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2015 (11) TMI 867 - ITAT MUMBAI

2015 (11) TMI 867 - ITAT MUMBAI - TMI - Disallowance of ESOP (Employee Stock Option) expenses claimed by the assessee company as revenue expenditure - Held that:- In the case of Biocon Limited (2014 (12) TMI 838 - ITAT BANGALORE) has held that 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 share at the time of grant of options to the employees. The Hon'ble Special Bench has held that the amount of discount claime .....

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lowing the decision of Hon'ble Special Bench, Bangalore Tribunal in Biocon Limited(supra), we decide this issue in favour of the assessee company and against the Revenue that 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 share at the time of grant of options to the employees. The amount of discount claimed as deduction during the vesting period is required to be reversed in relation to the unvesting/lapsing opti .....

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case we have noticed that the AO has refused to grant the deduction of the discount on ESOP at the very threshold and the CIT(A) has allowed the said claim based on the decision of Hon'ble Special Bench in the case of Biocon Limited(supra). Resultantly, the verification of correctness of calculation of discount stood ousted and have become now imperative in view of our directions in light of Hon'ble Special Bench, Bangalore Tribunal orders in Biocon Ltd (supra) which are binding on us and also f .....

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For the Respondent : Shri B S Bisht ORDER Per Ramit Kochar, Accountant Member The two appeals bearing ITA Nos. 6990, 6986/Mum/2013 have been filed by the Revenue against separate orders by the Commissioner of Income Tax (Appeals)- 8, Mumbai,(Hereinafter called "the CIT(A)) for the assessment years 2007-08 and 2008-09 both dated 25th September 2013. The assessee company has filed one appeal bearing ITA No. 4979/Mum/2013 against orders dated 12th April 2013 of the Commissioner of Income Tax( .....

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d 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 ₹ 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- .....

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the Act as the same is not revenue expenditure rather the same is merely share premium foregone on allotment of shares which can not be allowed as expenditure under the Act. 4. The assessee company challenged the re-opening of assessment u/s 147 read with Section 148 of the Act by submitting that the AO does not have any tangible material, additional information or fresh evidence to re-open the assessment and rather it is a case of change of opinion of the AO based on same set of facts, materia .....

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re not capital in nature. It was submitted that it is not share premium foregone on allotment of shares rather it is a benefit given to employees and hence allowable as revenue expenditure. b) The ESOP expenses of ₹ 81,93,150/- are incurred by the assessee company in accordance with Employees Stock Option Scheme, 2006 of the company and are in accordance with the Securities Exchange Board of India guidelines and guidelines issued by Institute of Chartered Accountants of India. c) ESOP is a .....

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y 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 the assessee company relied upon Hon'ble Supreme Court decision in Bharat Earth Movers v. CIT (2000) 245 ITR 428(SC) where by it has been held by Ap .....

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ed 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 ₹ 3,46,75,325 as at 31-03-2006 and also as a .....

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ese expenses as capital expenditure not allowable as revenue expenses, more so these are merely share premium foregone and no such actual expenditure is incurred by the assessee company. Thus, AO disallowed the ESOP expenditure of ₹ 81,93,150/- and added the same to income of the assessee company in the orders dated 25th October 2012 u/s 143(3) read with section 147 of the Act. 7. Aggrieved the assesee company filed first appeal with the CIT(A) and reiterated its submissions as made before .....

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f the company and are in accordance with the Securities Exchange Board of India guidelines and guidelines issued by Institute of Chartered Accountants of India. c) ESOP is an employee compensation scheme intended to encourage a sense of belongingness and feeing of ownership in the employees to create partnership with the employees to make them stakeholder in the assessee company so that the employees are encouraged to work in the best interest of the assessee company. d) The liability of the ass .....

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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 deductio .....

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enses are not capital as there is no increase in the capital base of the company which is ₹ 3,46,75,325 as at 31-03-2006 and also as at 31-03-2007. l) The assessee company also relied upon the decision of Hon'ble Special Bench- ITAT Bangalore in the case of Biocon Ltd. V. DCIT(LTU) in appeal no. 368 to 371 & 1206 all of 2010 for assessment year 2003-04, 2004-05, 2005-06, 2006-07 and 2007-08 and appeal no. 248/Bang/2010 in CIT(LTU) Bangalore v. Biocon Ltd. for assessment year 2004-0 .....

