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2016 (8) TMI 821 - ITAT DELHI

2016 (8) TMI 821 - ITAT DELHI - TMI - Transfer pricing adjustment - mark up of managerial services post incorporation - mark-up on reimbursement of expenses - Held that:- The expenditure incurred by the assessee, when the A.E. of the assessee was not in existence cannot in our view be taken as a factor for determining the A.L.P. of an international transaction that took place between the assessee and its A.E. post incorporation. Just because, post incorporation NDTV Network Plc UK has reimbursed .....

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k up on reimbursement of expenditure on these management services. In view of the above discussion, we are of the considered opinion that the TPO is right in making a mark up of managerial services post incorporation of the A.E. - Thus we hold that: - (a) There can be no mark-up on reimbursement of expenses incurred by the assessee prior to incorporation of NDTV Network Plc UK. - (b) The action of the A.O. in charging a mark-up on reimbursement of expenses incurred by the assessee on .....

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ture. While doing so he observed that the assessee itself has characterised certain software purchase on its own as capital assets. He observed that certain software needs regular upgradation or change as per the requirement of fast changing broadcasting industry and that his predecessor has allowed similar expenditure on upgradation of software as revenue in nature. We find no infirmity in this finding of the Ld.CIT(A). - Decided against revenue - ITA No. 2851/Del/2013, ITA No. 2752/Del/2013 - .....

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ss of Television, News Broadcasting to its two channels namely NDTV 24x7 and NDTV India. It also produced customized software programmes for broadcasters. It filed its return of income on 2.11.2007 declaring loss of ₹ 7,08,80,472/-. The A.O. completed the assessment u/s 143(3) of the Act on 17.2.2011 determining the total income at ₹ 15,01,72,110/- inter alia making a transfer pricing adjustment of ₹ 94,16,785/- u/s 92CA(3) of the Act, disallowing claim of software expenditure .....

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s passed by the Assessing Officer (A.O.)/CIT(A) Transfer Pricing Officer (TPO) are bad in law and void ab initio. 2. That on facts and in law the CIT(A)/TPO erred in upholding/making an addition of ₹ 94,16,785/- under Chapter X of the Act. 3. That on facts and in law, as regards appellant s receipts of ₹ 4,52,95,590/- the CIT(A) erred in upholding that the nature of services rendered by the appellant to its AE are in the nature of Management services and not Shareholder services . 3. .....

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the appellant on the alleged provision of Management services . 6. That on facts and in law the CIT(A) erred in upholding that for the purposes of benchmarking the international transactions the TPO was justified in using only the current year data. 7. That on facts and in law the CIT(A) erred in upholding a disallowance of ₹ 21,28,41,993/- on account of Employees Stock Option Plan (ESOP) expenses claimed by the appellant on a pro rata basis over the total vesting period. 7.1. That withou .....

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an application for modification of ground no.7. The Ld.D.R. did not have any objection to the modification of this ground. Hence we modify this ground as requested by the assessee as follows. that in view of the decision of Hon ble Tribunal dated December 20, 2013 in appellant s own case on the allowability fo ESOP expenditure for AY 2006- 07, the Ld.AO ought to have allowed the ESOP expenditure of ₹ 4,35,320,484/- in the year under consideration in accordance with the aforesaid decision a .....

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ing issues and ground no.7 is on the issue of ESOP expenditure. 7. On the issue of transfer pricing the Ld.D.R. submitted that the assessee during the year, in order to diversify and expand into various domains, conceptualised, to establish a subsidiary in UK namely NDTV Net Works Plc. After taking us through the various international transactions reflected in 3CEB report in the transfer pricing study he emphasized on page 3 of the executive summary of the Transfer Pricing Report and drew our at .....

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and further considering the amount received by NDTV for shareholder activity, it is reasonable to conclude that this international transaction appears to be consistent with the arm s length standard from an Indian transfer pricing perspective. 7.1. He further took us through the various findings in the transfer pricing reports, as regards the reimbursement expenditure, the FAR analysis etc. Thereafter he argued as follows. (a) The receipt of amount as reimbursement for share holder activity and .....

