Expenditure on ESOP’s allotted to the employees is not allowed as a “Business Expenditure”

Income Tax - Section 37 - Business Expenditure – Expenditure on ESOP’s allotted to the employees is not allowed as a “Business Expenditure”


IN THE INCOME TAX APPELLATE TRIBUNAL BENCHES 'F', MUMBAI


ITA No.7242/Mum/08 Assessment Year 2005-06
ITA No.1004/Mum/08 Assessment Year : 2006-07



M/s VIP INDUSTRIES LTD Vs DCIT, CC 32, AAYAKAR BHAWAN,GR FLR, M K ROAD, MUMBAI - 20


11. Ground No. 6 relates to the disallowance of Rs.66,24,877/- made by the A.O. and confirmed by the ld. CIT(A) on account of expenses claimed to be incurred by the assessee company on account of Employees Stock Option Scheme (ESOP).


12. During the year under consideration, the assessee company had allotted shares to its employees under the Employees Stock Option Scheme (ESOP). The said ESOP was granted on 22.11.2004 in respect of 8 lacs shares of the assessee company at Rs.30/- per share as against the market price of Rs.53.80/- per share. There was thus a price difference of Rs.23.80 per share which came a total of Rs.190.40 lacs in respect of 8 lacs shares given under ESOP. Out of this total amount, the assessee company had charged ` 66.25 lacs to its P&L account for the year under consideration and the balance amount of Rs.124.15 lacs claimed in the immediately succeeding year i.e. A.Y. 2006-07. In support of the claim made on this issue, reliance was placed on behalf of the assessee company before the A.O. on relevant SEBI Rules which specified that the difference between the market price and the price at which the option is exercised by the employees has to be debited in the P&L account as expenditure. It was contended that since there was no specific provisions contained in the Income Tax Act dealing with this issue, accounting practice suggested by the SEBI is required to be applied and adopted for tax purposes also.


13. The submissions made on behalf of the assessee on this issue were not found acceptable by the A.O. for the following reasons given in the assessment order:-


“ (i) The market price of the shares of the assesee company was Rs.53.80 and the assessee company allotted the shares at ` 30.00/-. Thus, there was a price difference of Rs.23.80.


(ii) During the year under consideration the assessee company allotted the shares of Rs. 66,24,877/- to its employees and debited this amount in the profit and loss account.


(iii) The shares were the capital of the assessee company and any loss to the capital can be considered as capital loss and not the revenue expenditure.


(iv) By allotting the shares the assessee has reduced the tax liability by an amount of Rs. 66,24,877/- .


(v) The employees also did not disclose the gain as taxable in their hands.”


13. For the reasons given above, the A.O. held that the loss suffered by the assessee as a result of allotment of shares to its employees under ESOP below the market price was on capital account and the same was not allowable as deduction.


14. The matter was carried before the ld. CIT(A) and reliance was placed on behalf of the assessee on the decision of Chennai Bench of ITAT in the case of SSI vs. DCIT reported in 85 TTJ 104 wherein it was held that ESOP will not be taxable either in the hands of the employees or in the hands of the employers. A reference again was made to the relevant SEBI Rules specifying the accounting treatment to be given to the difference between the market price and the price at which shares were allotted to the employees under ESOP. It was contented that the accounting treatment so prescribed is required to be adopted even for Income Tax purpose and the difference amount debited as expenditure in the P&L account has to be allowed as deduction being expenditure incurred wholly and exclusively for the purpose of business. It was contended that ESOP was one of the ways to compensate the top management employees of the assessee company in order to stay with it and do hard work so that the company could earn more profit.


15. The submissions made on behalf of the assessee on this issue did not find favour with the ld. CIT(A) who confirmed the disallowance made by the A.O. on account of assesse's claim for deduction on account of ESOP expenditure for the following reasons given in para 6.3 and 6.4 of his impugned order:


“ I have carefully considered the submission of the appellant and perused the order of the Assessing Officer. The appellant has formulated employees stock option scheme and granted 800000 shares @ 30 per share on 22.11.2004. At the time of granting option, the market price of the share was 53.80. Thus there was a price difference 23.80 per share on the total shares allotted of 800000 which comes to ` 190.40 lakhs. Out of the said amount the assessee company has charged to the Profit & Loss account a sum of ` 66.25 lakhs in this year and the balance in A.Y. 06-07. The Assessing Officer has not allowed this expenditure being a capital expenditure on the ground that by allotting the shares the assessee has reduced tax liability by an amount of Rs.66,24,877/-. The appellant has relied on the decision of Hon'ble Chennai ITAT in the case of SSI v. DCIT 85 TTJ 1049 in which the Tribunal has held that ESOPS received by the employees was not taxable as perquisites by virtue of proviso to section 17(2)(3c) of the I.T. Act which is omitted with effect from 1.4.2008 by Finance Act 2007. Since the amount of ESOPS was not perquisited in the hands of the employees, the same was not allowable as expenditure in the hands of the company also. This fact has not properly represented before the ITAT Chennai by the Department. Moreover, the decision of ITAT is with reference to appeal against the revision order passed by CIT u/s 263 and not on the basis of regular appeal. In view of this fact, I respectfully dis-agree with the observation of the Hon'ble ITAT that ESOPS expenditure is allowable as revenue expenditure to the assessee.


The appellant's contention that whatever is correct under accounting practices is also correct for tax purpose cannot be accepted. There is no provision under the income tax Act to allow distribution of capital by way of share or difference in market price of shares as allowable expenditure u/s 37 of the IT Act. When the company received any premium on allotment of shares over and above the issue price the same is credited to the premium reserve account and it never offered as taxable income or revenue receipt. In the same logic any capital distribution over and above on account of difference of the cost of shares and its market price of the share under ESOP scheme is going to reduce the reserve and allowable as business expenditure u/s. 37(1) of the I.T. Act. The appellant has not explained that in allotting shares to the employees, it incur any revenue loss on account of the price difference. In view of the above, the Assessing Officer is justified in not allowing an amount of ` 66,24,877/- as business expenditure to the appellant. The disallowance made by the Assessing Officer is confirmed. This ground of appeal is not allowed.”


16. The ld. Counsel for the assessee submitted that ESOP 2004 framed by the assessee company was approved by its Board of Directors as well as in its Annual General Meeting held on 24.9.04. He submitted that as specified in the relevant SEBI Rules, the difference between the market value of shares and value at which they were allotted under the scheme was debited by the assessee company in its P&L account and note to this effect was also given in the notes forming part of the final accounts of the assessee company. He submitted that the option under the scheme was granted by the assesasee company to its employees on 22.11.04 and since the same was vested with them on 30.11.05, the total expenses of Rs. 190.40 lacs were written off during the year under consideration as well as in the subsequent year on pro rata basis taking the vesting period as 22.11.04 to 30.11.05. He contended that the expenditure incurred by the assessee on ESOP being the difference between the market price of shares and the price at which the said shares were allotted to the employees was taxable as perquisite in the hands of the employees as per the provisions of section 17(2)(iii)(c) upto 31.3.01 and the same has now been treated as fringe benefit w.e.f. 1.4.08 whereby the benefit given to the employees is treated as fringe benefit and the company has to pay fringe benefit tax. He contended that this treatment given by the statute to ESOP itself shows that the expenditure incurred on ESOP is of revenue nature and there was no justification for the authorities below to treat the same as capital expenditure. In support of this contention, he relied on the decision of Hon'ble Supreme Court in the case of CIT vs. Infosys Technologies Ltd. 297 ITR 16. He also relied on the decision of Chennai Bench of ITAT in the case of SSI vs. DCIT (supra) to contend that once the ESOP is granted and exercised by the employees, the liability of the company in this behalf is an ascertained liability which is admissible an expenditure in accordance with the SEBI guidelines. He contended that the assessee company had an option to pay even directly to its employees certain sum as compensation for the services rendered without taking ESOP rout and the employees could have used the said amount for acquiring the shares in the assessee company. He contended that the payment made to employees in such scenario would have been considered as allowable business expenditure. He also contended that the ESOP was framed by the assessee company to give incentive to its top management employees in order to encourage them to continue to stay with the assessee company and also to do hard work so that the company can earn more profit. He contended that the ESOP expenditure thus was incurred by the assessee wholly and exclusively for the purpose of its business and the same being revenue in nature should be allowed as deduction.