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bility nor it could be described as a share capital/share premium receipt or capital expenditure. 9. The CIT(A) held that the issue in hand is squarely covered by the judgment of Hon'ble Special Bench of Bangalore Tribunal in Biocon Ltd. v. DCIT(LTU) in ITA no 368 to 371 & 1206 /Bang/2010 which was pronounced on 16th July 2013 by Special Bench, Bangalore and allowed the appeal of the assessee company. 10. Aggrieved, the Revenue is in appeal before us. 11. The Ld. DR relied upon the order .....

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e company in accordance with Employees Stock Option Scheme, 2006 of the company and are in accordance with the Securities Exchange Board of India guidelines and guidelines issued by Institute of Chartered Accountants of India. c) ESOP is an employee compensation scheme intended to encourage a sense of belongingness and feeing of ownership in the employees to create partnership with the employees to make them stakeholder in the assessee company so that the employees are encouraged to work in the .....

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ty 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 Ch .....

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ands 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 ₹ 3,46,75,325 as at 31-03-2006 and also as at 31-03-2007. l) The assessee company also relied upon the decision of Hon'ble Special Bench- ITAT Bangalore in the case of (2013) 35 taxmann.com 335(SB)- Biocon Ltd. V. DCIT(LTU) in appeal no. 368 to 371 & 1026 all of 2010 for assessment year 2003- 04, 2004-05, 2005-06, 2006-07 and 2007-08 and appeal no. 2 .....

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ascertained liability and cannot be described as a notional or contingent liability nor it could be described as a share capital/share premium receipt or capital expenditure. 13. We have considered the rival contentions and perused the material on record and the case laws relied upon by the parties. We have observed that the assessee company has claimed as revenue expenditure during assessment year 2007-08, an amount of ₹ 81,93,150/- on account of ESOP expenditure which has been debited t .....

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ecial Bench has held as under : " 7. We have heard Shri H. Padam Chand Khincha 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 .....

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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 deduction is warranted. On the other hand, the Revenue has set up a case that no deduction can be allowed as such discount is not only a short capital receipt but also a continge .....

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ffers of the assessee. It was put forth that by issuing shares at discounted premium, nothing is paid out by the company. Once there is no "paying out or away", the same cannot constitute an expenditure and resultantly section 37(1), which applies to only expenditure, cannot be activated. He further took pains in explaining that there is no revenue expenditure involved in the transaction of issuance of ESOP at discount. The so called 'discount' represents the difference between .....

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expenditure. He supported his view by relying on the order passed by the Delhi Bench of the Tribunal in Ranbaxy Laboratories Ltd. v. Addl. CIT [2010] 39 SOT 17 (URO). It was stated that the Tribunal in that case has held that since the receipt of share premium is not taxable, any short receipt of such premium on issuing options to employees will be notional loss and not actual loss for which any liability is incurred. The learned Departmental Representative contended that the Mumbai bench of the .....

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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 s .....

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ket price on the date of grant at ₹ 738.95 per share. The assessee treated the difference between ₹ 738.95 and ₹ 595 as employees compensation in the books of account and charged the same to its Profit and loss account by spreading it over the vesting period. It was one of the years of the vesting period for which the assessee claimed deduction that came up for consideration before the Tribunal. It was held by the Tribunal that the market price of ₹ 738.55 per share would .....

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emium will only be a notional loss and not actual loss requiring any deduction. The Tribunal further noticed that incurring of such notional loss cannot be considered as expenditure within the meaning of section 37(1) as there was no "spending" or "paying out or away". The contention of the assessee that SEBI Guidelines recommend claim for deduction of discount over the vesting period, did not find favour with the Tribunal on the ground that the SEBI Guidelines were not relev .....

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the company at a predetermined price". In an ESOP, the given company undertakes to issue shares to its employees at a future date at a price lower than the current market price. This is achieved by granting stock options to its employees at discount. The amount of discount represents the difference between market price of the shares 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 .....