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TV group. Only an amount of 1,73,88,214 towards management services is to be reimbursed. (c) That there is no risk involved in respect of reimbursement of expenditure or in respect of share holder activity and hence such reimbursement does not require any mark up. (d) TNMM is found to be the most appropriate method (MAM) in respect of the transactions entered into by the assessee. As the assessee was not entitled to receive reimbursement of expenditure incurred on share holders activity, but was .....

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relation to share holding activity which were reimbursed to the assessee company. He submitted that there is a distinction as, expenditure for share holder activity was incurred prior to incorporation of NDTV Net Works Plc in UK, for which the assessee is not entitled for reimbursement and whereas, the expenditure which was entitled to reimbursement, was incurred after incorporation of the company. (g) He argued that the mark up of 18.18% made by the TPO on the management services is unjustifie .....

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transaction itself. For this proposition he relied on the judgement of Hon ble Mumbai High Court in the case of Vodafone India Services P.Ltd. 368 ITR 1 (Bom) and submitted that advice given prior to incorporation is not an international transaction and hence such activity is outside the ambit of Transfer Pricing provisions. He submitted that, as a parent company, the assessee was performing its obligation of setting up of a Subsidiary. (j) He pointed out that the TPO has not charged any mark u .....

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re holder activity does not have a bearing on these items. (l) He relied on the decision of Hon ble Delhi High Court in the case of M/s Li & Fung India Pvt.Ltd. vs. CIT (2014) 361 ITR 85 and submitted that, no intangible asset has been created. When the assessee s employees worked for the formation of the assessee s UK Subsidiary and the expenditure reimbursed was nothing but the cost of assessee s employees for the time worked in formation of the UK company. 7.2. On the issue of ESOPs, the .....

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7.3. The Ld.D.R. Mr.Amit Mohan Govil, Ld.CIT(A) on the other hand controverted the submissions of the assessee and argued that the mandate given to the TPO is to identify whether there is an international transaction and if so determine its arm s length price. He referred to the transfer pricing study filed by the assessee and specifically took us through executive summary, wherein it is stated that the provision of management services by the assessee to NDTV Net Works PLC was an international t .....

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ated Enterprises. (b) That activities were performed (c) That consideration was received and (d) That the transaction is characterized as of international transaction with the transfer pricing study. 7.5. He further argued that the assessee can not at this stage retract and argue that this is not an international transaction. While submitting that the assessee based its opinion on OECD commentary, he relied on the very same commentary in paragraph 7.9 to 7.10 to argue that this activity is an in .....

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older services. 7.6. He submitted that there are no share holder services as such and it was nothing but management services. He vehemently contended that transactions cannot be clubbed. He found fault with the arguments that, just because cost of share holder activity was reimbursed, there is no requirement of charging a mark up on provision of management services and that such cross subsidisation is not permitted under Transfer Pricing provisions. He relied on the order of the TPO and submitte .....

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as a case relating to creation of intangible assets. Regarding Mumbai High Court decision in Vodafone, 368 ITR 1, it was submitted that this decision was rendered in the context of attribution of income and hence not relevant to the case on hand. 7.7. On the issue of disallowance of ESOPs he made elaborate oral and written submissions. On a query from the Bench he submitted that the issue has been considered by the Special Bench of the Tribunal in the case of Biocon (supra) but as the revenue ha .....

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ding managerial services. He emphasized that the expenditure was incurred prior to incorporation of the Associated Enterprises. He rebutted the contentions of the Ld.D.R. 10. Rival contentions heard. On a careful consideration of the facts and circumstances of the case and perusal of material on record and orders of lower authorities, case laws cited, we hold as follows. 10.1. For ready reference we extract some portions of the Transfer Pricing Study presented by the assessee. 2.1 New Delhi Tele .....

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nsformed into a 'News Broadcaster'. Now in the third phase, the Company is morphing into it full-fledged media network. To achieve its goal of moving beyond news into a full-fledged media company as well as turning global - a new company called NDTV Networks Plc was incorporated in the UK during financial year 2006-07. During the financial year 2006-07, NDTV has entered into international transactions with NDTV Networks B.Y. (Netherlands), NDTV Networks Plc (UK) and Emerging Markets 24X7 .....

