2022 (8) TMI 1234 - HC - Income Tax

Allowable revenue expenditure u/s 37(1) - difference between the price at which stock options were offered to employees of the appellant company under ESOP and ESPS and the prevailing market price of the stock on the date of grant of such options - HELD THAT - As following the judgment of CIT vs. Biocon Ltd. 2020 (11) TMI 779 - KARNATAKA HIGH COURT the question of law is decided in favour of the assessee and it is held that the Income Tax Appellate Tribunal erred in law in holding that the difference between the price at which stock options were offered to employees of the appellant company under ESOP and ESPS and the prevailing market price of the stock on the date of grant of such options was not allowable revenue expenditure under Section 37(1) of the Income Tax Act, 1961. Accordingly, the impugned judgment of the Tribunal is set aside.

Summary

Issues involved:
Interpretation of Section 37(1) of the Income Tax Act, 1961 regarding the allowance of revenue expenditure for the difference between the price of stock options offered to employees under ESOP and ESPS and the prevailing market price on the date of grant.

Analysis:
The High Court considered the core issue of whether the difference between the grant price and the market price of shares under ESOPs can be claimed as a deduction under Section 37(1) of the Income Tax Act. The Court referred to the definition of 'employees stock option' under Section 2(15A) of the Companies Act, 1956, which allows employees to purchase securities at a predetermined price in the future. It was highlighted that the provision of Section 37(1) permits deduction for expenditure laid out or expended without the necessity of a cash pay out, emphasizing that the incurrence of expenditure is sufficient to attract the provision.

The Court examined the nature of ESOPs where employees are granted stock options at a discount, representing the difference between the market price of shares at the time of grant and the offer price. It was noted that the employees must fulfill obligations, such as rendering services during the vesting period, to be eligible to acquire shares under the scheme. The Court emphasized that if a business liability arises in an accounting year, it is deductible even if quantified and discharged in the future. Relying on previous judgments, the Court determined that the discount on ESOPs is not a contingent liability but an ascertained liability, making it an allowable deduction under Section 37(1) of the Act.

Furthermore, the Court clarified that the term 'expenditure' in Section 37(1) includes losses, indicating that issuing shares at a discount, where the difference between the issuance price and market value is absorbed by the assessee, qualifies as expenditure incurred for business purposes. The Court emphasized that the objective is to secure consistent employee services to earn profits, rather than wasting capital, establishing the deductibility of such expenditure under Section 37(1) of the Act.

In alignment with previous judgments and following the decision of the Karnataka High Court in a similar case, the High Court ruled in favor of the assessee, holding that the Income Tax Appellate Tribunal erred in law by disallowing the difference between the price of stock options and the prevailing market price as revenue expenditure under Section 37(1) of the Income Tax Act. Consequently, the impugned judgment of the Tribunal was set aside, and the appeal was disposed of accordingly.