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ees, 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 .....

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o doubt that the amount of share premium is otherwise a capital receipt and hence not chargeable to tax in the hands of company. The Finance Act, 2012 has inserted clause (viib) of section 56(2) w.e.f. 1.4.2013 providing that: 'where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration recei .....

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a lower amount on capital account. It is so because the object of issuing such shares at a lower price is nowhere directly connected with the earning of income. It is in such like situation that the contention of the learned Departmental Representative would properly fit in, thereby debarring the company from claiming any deduction towards discounted premium. It is quite basic that the object of issuing shares can never be lost sight of. Having seen the rationale and modus operandi of the ESOP, .....

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tute 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 amountin .....

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es, the object is to compensate employees to the tune of ₹ 60. It follows that the discount on premium under ESOP is simply one of the modes of compensating the employees for their services and is a part of their remuneration. Thus, the contention of the ld. DR that by issuing shares to employees at a discounted premium, the company got a lower capital receipt, is bereft of an force. The sole object of issuing shares to employees at a discounted premium is to compensate them for the contin .....

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t an expenditure denotes "paying out or away" and unless the money goes out from the assessee, there can be no expenditure so as to qualify for deduction u/s 37. Sub-section (1) of the section provides that any expenditure (not being expenditure in the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed i .....

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is 'paid out or away' and is something which has gone irretrievably. However, it is pertinent to note that this section does not restrict paying out of expenditure in cash alone. Section 43 contains the definition of certain terms relevant to income from profits of business or profession covering sections 28 to 41. Section 37 obviously falls under Chapter IV-D. Sub-section (2) of section 43 defines "paid" to mean: "actually paid or incurred according to the method of accou .....

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diture' 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 un .....

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it is worth noting that the Hon'ble Supreme Court in the case of CIT v. Woodward Governor India (P.) Ltd. [2009] 312 ITR 254/179 Taxman 326 has gone to the extent of covering "loss" in certain circumstances within the purview of "expenditure" as used in section in 37(1). In that case, the assessee incurred additional liability due to exchange rate fluctuation on a revenue account. The Assessing Officer did not allow deduction u/s 37. When the matter finally reached the Ho .....

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head "profits and gains of business or profession". In sections 30 to 36 the expression "expenditure incurred", as well as allowance and depreciation, has also been used. For example depreciation and allowances are dealt with in section 32, therefore, the parliament has used expression "any expenditure" in section 37 to cover both. Therefore, the expression "expenditure" as used in section 37 made in the circumstances of a particular case, covers an amount .....

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so does not hold water in the light of the above judgment. In view of the above discussion, we, with utmost respect, are unable to concur with the view taken in Ranbaxy Laboratories Ltd.(supra). B. Is discount a Contingent liability? 9.3.1 The learned Departmental Representative supported the impugned order 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 re .....

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od. 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 .....

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;. We need to determine as to whether the liability arising on the assessee-company for issuing shares at a discounted premium can be characterized as a contingent liability in the light of the definition of contingent contract. From the stand point of the company, the options under ESOP 2000 vest with the employees at the rate of 25% only on putting in service for one year by the employees. Unless such service is rendered, the employees do not qualify for such options. In other words, rendering .....

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by the employees. Now the question arises as to whether the liability at the end of each year can be construed as a contingent one? 9.3.3 The Hon'ble Supreme Court in Bharat Earth Movers v. CIT [2000] 245 ITR 428/112 Taxman 61 dealt with the deductibility or otherwise of provision for liability towards encashment of earned leave. In that case, the company floated beneficial scheme for its employees for encashment of leave. The earned leave could be accumulated up to certain days. The assess .....

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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 .....

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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 the case of Bharat Earth Movers (supra) to the provision for leave encashment has been nullified. However, the principle laid down in the said judgment is absolutely intact that a liabil .....

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-company was engaged in selling certain products. At the time of sale, the company provided a standard warranty that in the event of certain part becoming defective within 12 months from the date of commissioning or 18 months from the date of dispatch, whichever is earlier, the company would rectify or replace the defective parts free of charge. This warranty was given under certain conditions stipulated in the warranty clause. The assessee made a provision for warranty at ₹ 5.18 lakh towa .....