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the laws of England and Wales. The company has been incorporated to create a presence for NDTV in the global media market and to develop new avenues of businesses around the world. NDTV Networks Plc has a total of four subsidiaries and two Joint Ventures, each focused on a different genre of media: Entertainment; Internet and Convergence; Lifestyle channels; technology innovation and integration services; Media Process Outsourcing: and establishing news channels in other countries. The subsidiar .....

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eted channels. The aim of these channels will be to capture the growing retail market in India and to tap the aspirations of the new urban Indian. The first of these lifestyle channels under NDTV Lifestyle Ltd is a 'composite' lifestyle channel coveting a wide range of programming ideas and concepts. NDTV Labs:- NDTV Labs is engaged in developing technology and software solutions for television broadcasting, software development, and sale of this software in domestic and international ma .....

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finalization of potential agreements with them; Formulation and implementation of accounting policies and guidelines customized for local requirements; Assistance in obtaining regulatory compliances; Assistance in obtaining finances; Negotiations with financial and tax consultants to conceptualise an efficient business model of NDTV Networks Plc; and Provision of other services that may be deemed necessary to enable NDTV Networks Plc to commence and efficiently run its operations. 3.1.2 Assets N .....

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uring the financial year 2006-07. NDTV has advanced loan of Euros 7,62.000 to NDTV Networks B.Y. Further. the loan was repaid by NDTV Networks B.Y. to NDTV during the financial year 2006-07. 3.2.2 Risk Analysis There are no inherent external risks in respect of the above international transaction except for foreign exchange fluctuation risk, which is borne by NDTV as the loan was advanced in a currency which is different from the domestic currency of NDTV. 3.3 Receipt of Interest on Loan 3.3.1 F .....

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Networks Plc has further established subsidiaries to enable NDTV become a full-fledged media group, in order to conceptualise and give effect to an efficient NDTV group structure. the management of NDTV has performed activities prior to the incorporation of NDTV Networks Plc. The activities include making decisions regarding the subsidiaries to be established and the business activities to be performed by those subsidiaries, and dealing with tax, financial and other advisers. The activities perf .....

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nctions During the financial year 2006•07, NDTV has subscribed to the share capital or NDTV Networks B.Y. and Emerging Markets 24X7 B.Y. NDTV has subscribed to 980 equity shares of Euro 100 each of NDTV Networks B.Y. and 90 shares of Euro 100 each of Emerging Markets 24X7 B.Y. 3.5.2. Risk Analysis There are no inherent external risks in respect of the above international transactions except for foreign exchange fluctuation risk, which is borne by NDTV as the shares have been subscribed in a .....

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ause 13(a) Clause 13(b) Clause 13(c ) Clause 13(d) 1. NDTV Networks B.V. Martinus Nijhoflan 2,264 ES Delft, Amsterdam, The Neth erlands Reimbursement of courier expenses 3,460 3,460 Refer Note 1 below 2. NDTV Networks Plc 90, High Holborn, London WC V 6XX Reimbursement of expenses in the nature of legal and consultancy, hotel, tour and travel 6,501,612 6,501,612 Refer Note 1 below 3. NDTV Networks Plc 90, High Holborn, London WC V 6XX Reimbursement of costs 62,180,644 62,180,644 Refer Note 2 bel .....

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. Martinus Nijhoflan 2,264 ES Delft, Amsterdam, The Netherlands Bank charges recoverable from Emerging Markets 24x7 B.V. 2,875 2,875 Refer Note 4 below Note 1: In the opinion of the assessee, these reimbursements do not include provision of any services and the actual cost incurred is recovered without any mark up. Based thereon, the assessee considers that the amount received/receivable in respect of the above transactions is at arm s length as provided u/s 92C of the Act. 2. Out of the above, .....

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shares the company became an associated enterprise of the assessee. Further, this transaction does not have an impact on the incomes/expenses of the assessee and thus does not warrant the computation of arm s length price. 4. The above transaction represents misc. Amount recoverable from the company. Since this do not have an impact on the incomes or expenses of the assessee, the said transaction does not warrant the computation of arm s length price. (Emphasis ours). 10.3. OECD transfer pricin .....