17. The ld. D.R., on the other hand, submitted that this issue is squarely covered in favour of the Revenue and against the assessee by the decision of the Delhi Bench of ITAT in the case of Ranbaxy laboratories Ltd. vs. Addl. CIT 124 TTJ (Del) 771. He submitted that in the said case involving in similar facts and circumstances, the co-ordinate Bench of this tribunal has held that the issue of shares under ESOP at less than market price only results in short receipt of share premium and not in incurring of any expenditure within the meaning of section 37. It was held that such notional loss therefore cannot be allowed as deduction.


18. In the rejoinder, the ld. Counsel for the assessee submitted that the Tribunal while deciding a similar issue against the assessee in the case of Ranbaxy Laboratories Ltd. (supra) cited by the ld. D.R. has not taken into consideration several material aspects. He contended that the Tribunal has not considered the vital aspect that ESOP was taxable as perquisite in the hands of employees upto A.Y. 2000-01 and the same has subsequently been made liable to FBT as perquisite from A.Y. 2008-09. He contended that even the important aspect of business consideration involved in allotment of shares to the permanent employees under ESOP was not considered by the Tribunal. He pointed out that even the decision of Chennai Bench of ITAT in the case of SSI (supra) was cited on behalf of the assessee before the Tribunal but the same has not been followed on the ground that the issue in the said case was involved in the context of order passed by the CIT u/s 263. He contended that even the SEBI guidelines specifying the accounting treatment for the difference in the market value of shares and the value at which the same were allotted to the employees under ESOP were not properly appreciated by the Tribunal in the case of Ranbaxy Laboratories Ltd. (supra). According to him, even the cases relied upon by the Tribunal to decide the similar issue against the assessee in the case of Ranbaxy Laboratories Ltd. (supra) involved different issue and the same were also distinguishable on facts.


19 We have heard the arguments of both sides and also perused the relevant material on record. We have also carefully perused the case laws cited by the ld. Representatives of both the sides. In our opinion, the decision of Delhi Bench of ITAT in the case of Ranbaxy Laboratories Ltd. (supra) cited by the ld. D.R. is directly applicable in the present case and the same squarely covers the issue under consideration against the assessee and in favour of the Revenue. In the said case, the decision of Chennai Bench of ITAT in the case of SSI Ltd. (supra) heavily relied upon by the learned counsel for the assessee in the present case was also cited on behalf of the assessee. The same, however, was found by the Tribunal to be distinguishable on facts for the following reasons given in para 7.16 of its order:


“ The decision of Tribunal, Chennai in the case of S.S.I. Ltd. (supra) relied upon by the learned counsel for the assessee is also distinguishable on facts. In the case the assessee claimed similar expenditure which was allowed by the Assessing Officer. The learned CIT in his revision jurisdiction under s. 263 held such expenditure as notional and contingent in nature. The Tribunal held that in view of SEBI guidelines which the assessee was required to follow, such expenditure are in the nature of ascertained liability and not contingent liability upon happening of certain events. Hence, it was held that the order was not erroneous so as to be validly revised under s. 263 of the Act. However, the Tribunal in the said case has not answered the issue whether the loss is notional in nature or not. The Tribunal has also not considered the decision of Hon'ble Supreme Court in the case of Eimco K.C.P. Ltd. (supra) and that of Delhi High Court in the case of Reinz Talbros (P) Ltd. (supra) which is a jurisdictional High Court for us. For all the reasons stated above we, therefore, hold that the expenses as claimed by the assessee are not allowable as such.”


20. In the case of Ranbaxy Laboratories Ltd. (supra), shares were allotted by the assessee company to its employees under ESOP at price less than the market price and the resultant difference was claimed as expenditure relying, inter alia, on SEBI guidelines. The Tribunal, however, confirmed the disallowance made by the authorities below on account of the said expenditure after examining all the relevant aspects and after giving elaborate reasons as can be seen from the relevant portion of its order which is extracted from the held portion:


“ The assessee was to issue shares of face value of Rs.10 /- by receiving a sum of Rs.595/- per share from its employees. Thus the assessee was entitled to receive Rs.585/- towards premium on issue of shares. The market price at Rs. 738.95 per share would have resulted in realization of higher share premium. The assessee has not accounted for the difference between Rs.738.95 and Rs.10/- as its income during the year. Thus there is no loss of income held to be taxable. What is loss to the assessee is by way of short receipt of share premium amount and not by way of any expenditure or incurring any liability for such expenditure. By issuing shares at below market price, the same does not result into incurring any expenditure. By issuing shares at below market price, the same does not result into incurring any expenditure rather it results into short receipt of share premium which the assessee was otherwise entitled to. Though the guidelines of SEBI requires the assessee to account for short receipt of share premium as employees compensation expense, for claiming such expense as allowable, the assessee has to qualify that expenses are incurred and the same are wholly and exclusively for the purpose of business. By issuing shares at lesser that market price, the assessee cannot be said to have incurred any expenditure rather it amounts to short receipt of share premium. The receipt of share premium is not taxable and hence any short receipt of such premium will only be a notional loss and not actual loss for which no liability is incurred. SEBI guidelines are relevant for the purpose of accounting but are not conclusive for the purpose of allowing the same as expenditure. Therefore, such notional losses are not allowable under the Act. The assessee is not to defray or pay any liability under the claim. Therefore, such notional loss cannot be held to be allowable under the scheme of the Act.


What is allowable under s. 37 is any expenditure not being expenditure of the nature described in ss. 30 to 36 and not being in the nature of capital expenditure or personal expenditure of the assessee. Such expenditure should be wholly and exclusively for the purpose of business. Thus, the prerequisite is that the assessee should have incurred an expenditure. ‘Expenditure' is what is ‘paid out or away' and is something which has gone irretrievably. A benefit or income foregone cannot be considered as in expenditure. Since the assessee had not incurred any expenditure but has merely received lesser amount of share premium, the same does not amount to expenditure within the meaning os s. 37. Therefore, the claim of assessee is not allowable. – Eimco K.C.P. Ltd. Vs. CIT (2000) 159 CTR (SC) 137 : (2000) 242 ITR 659 (SC) and CIT vs. Reinz Talbros (P) Ltd. (2001) 252 ITR 637 (Del) followed.


It is now settled law that entry or absence thereof in books of account is not conclusive either for treating the amount as income or allowability or otherwise of the expenditure. Thus, only on the basis of entry in the books of account the claim of expenditure is not allowable. The entry is made on the basis of recommendation of SEBI which is said to be mandatory for a listed company. The same may be relevant for the purpose of accounting but for allowability of expenditure under IT Act the direction of SEBI does not determine the alowability of expenditure. For the purpose of allowability of expenditure under IT Act the same has to be in consonance with the scheme of the Act. In the instant case the entry made in books of accounts as per direction of SEBI cannot be held to be conclusive for the purpose of allowing expenditure under s. 37. Unless the provision of s. 37 is complied with, the deduction is not permissible.- New India industries Ltd. Vs. asstt. CIT (2007) 112 TTJ (Del)(SB) 917 : (2008) 1 DTR (Del) (SB) (Trib) 247 and TVS Finance & services Ltd. Vs. jt. CIT (2009) 23 DTR (Mad) 33”


21. At the time of hearing before us, the ld. Counsel for the assessee has made an attempt to point out that certain aspects have not been considered by the tribunal while rendering its decision in the case of Ranbaxy Laboratories Ltd. (supra) on the similar issue. In our opinion, the said aspects pointed out by the ld. Counsel for the assessee, however, are not material enough to have any direct bearing on the well considered and well reasoned decision rendered by the Tribunal. As held by the Tribunal, any short receipt of share premium would only be a notional loss to the assessee and not an actual loss. As further held by the Tribunal, any benefit or income foregone by the assessee cannot be considered as an expenditure and since the assessee had not incurred any expenditure but had merely received lesser amount of premium, the same could not amount to expenditure within the meaning of section 37. In our opinion, the issue involved in the present case as well as all the material facts relevant thereto are thus similar to the case of Ranbaxy laboratories Ltd. (supra) and the decision rendered in the said case by the co-ordinate Bench of this Tribunal is squarely applicable in the present case. Even the decision of Hon'ble Supreme Court in the case of CIT vs. Infosys Technologies Ltd. (supra) cited by the ld. Counsel for the assessee was rendered in altogether different context and the same cannot be of any help to the assessee on the issue involved in the present case. Respectfully following the decision of the co-ordinate Bench of this Tribunal in the case of Ranbaxy Laboratories Ltd. (supra), we uphold the impugned order of the ld. CIT(A) confirming the disallowance made by the A.O. on account of ESOP expenses claimed by the assessee and dismiss ground No. 6 of the assessee's appeal.