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past event; (b) it is probable that an outflow of resources will be required to settle the obligation : and (c) a reliable estimate can be made of the amount of the obligation". Resultantly, the provision was held to be deductible. 9.3.5 When we consider the facts of the present case in the backdrop of the ratio laid down by the Hon'ble Supreme Court in Bharat Earth Movers (supra) and Rotork Controls India (P.) Ltd. (supra), it becomes vivid that the mandate of these cases is applicabl .....

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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-gr .....

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ore, hold that the discount in relation to options vesting during the year cannot be held as a contingent liability. C. Fringe benefit 9.4.1 There is another important dimension of this issue. Chapter XII-H of the Act consisting of sections 115W to 115WL with the caption : "Income-Tax on Fringe Benefits" has been inserted by the Finance Act, 2005 w.e.f. 1.4.2006. Memorandum explaining the provisions of the Finance Bill, 2005 highlights the details of the Fringe Benefits Tax. It provide .....

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ve been provided by an employee to his employees during the previous year………….". Section 115WB gives meaning to the expression 'Fringe Benefits'. Subsection (1) provides that for the purposes of this Chapter, 'fringe benefits' means any consideration for employment as provided under clauses (a) to (d). Clause (d), which is relevant for our purpose, states that : 'any specified security or sweat equity shares allotted or transferred, directly o .....

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securities offered under such plan or scheme. Thus it is discernible from the above provisions of the Act that the legislature itself contemplates the discount on premium under 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 natura .....

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;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 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 recei .....

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rth Movers (supra) that if a business liability has definitely arisen in an accounting year, then the deduction should be allowed in that year itself notwithstanding the fact that such liability is incapable of proper quantification at that stage and is dischargeable at a future date. It follows that the deduction for an expense is allowable on incurring of liability and the same cannot be disturbed simply because of some difficulty in the proper quantification. A line of distinction needs to be .....

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ns. The period from grant of option to the vesting of option is the 'vesting period'. It is during such period that an employee is supposed to render service to the company so as to earn an entitlement to the shares at a discounted premium. The vesting period may vary from a case to case. If the vesting period is, say, four years with equal vesting at the end of each year, then it is at the end of the vesting period or during the exercise period, which in turn immediately succeeds the ve .....

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r 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 p .....

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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 of the second year of service by the employees, the company can claim deduction for discounted premium in respect of further 25 shares so on and so forth till fourth year when the last tranche of discounted premium in respect .....

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entitle the employee to exercise such option nor allow the company to claim deduction for the discounted premium. It is during the vesting period that the company incurs obligation to issue discounted shares at the time of exercise of option. Thus the event of granting options does not cast any liability on the company. On the other end is the date of exercising the options. Though the employees become entitled to exercise the option at such stage but the fact is that it is simply a result of v .....

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res at the discounted premium only during the vesting period. The liability is neither incurred at the stage of the grant of options nor when such options are exercised. 10.6 Let us consider the facts of the case of S.S.I. Ltd. (supra), which has been strongly relied by the ld. AR in support of his claim for deduction 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 o .....

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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 .....

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100 divided over the vesting period of four years on straight line basis at the rate of ₹ 25 each. The case of S.S.I. Ltd. (supra) deals with a controversy relating to one of the vesting years. The tribunal entitled the assessee to proportionate deduction. Thus it is evident that the view taken by the tribunal in that case not only matches with the SEBI Guidelines but also the 'accrual concept' in the mercantile system of accounting, thereby allowing deduction at the stage of incu .....

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allowing deduction of the discounted premium during the years of vesting on a straight line basis, which coincides with our above reasoning. III. SUBSEQUENT ADJUSTMENT TO DISCOUNT 11.1.1 Having answered the first major issue in affirmative that the discount on options under ESOP is an ascertained liability and the second major issue that the discount is deductible over the vesting period on straight line basis unless the vesting is not uniform, then arises the present issue as to whether any sub .....

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e 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 actua .....

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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 over .....

