2023 (1) TMI 1263 - AT - Income Tax

Disallowance of foreign exchange loss by the AO and confirmed by the DRP - HELD THAT - As relying on case Woodward Governor India 2009 (4) TMI 4 - SUPREME COURT we direct the Assessing officer to delete the addition of foreign exchange loss . ESOP scheme expenditure and provisions of law on the allowability of claim - HELD THAT - We found that in the case of CIT(LTU) VS M/S Biocon Ltd 2020 (11) TMI 779 - KARNATAKA HIGH COURT as held deduction of discount on ESOP over the vesting period is in accordance with the accounting in the books of accounts which has been prepared in accordance with Securities And Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines 1999. Assessee has incurred a definite legal liability and on following the mercantile system of accounting the discount on ESOPs has rightly been debited as expenditure in the books of accounts. We are in respectful agreement with the view taken in PVP Ventures Ltd. 2012 (7) TMI 696 - MADRAS HIGH COURT And Lemon Tree Hotels Ltd. 2015 (11) TMI 404 - DELHI HIGH COURT Decided in favour of assessee.

Summary

Issues Involved:
1. Transfer Pricing Adjustments
2. Disallowance of Unrealized Foreign Exchange Loss
3. Disallowance of Employee Share Option Scheme (ESOP) Expense
4. Deduction in respect of Education Cess

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustments:
The assessee contested the adjustments made by the AO/TPO regarding the arm's length price of international transactions. These adjustments included Rs. 9,38,84,840 for scientific and technical services, Rs. 48,61,66,505 for enterprise support services, and Rs. 98,10,00,000 for royalty income. The assessee argued that the AO/TPO disregarded functionally comparable companies and failed to exclude pass-through costs from operating revenues and costs. The DRP directed the AO/TPO to revise these adjustments, resulting in a reduction of the total adjustment to Rs. 5,43,29,788. However, the grounds related to these adjustments were withdrawn by the assessee following the conclusion of an Advance Pricing Agreement (APA).

2. Disallowance of Unrealized Foreign Exchange Loss:
The AO disallowed an unrealized foreign exchange loss of Rs. 2,78,362, considering it merely an accounting entry and contingent in nature. The assessee argued that, as per mercantile accounting and applicable accounting standards, such losses should be allowed as they are marked to market on the closing balance sheet date. The Tribunal referred to the Supreme Court decision in CIT Vs. Woodward Governor India (P) Ltd., which held that loss due to foreign exchange difference as on the balance sheet date is an allowable expenditure under section 37(1). Consequently, the Tribunal directed the AO to delete the addition of the foreign exchange loss.

3. Disallowance of Employee Share Option Scheme (ESOP) Expense:
The AO disallowed ESOP expenses of Rs. 30,41,00,000, deeming them contingent, notional, and capital in nature. The assessee contended that these expenses are revenue in nature and should be allowed under section 37(1) as they are incurred to incentivize and retain employees. The Tribunal referred to the Karnataka High Court decision in CIT(LTU) Vs. M/s Biocon Ltd., which established that ESOP expenses are an ascertained liability and deductible under section 37(1). The Tribunal followed this precedent and directed the AO to delete the addition, allowing the ESOP expenses as deductible.

4. Deduction in respect of Education Cess:
The ground related to the deduction of education cess was not pressed by the assessee and was subsequently withdrawn.

Conclusion:
The Tribunal partly allowed the appeal, directing the deletion of additions related to the unrealized foreign exchange loss and ESOP expenses, while the grounds related to transfer pricing adjustments and education cess were withdrawn by the assessee. The order was pronounced on 02.01.2023.