that revisionary jurisdiction under section 263 is not to be exercised to correct every error or to reappreciate evidence but only when the order is prima facie erroneous and prejudicial to revenue.

Court's Interpretation and Reasoning: The PCIT in the impugned order held that the assessment order was erroneous and prejudicial because the AO did not make any enquiry into the ESOP expenses claimed as deduction. The PCIT further held that the ESOP expenses are not real expenditure but merely notional and thus not allowable under section 37(1). The PCIT relied on the fact that no mention of enquiry on ESOP expenses was made in the assessment order and that the ESOP expenses are capital in nature related to issue of shares.

Key Evidence and Findings: The assessee submitted that the AO had issued notices under sections 142(1) and 143(2), called for documents including cash flow statement and audited financials, which disclosed ESOP expenses. The AO accepted the return and allowed the deduction after considering these documents. The assessee also relied on binding judicial precedents, particularly the decision of the Karnataka High Court in CIT vs. Biocon Ltd., which upheld the allowance of ESOP expenses under section 37(1).

Application of Law to Facts: The Tribunal examined the factual matrix and found that the AO had indeed made relevant enquiries and considered the ESOP expenses before passing the assessment order. The Tribunal also noted that the PCIT's reliance on the absence of explicit mention of enquiry in the assessment order was insufficient to conclude lack of enquiry, especially when the record showed otherwise.

Treatment of Competing Arguments: The PCIT's view that the order was erroneous was contrasted with the Tribunal's finding that the AO's order represented a plausible and valid view supported by proper enquiry. The Tribunal also observed that the PCIT's exercise of revisionary jurisdiction was possibly to keep the issue alive despite the binding precedents favoring the assessee.

Conclusions: The Tribunal concluded that the revisionary order under section 263 was not valid as the AO's order was not erroneous or prejudicial to revenue, and the PCIT had effectively changed the AO's view without sufficient basis.

2. Allowability of ESOP Expenses under Section 37(1) of the Act

Legal Framework and Precedents: Section 37(1) allows deduction of any expenditure (other than those specified under sections 30 to 36 or capital or personal expenses) laid out wholly and exclusively for business purposes. The question is whether ESOP expenses, which represent the difference between market price and offer price of shares issued to employees, constitute allowable business expenditure or capital expenditure.

The Hon'ble Karnataka High Court in CIT vs. Biocon Ltd. upheld the claim of ESOP expenses as allowable deduction under section 37(1), as endorsed by the Special Bench of the Tribunal. The Supreme Court has recognized that "expenditure" includes not only amounts paid out but also amounts "incurred" or "losses" in certain contexts.

Court's Interpretation and Reasoning: The PCIT considered ESOP expenses as notional and capital in nature, not involving actual payment or liability, hence not deductible. The PCIT noted that the company receives share issue proceeds at a strike price higher than book value, implying no real loss or liability.

The Tribunal, however, relying on the Special Bench decision in Biocon Ltd. and subsequent decisions, held that ESOP expenses are incurred obligations to issue shares at discounted prices to employees in return for their services, thereby constituting business expenditure allowable under section 37(1). The Tribunal emphasized that "expenditure" includes amounts "incurred" and not necessarily paid out in cash, and that the notional nature of ESOP expenses does not exclude their allowability.

Key Evidence and Findings: The assessee's financial statements disclosed ESOP expenses as amortized over the ESOP tenure. The AO accepted this treatment in assessment. The Department's appeal against Biocon Ltd. decision was admitted by the Supreme Court but that did not affect the binding nature of the decision on the Tribunal and High Courts at the time of assessment.

Application of Law to Facts: The Tribunal applied the settled legal principle that ESOP expenses are allowable under section 37(1) as business expenditure incurred in the course of employment benefits. The Tribunal rejected the PCIT's view that ESOP expenses are capital or notional losses not deductible.

Treatment of Competing Arguments: The Tribunal considered the Department's reliance on Supreme Court precedents emphasizing "expenditure" as amounts paid out but distinguished those by referring to the definition of "paid" under section 43(2) and the Expenditure Act, 1957, which includes "incurred" liabilities. The Tribunal also noted that the Department's reliance on the admitted Special Leave Petition against Biocon Ltd. did not diminish the binding effect of the decision.

Conclusions: The Tribunal held that ESOP expenses are allowable deductions under section 37(1) and that the PCIT's contrary conclusion was not tenable.

3. Whether Proper Enquiry was Conducted by AO on ESOP Expenses

Legal Framework and Precedents: For the PCIT to invoke section 263 on the ground of erroneous and prejudicial order due to lack of enquiry, it must be shown that AO did not make any enquiry or verification on the issue. The Courts have held that mere absence of detailed discussion in the assessment order does not necessarily mean no enquiry was made.

Court's Interpretation and Reasoning: The PCIT contended that no enquiry was made on ESOP expenses as no mention was made in the assessment order. The assessee demonstrated that notices under sections 142(1) and 143(2) were issued, documents including cash flow statement and financials were called for and submitted, which disclosed ESOP expenses. The AO accepted the return after scrutiny.

The Tribunal found that the AO had indeed made relevant enquiries and considered the ESOP expenses, and that the PCIT's reliance on the absence of explicit mention of enquiry in the assessment order was insufficient to hold that no enquiry was conducted.

Key Evidence and Findings: The record showed notices issued, submissions made by the assessee, and acceptance of ESOP expenses in the assessment order. The Tribunal also referred to judicial precedents holding that lack of enquiry is a valid ground for revision under section 263 but in this case, enquiry was made.

Application of Law to Facts: The Tribunal applied the principle that where enquiry and verification have been made, the revisionary power under section 263 cannot be invoked merely on the basis of a difference of opinion.

Treatment of Competing Arguments: The PCIT's contention was rejected as the Tribunal found no merit in the claim of lack of enquiry. The Tribunal also noted that the PCIT's invocation of Explanation 2 to section 263(1) without confronting the assessee on the issue was improper.

Conclusions: The Tribunal concluded that the AO conducted proper enquiry and the PCIT's order setting aside the assessment on this ground was unsustainable.

Significant Holdings

"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 learned PCIT would not be justified in exercising powers of revision under Section 263 of the Act."

"The expenditure under the head 'ESOP' by its method of calculation, is a notional expenditure, which is calculated as difference between the market price and predetermined offer price of share on the date of vesting of shares to the employees. However, the Special Bench of the Tribunal in the case of Biocon Ltd. has held that discount under ESOP is an expenditure incurred by the company and allowable under section 37(1) of the Act."

"Section 37(1) allows deduction of any expenditure laid out or expended wholly and exclusively for the purposes of business or profession, and the term 'expenditure' includes not only amounts paid out but also amounts incurred as liabilities. The notional nature of ESOP expenses does not exclude their allowability."

"The AO had conducted proper enquiry and verification regarding the ESOP expenses before passing the assessment order. The absence of explicit mention of such enquiry in the assessment order is not sufficient to hold that no enquiry was made."

"The revisionary jurisdiction under section 263 cannot be exercised merely to change the opinion of the AO or to keep the issue alive when the AO has taken a plausible view supported by relevant enquiries and binding judicial precedents."

"The impugned order under section 263 is set aside and the assessment order passed under section 143(3) read with section 144B of the Act is reinstated."