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nt as income in the relevant years, we stop here by holding that the amount of discount claimed as deduction earlier in respect of unvested/lapsing options, has to be taxed as income on the happening of such events. 11.1.4 Now we take up the second situation in which the options are exercised by the employees after putting in service during the vesting period. In such a scenario, the actual amount of remuneration to the employees would be only the amount of actual discounted premium at the time .....

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section 17(2)(iiia) with effect from 1st April, 2000 providing that : "the value of any specified security allotted or transferred, directly or indirectly, by any person free of cost or at a concessional rate to an individual who is or has been in employment of that person" shall be treated as a perquisite. It further provides that in a case the allotment or transfer of specified securities is made in pursuance of an option exercised by an individual, the value of the specified securi .....

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f 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 provis .....

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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 benefit accrued to the assessee but the same did not attract tax. The position has now been clarified beyond doubt by the legislature that the ESOP discount, which is nothing but the reward for services, is a taxable perquisite to the employee at the time of exercise of option, and its valuation is to be done by considering the fair .....

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hod of account followed by the company, but the amount of such discount or employees remuneration can never be different. If the value of perquisite in the hands of the employee, whether or not taxable, is 'x', then its cost in the hands of the company has also to be 'x'. It can neither be 'x+1' nor 'x-1'. It is simple and plain that the amount of remuneration which percolates to the employees will always be equal to the amount flowing from the company and such re .....

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e of grant of options is always a tentative employees cost because of the impossibility 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 th .....

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ith 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 100 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 ₹ 110 against the option price of ₹ 10, which resulted in discount at ₹ 100. With the vesting period of f .....

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option. As the total amount of discount of ₹ 100 over the vesting period is actually quantified at ₹ 100, no further adjustment to the discount is required at the time of exercise of option. In Situation II, the market price of the share at the time of exercise of option has gone up to ₹ 130. The amount of real compensation to employee is ₹ 120 as against the tentative compensation of ₹ 100 per share which was accounted for and allowed as deduction during the vesti .....

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of the compensation has turned out to be ₹ 80, the company is liable to reverse the deduction of ₹ 20 at the time of exercise of option. Taxation vis-à-vis Accountancy principles 11.2.1 It has been noticed that broadly there are three stages having effect on the total income of the company in the life cycle of ESOP, viz., (i) during the vesting period, (ii) at the time of unvesting/lapse of options and (iii) finally at the time of exercise of options. It has been argued that .....

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ount 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 .....

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ccepted accountancy rule. Similarly in the case of U.P. State Industrial Development Corpn. (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 commission received by the underwriter as investment as against treating the gross amount by taking into consideration the principles of commercial accounting. He stated that since there is no specific provision in the Act providing .....

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tricity Co. Ltd. (supra) in support of this proposition. 11.2.3 We are not persuaded by the submissions put forth by the ld. AR that, in the absence of any specific provision in the Act, the accounting principles should be followed for determining the total income of the assessee. What is true for accounting purpose need not necessarily be true for taxation. Taxation principles are enshrined in the legislature. Power to legislate lies with the Parliament. Accounting standards or Guidance Note or .....

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iament which can legislate on its scope. 11.2.4 Be that as it may, there is no weight in the contention of the ld. AR that there is no specific provision in the Act on the ESOP discount. It is axiomatic that the taxation rules are always embodied in the relevant Act, 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 whi .....

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ctions. 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 words, this section is a specific .....

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contend that there is no requirement for the adjustment of discount at the time of exercise of options. Primarily, we are unable to trace the proposition anywhere from the Act that the accounting principles are also determinative of the tax liability. The jurisprudence is rather the other way around. InTuticorin Alkali Chemicals & Fertilizers Ltd. (supra), the Hon'ble Supreme Court has laid down in so many words that the taxing principles cannot walk on the footsteps of the accounting pr .....

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ding to the principles of law and not in accordance with accountancy practice. Accounting practice cannot override section 56 or any other provision of the Act. As was pointed out by Lord Russell in the case of B.S. C. Footwear Ltd. v. Ridguary (Inspector of Taxes [1970] 77 ITR 857 (CA), the income-tax law does not march step by step in the footprints of the accountancy profession.' 11.2.6 The same view has been adopted by the Hon'ble Supreme Court in Godhra Electricity Co. Ltd. (supra), .....