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rein Associated Enterprise undertakes activities that relate to more than one member of the group or to the group as a whole. In a narrow range of such cases, an intra group activity may be performed relating to group members even though those group members do not need the activity ( and would not be willing to pay for it were they independent enterprises). Such an activity would be one that a group member (usually the parent company or a regional holding company) performs solely because of its .....

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centre. These latter types of non-shareholder activities could include detailed planning services for particular operations, emergency management or technical advise (trouble shooting), or in some cases assistance in day to day management. (Emphasis ours). 10.4. We would now examine the nature of activities that the assessee has undertaken. During the F.Y. 2006-07, the assessee has rendered management services to NDTV Net Works Plc, prior to its incorporation. It also assisted NDTV Network Plc .....

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unctions, to conceptualise and give effect to an efficient group structure of NDTV Network Plc and got reimbursement of ₹ 4,52,95,590. 10.5. The management services rendered by NDTV are listed out by the assessee as follows: 1. Facilitation of business development; 2. Assistance in negotiation with the other persons and in drafting and finalisation of potential agreements with them; 3. Formulation and implementation of accounting policies and guidelines customised for local requirement; 4. .....

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ling with tax finance and other advisories. The shareholder activities are defined in the OECD Transfer Pricing Guidelines as : an activity which is performed by a Member of an MNE group(usually the parent company or a regional holding company) solely because of its ownership interest in one or more other group members i.e. in its capacity as a shareholder . 10.6. The expenditure in question is listed below. Details of reimbursement of expenses Transaction Date Journal No. Description Base Amoun .....

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84249 Mobile Phone Charges (55,310) Total : 45,295,590 10.7. In our view the expenditure incurred prior to incorporation of the U.K. Company i.e. NDTV Network Plc UK can be classified as incurred for share holder activity. This subsidiary company has not come into existence on the date of incurring of this expenditure. The assessee company has incurred the expenditure solely because of its ownership interest. The pre incorporation expenses incurred of the type and nature incurred by the assesse .....

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Sec.92B of the Act. 10.8. The expenditure incurred by the assessee, when the A.E. of the assessee was not in existence cannot in our view be taken as a factor for determining the A.L.P. of an international transaction that took place between the assessee and its A.E. post incorporation. Just because, post incorporation NDTV Network Plc UK has reimbursed the employee cost incurred by the assessee prior to incorporation, to the assessee, it does not lead us to a conclusion that on other managerial .....

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is right in making a mark up of managerial services post incorporation of the A.E. 10.9. Thus we hold that: (a) There can be no mark-up on reimbursement of expenses incurred by the assessee prior to incorporation of NDTV Network Plc UK. (b) The action of the A.O. in charging a mark-up on reimbursement of expenses incurred by the assessee on management services after incorporation is upheld. Though the Ld.Counsel for the assessee raised arguments on percentage of mark-up, in view of the percenta .....

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ssed by different benches. In the case of Ranbaxy Laboratories v DC1T [2009 TIOL 632 ITAT DEL], the tribunal has upheld the action of the AO of denial of allowability of the claim of ESOP cost in the profit and loss account and has held that since the receipt of share premium is not taxable, any short receipt of such premium on issuing option to the employees will be notional loss and not actual loss for which any liability is incurred. However, Hon ble Delhi High Court has admitted further appe .....

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market price of the stock on the date of grant of such options was not allowable expenditure under Section 37(1) of the Act? (ii) Whether on the facts and in the circumstances of the case, the tribunal erred in law in not holding that the difference between the prevailing market price of the stock and the price at which stock options were offered to the employees under the ESOP Scheme, resulting in benefit to the employees and thus constituting remuneration of the employees was, allowable deduct .....

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1.3 The Special Bench of Bangalore in the case of DCIT V Biocon Ltd. [Supra) has considered the identical issue and has held that the ESOP cost is deductible u/s 37(1) of the Act to the profit and loss account. The Special Bench laid down following principles: • Discounted premium on the ESOP is neither a short capital receipt nor is a capital expenditure but it is employees cost incurred by the company. • Discounted premium on the ESOP cannot be held as contingent liability. • L .....

