2016 (4) TMI 905 - AT - Income Tax

Disallowance u/s 14A - Held that - We find that the AO had not mentioned as to how much expenditure was incurred by the assessee for earning tax free income. We are of the opinion that, if the assessee had not incurred any expenditure to earn tax free income, then, the AO cannot invoke the provisions of section 14A r.w. Rule 8D of the Rules. First of all, the AO has to record his satisfaction about invoking the provisions and has to decide the issue after obtaining the explanation of the assessee . We also do not endorse the view of the FAA that investment out of the own funds has no relevance for making the disallowance. We find that in the case of Om Prakash Khaitan (2015 (7) TMI 785 - DELHI HIGH COURT ), the Hon ble Delhi High Court has held that in order to disallow the expenditure there must be a nexus between the expenditure incurred and the income not forming the part of the total income. Considering the above, we reverse the order of the FAA. - Decided in favour of assessee Addition of the expenditure incurred under ESOP(Employee Stock Option Scheme) - Held that - We find that stock options of the parent company were offered to the employees of the assessee company, that the assessee had made payment of ₹ 1.07 crores to the parent company, that during the year FBT was paid for sum of ₹ 50.65 lakhs. In our opinion, once a stock option is granted to and exercised by the employee of an assessee the liability in that behalf is ascertained and cost is allowable in the year in which stock options are granted. We find that in the case of Novo Nordisk India Pvt. Ltd.(2013 (11) TMI 218 - ITAT BANGALORE), it has been held that in terms of ESOP if an assessee offers shares of its parent company to its employees, the difference between the FMV of the shares of the parent company on date of issue of shares and the price at which those shares were issued by the assessee to its employees had to be regarded as expenditure incurred for business purposes allowable u/s. 37(1) of the Act. Respectfully following the above decision, we decide Ground in favour of the assessee

Summary

Issues:
1. Disallowance u/s. 14A of the Act
2. Addition of expenditure under ESOP (Employee Stock Option Scheme)

Analysis:

Issue 1: Disallowance u/s. 14A of the Act
The appellant, a company engaged in executive search and consulting, challenged the disallowance of &8377; 2.74 lakhs under section 14A of the Income Tax Act. The Assessing Officer (AO) invoked Rule 8D of the Income Tax Rules, 1962, to make the disallowance based on the dividend income claimed by the appellant. The First Appellate Authority (FAA) upheld the AO's decision, citing the judgment of Godrej & Boyce Ltd. The Appellate Tribunal found that the AO did not specify the actual expenditure incurred for earning tax-free income and emphasized the need for a nexus between expenditure and income not forming part of total income. Relying on the case of Om Prakash Khaitan, the Tribunal reversed the FAA's order, stating that the AO must establish a connection between expenditure and non-taxable income. Ground No.1 was decided in favor of the appellant.

Issue 2: Addition of expenditure under ESOP
The AO added &8377; 56.40 lakhs to the appellant's income, alleging that the full amount debited under ESOP was not paid as Fringe Benefit Tax (FBT). The appellant argued that ESOP expenses and FBT payment were distinct concepts, and the FBT liability arises upon ESOP vesting in employees. The Tribunal noted that the appellant had paid FBT on a portion of the ESOP amount and treated the ESOP expenditure as compensation cost. Relying on precedents like Biocon Ltd. and Novo Nordisk India Pvt. Ltd., the Tribunal held that once stock options are exercised, the liability is ascertained, and the cost is allowable in the same year. Following the decision in Novo Nordisk India Pvt. Ltd., the Tribunal decided Ground No.2 in favor of the appellant.

In conclusion, the appeal filed by the appellant was allowed by the Appellate Tribunal, emphasizing the importance of establishing a direct link between expenditure and income for disallowance under section 14A and recognizing ESOP expenses as deductible business costs.