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lay 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 .....

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i Sugars Ltd. (supra), was also taken up before the Hon'ble Supreme Court in the case ofTuticorin Alkalis Chemicals & Fertilizers Ltd (supra). Dealing with the same, the Hon'ble Supreme Court held that : "The question in Challapalli Sugars Ltd.'s case (supra) 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 t .....

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how that the court was not in any way departing from legal principles because of any opinion expressed by the Institute of Chartered Accountants." From the above observations there is not even an iota of doubt in our minds that there can be no question of following the accounting principle or Guidance notes etc. in the matter of determination of total income. 11.2.9 The trump card of the ld. AR to bolster his submission for assigning the status of binding force to the SEBI Guidelines is the .....

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ity of discount in the hands of company during the years of vesting period. These Guidelines are silent on the position emanating from variation in the market price of the shares at the time of exercise of option by the employees vis-à-vis the market price at the time of grant of option. In other words, the SEBI Guidelines prescribe accounting treatment only in respect of the period of vesting of the options and the situation arising out of unvested options or vested options lapsing. The .....

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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 wa .....

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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 of options to the employees. The amount of discount claimed as deduction during the vesting period is required to be reversed in relation to the unvesting/lapsing options at the appropriate time. However, an adjustment to the income is called for at the time of exerci .....

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9;Profits and gains of business or profession'. SOME RELEVANT FACTORS IN ASSESSEE'S CASE 12.1 Having answered the question in affirmative, let us examine its applicability to the facts of the appellant's case. It has been seen above that the authorities below refused to grant deduction of the discount at the very threshold. Resultantly, the verification of the correctness of calculation of discount stood ousted. Since we have overturned such view in above terms, the verification of c .....

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any was a closely held company in the previous year relevant 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 th .....

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laimed at ₹ 909, meaning thereby that the market price of the share on the date of grant of option was taken at ₹ 919. No material worth the name has been placed on record to indicate as to how a share with face value of ₹ 10 has been valued at ₹ 919 for claiming deduction towards discount at ₹ 909 per share. This aspect of valuation of shares at ₹ 919 per share needs to be examined by the Assessing Officer. b. We have held above that the deduction of the disc .....

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he of 25% option and the last amount of ₹ 40.62 lakh as the fourth tranche of 25% option. We are unable to understand as to how the last three amounts can qualify for deduction at the end of the first year itself. On a specific query, it was stated by the ld. AR that the assessee claimed deduction for the proportionate part of discount for the second, third and fourth year at the end of the first year itself because 25% of options vested in the employees at the end of the first to fourth y .....

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sulted in needlessly increasing the amount of deduction for the first year at the cost of deduction for the subsequent three years. It needs to be set right by apportioning the total amount of the discounted premium evenly over the vesting period of four years. c. It has been noticed above that the stage for the grant of deduction of discount is on the respective vesting of the options. In ESOP 2000, the vesting takes place @ 25% after each year of service. It means that the first part of 25% de .....

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s 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/lap .....

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e market price of share at the time of grant of options to the employees. The Hon'ble Special Bench has held that the amount of discount claimed as deduction during the vesting period is required to be reversed in relation to the unvesting/lapsing options at the appropriate time , however, an adjustment to the income is called for at the time of exercise of option by the amount of difference in the amount of discount calculated with reference to the market price at the time of grant of optio .....

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), we decide this issue in favour of the assessee company and against the Revenue that 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 share at the time of grant of options to the employees. The amount of discount claimed as deduction during the vesting period is required to be reversed in relation to the unvesting/lapsing options at the appropriate time, however, an adjustment to the income is called for at the t .....

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) In the instant case we have noticed that the AO has refused to grant the deduction of the discount on ESOP at the very threshold and the CIT(A) has allowed the said claim based on the decision of Hon'ble Special Bench in the case of Biocon Limited(supra). Resultantly, the verification of correctness of calculation of discount stood ousted and have become now imperative in view of our directions in light of Hon'ble Special Bench, Bangalore Tribunal orders in Biocon Ltd (supra) which are .....

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