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ld reflect correct employee cost. • Since definite liability is incurred during the vesting period, it has to be quantified on some logical basis. Since the actual amount of employee cost can be precisely determined only at the time of the exercise of option by employee, the provisional amount of discount availed as deduction during vesting period needs to be adjusted in the light of actual discount on the basis of market price of the shares at the time of exercise of option. It can be done .....

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es 1999 up to dated September 3, 2009 (the SEBI Guidelines). The silent features of the guidelines are as under: 1.4.2 Employee compensation does not include ESOP. For the sake of clarity, definition of employee compensation as stipulated under the SEBI guidelines is extracted as under: "(2) employee compensation means the total cost incurred by the company toward employee compensation including basic salary, dearness allowance, other allowances, bonus and commissions including the value of .....

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ned price.] 1.4.3 Accounting policies of the ESOP have been provided in Schedule 1 to SEBI Guidelines 1999. For the sake of convenience, the relevant part of accounting policies is extracted as under:- (a) In respect of options granted during any accounting period, the accounting value of the options shall be treated as another form of employee compensation in the financial statements of the company. [(b)] The accounting value of options shall be equal to the aggregate, over all employee stock o .....

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shall be determined separately for each separate vesting portion of the option, as if the option was, in substance, multiple option and the amount of employee compensation cost shall be accounted for and amortized accordingly on a straight-line basis over the vesting period; Or (2) the amount of employee compensation cost shall be accounted for and amortized on a straight-line basis over the aggregate vesting period of the entire option (that is, over the vesting period of the last separately ve .....

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e compensation expense equal to the amortized portion of the accounting value of the lapsed options and a credit to deferred employee compensation expense equal to the unamortized portion. (e) When a vested option lapses on expiry of the exercise period, after the fair value of the option has already been accounted for as employee compensation, this accounting treatment shall be reversed by a credit to employee compensation expense. 1.4.4 Schedule 3 to the SEBI Guidelines provides methodology to .....

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contained in Schedule 1 to SEBI guidelines has not laid down any principle that ESOP cost is revenue expenditure and is deductible in the Profit & Loss A/c of the assessee. It is evident from clause (f) of the Schedule 1 of the SEBI guidelines that ESOP cost has been classified as balance sheet item not an item of Profit & Loss A/c for the sake of clarity the relevant part of the guideline is reproduced as under:- Employee Stock Options Outstanding will appear in the Balance Sheet as pa .....

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of the Companies Act, 1956 along with the SEBI guidelines on accounting treatment of ESOP cost has revealed that discounted premium on shares under the ESOP could be met out of premium reserve of the company if any i.e. the ESOP cost which is discounted premium on shares is a balance sheet item which is capital in nature and can only be adjusted against the reserve. The analysis of SEBI guidelines clearly proves that ITAT has mis-directed itself in reaching a conclusion that the SEBI guidelines .....

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remium is a capital receipt? 1.5.1 Section 78 of the Company Act 1956 which is relevant for the assessment year under consideration provide that whether the company issue shares at premium, whether for cash for otherwise, a sum equal to the aggregate amount or value of the premiums on those shares shall be transferred to an account to be called the share premium account ; and the provisions of this Act relating to the reduction of share capital of the company shall, except as provided in this se .....

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of this Act relating to the reduction of the share capital of a company shall, except as provided in this section, apply as if the share premium account were paid- up share capital of the company. (2) The share premium account may, notwithstanding anything in subsection (I), be applied by the company (a) in paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares; (b) in writing off the preliminary expenses of the company; fc) in writing off the .....

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t it does not at the commencement of this Act form an identifiable part of the company's reserves within the meaning of Schedule VI, shall be disregarded in determining the sum to be included in the share premium account. (Emphasis supplied) 1.5.2 The Indian Accounting Standards 1 stipulates presentation of financial statement of assets and liabilities. It further provides disclosure of each class of share capital on the liability side of the balance sheet. The standard provides that share c .....

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ction of some specified liabilities on capital account including payments of discount allowed as stipulated under section 78(2)(c) of the Companies Act which covers discounted premium on allotment of share under ESOP. The amount standing in securities premium is either converted into capital or reduces liabilities. Therefore, share premium including discounted share premium cannot be considered revenue receipt or expense at any stage like at the time of receipt or at the time of use. Hon ble 1TA .....

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settled proposition of law that any expenditure incurred for the expansion of the capital base of a company is to be treated as a capital expenditure as has been held by the Supreme Court in the cases of Punjab State Industrial Corporation Ltd v. C1T [1997] 225 ITR 792 (SC) and Brooke Bond India Ltd. v. CIT [1997] 225 ITR 798 (SC). Thus the expenditure and the receipts directly relating to the share capital of a company are of capital in nature and therefore, cannot be taxed under the Act save .....

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ich is listed on a recognized stock exchange and some other companies, which are also considered as company in which public is substantially interested. In case of issue of shares at premium by listed companies, share premium is not considered as income. However, in case of un-listed companies premium can be considered as income in case the price charged is more than face value (that is at premium) and is also higher than fair market value. In such case, excess of issue price above the fair mark .....

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s provide taxation of capital receipt it was brought to tax under the head Income from Other Sources . However, the character of receipt would still remain capital and would not change since the difference was charged to tax under section 56 of the Act. 1.5.4 It is pertinent to mention here that Hon ble IT AT in case of Biocon Ltd. Vs DC IT (Supra) ignoring the provisions of the Companies Act, Indian Accounting Standards and Legal Precedents on the issues by following erstwhile provisions of Fri .....

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2006-2007, 2007-08, 2008-09 and 2009-2010. The object was to ensure that fringe benefits given by the employer to employees disguised in expenditure is best taxed in the hands of the employer. With the abolition of this Act, the liability on the employees under Rule 3 on all benefits excluding benefit from ESOP was restored. It is evident from above that the FBT was introduced to tax benefits disguised in expenditure and for a limited period which is now repealed. Since provision of FBT were int .....

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ed to settled legal position on the issue of interpretation of statute, it is respectfully stated that the tribunal has misdirected itself in relying on the provisions of the FBT while examining the nature of share premium u/s 37(1) of the Act. 1.5.5 Since the legislature considers discounted premium to the employees as Fringe Benefit accordingly discounted premium is an expenditure and cannot be treated as short capital receipt. v^.6 As discussed above, the FBT was in force w.e.f assessment yea .....

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f the FBT provisions that it was meant to tax benefits including capital benefits disguised as expenditure. In other words, the FBT was applicable both on capital and revenue expenditure accordingly, the provisions of FBT in no way support the conclusion of the Tribunal that ESOP cost cannot be treated as short capital receipt. The provisions do not also support a conclusion of the Tribunal that ESOP cost was expenditure deductible u/s 37(1) of the Act. It is important to highlight here that the .....

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ployee compensation and had not paid taxes on it but had claimed deduction of ESOP cost u/s 37(1) of the Act. In view of above, the conclusion of ITAT that ESOP cost was allowable as deduction u/s 37(1) on the basis of provisions of FBT is without any legal basis and against the rule of construction of the statute. 1.7 In view of above analysis the conclusion of Special Bench that discounted premium on share is neither a short capital receipt or a capital expenditure it is nothing but employee c .....

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ESOP cost is capital in nature, the other part of judgment of special bench has been discussed in succeeding paragraphs. 1.8 Whether discounted premium on share issued under ESOP is expenditure u/s 37(1) of the Act. 1.8.1 The term Expenditure has been judicially interpreted by various Courts including Supreme Court of India. In case of Indian Molasses Company Private Limited Vs. Commissioner of Income Tax, West Bengal [1959] 37 ITR 66, Hon ble Apex court has held the Spending in the sense of pay .....

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e sense of paying out or away money is the primary meaning and it is with that meaning that we are concerned. Expenditure is thus what is paid out or away and is something which is gone irretrievably. 12.2. He further relied on certain other case laws, which we do not feel it necessary to deal with, as the Special Bench of the ITAT has dealt with the same. 13. In any event, in view of the decision of the Special Bench of the Tribunal in the case of Biocon Ltd. which is binding on us this issue i .....

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