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TMI Blog2017 (5) TMI 59X X X X Extracts X X X X X X X X Extracts X X X X ..... he company was held by REL. Since this fact has not been verified either by the Ld. AO or by the Ld. CIT-A, we feel it appropriate to restore the issue to the file of the Assessing Officer to verify the applicability of section 40A(2)(b) of the Act and decide the issue afresh in accordance with law. Not taking on record Memorandum of Understanding holding that the same being in the nature of additional evidence - Held that:- As we find that this Memorandum of Understanding goes to the root of the matter hence, the Assessing Officer is directed to also consider this Memorandum of Understanding while adjudicating the issue no. 3. This ground of appeal is allowed. Depreciation on UPS - @ 15% or 60% - Held that:- The Hon’ble High Court in the case of BSES Rajdhani Powers Ltd. (2010 (8) TMI 58 - DELHI HIGH COURT ) held that the computer accessories are peripherals such as, scanners and server etc. form an integral part of the computer system and the same cannot be used without the computer. Thus, they are entitled to depreciation at the higher rate of 60%. X X X X Extracts X X X X X X X X Extracts X X X X ..... of ₹ 29,19,920 was in the nature of employee compensation allowable as deduction under section 37(1) of the Act. 2.2 Without prejudice, and in the alternative, the Commissioner of Income tax (Appeals) erred on facts and in law in not allowing deduction of the above differential amount of ₹ 29,19,920 under section 36(1 )(ii) of the Act alleging that the same was not in accordance with the provisions of the Payment of Bonus Act, 1965. 3. That the Commissioner of Income tax (Appeals) erred on facts and in law in confirming the disallowance of ₹ 81,85,383 made under section 40A(2)(b) of the Act on account of rental payments made to Religare Securities Ltd.('RSL') and Religare Realty Ltd ('RRL'). 3.1 That the Commissioner of Income tax (Appeals) erred on facts and in law in not appreciating that provisions of section 40A(2)(b) of the Act were not applicable in the above transaction inasmuch as : (a) RSL and RRL were not specified entities covered under that section; and (b) without prejudice, the payment of rent to RSL and RRL was neither excessive nor unreasonable having regard to the fair market value of such rental payment. 4. That the Commissioner o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... /2013 and 3634/Del/2014 for assessment years 2008-09 and 2009-10 respectively, where in the same issue of stock Appreciation Right was involved. 4.2 On the other hand, learned Sr. DR relied on the order of the lower authorities. 4.3 We have heard the rival submissions and perused the relevant materials on record, especially the order of ITAT passed in the case of M/s Religare Commodities Ltd. in ITA Nos. 2283/Del/2013 and 3634/Del/2014 (supra) wherein we find that the issue in dispute has decided in favour of the assessee. The relevant portion of the decision is reproduced as under: "7. We have carefully considered the rival contentions and material placed before us. We have also perused the various judicial precedent placed before us. The claim of the assessee was that the assessee has introduced the writ stock option scheme to motivate reward and retained the employees including employees of its subsidiaries and it was implemented through separate employees stock option trust. The assessee was granted stock appreciation rights, which were equivalent to one share of the assessee aggregating to 532630 stock appreciation rights. To honour its commitment the trust purchased the eq ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... been described by the Hon'ble Supreme Court in the case of Indian Molasses Co. (P.) Ltd. v. CIT [1959] 37 ITR 66 as denoting spending or paying out, i.e. something going out of the coffers of the assessee. It was put forth that by issuing shares at discounted premium, nothing is paid out by the company. Once there is no "paying out or away", the same cannot constitute an expenditure and resultantly section 37(1), which applies to only expenditure, cannot be activated. He further took pains in explaining that there is no revenue expenditure involved in the transaction of issuance of ESOP at discount. The so called 'discount' represents the difference between market price of the shares at the time of grant of options and the price at which such options are granted. Since the amount over and above the face value of the shares, being the share premium, is itself a capital receipt, any under-recovery of such share premium on account of obligation to issue shares to employees in future at a lower premium, would be a case of short capital receipt. If at all it is to be viewed in terms of expenditure, then, at best, it would be in the nature of a capital expenditure. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Tribunal. It was held by the Tribunal that the market price of ₹ 738.55 per share would have resulted in realization of higher share premium. Since the assessee did not account for the difference between ₹ 738.55 and ₹ 10 as its income during the year, there was no loss of income. It was further noticed that by issuing shares at below the market price, there was no incurring of any expenditure. Rather it resulted into short receipt of share premium which the assessee was otherwise entitled to. As the receipt of share premium is not taxable, any short receipt of such premium will only be a notional loss and not actual loss requiring any deduction. The Tribunal further noticed that incurring of such notional loss cannot be considered as expenditure within the meaning of section 37(1) as there was no "spending" or "paying out or away". The contention of the assessee that SEBI Guidelines recommend claim for deduction of discount over the vesting period, did not find favour with the Tribunal on the ground that the SEBI Guidelines were not relevant in determining the total income chargeable to tax. 9.2.4 In order to appreciate the rival submission ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2.6 There is no doubt that the amount of share premium is otherwise a capital receipt and hence not chargeable to tax in the hands of company. The Finance Act, 2012 has inserted clause (viib) of section 56(2) w.e.f. 1.4.2013 providing that: 'where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares', then such excess share premium shall be charged to tax under the head 'Income from other sources'. But for that, the amount of share premium has always been understood and accepted as a capital receipt. If a company issues shares to the public or the existing shareholders at less than the otherwise prevailing premium due to market sentiment or otherwise, such short receipt of premium would be a case of a receipt of a lower amount on capital account. It is so because the object of issuing such shares at a lower price is nowhere directly connected with the earning of income. It is in such like situat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... can describe such discount as either a short capital receipt or a capital expenditure. It is nothing but the employees cost incurred by the company. The substance of this transaction is disbursing compensation to the employees for their services, for which the form of issuing shares at a discounted premium is adopted. 9.2.7 Now we espouse the second part of the submission of the ld. DR in this regard. He canvassed a view that an expenditure denotes "paying out or away" and unless the money goes out from the assessee, there can be no expenditure so as to qualify for deduction u/s 37. Sub-section (1) of the section provides that any expenditure (not being expenditure in the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession". To put it differently, an expenditure must be laid out or expended wholly and exclusively for the purpose of business so as to be eligible for deduction u/s 37(1). ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the extent of covering "loss" in certain circumstances within the purview of "expenditure" as used in section in 37(1). In that case, the assessee incurred additional liability due to exchange rate fluctuation on a revenue account. The Assessing Officer did not allow deduction u/s 37. When the matter finally reached the Hon'ble Supreme Court, their Lordships noticed that the word "expenditure" has not been defined in the Act. They held that : "the word "expenditure" is, therefore, required to be understood in the context in which it is used. Section 37 enjoins that any expenditure not being expenditure of the nature described in sections 30 to 36 laid out or expended wholly and exclusively for the purposes of the business should be allowed in computing the income chargeable under the head "profits and gains of business or profession". In sections 30 to 36 the expression "expenditure incurred", as well as allowance and depreciation, has also been used. For example depreciation and allowances are dealt with in section 32, therefore, the parliament has used expression "any expenditure" in section 37 to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ible in respect of an ascertained liability and not a contingent liability. Section 31 of the Indian Contract Act, 1872 defines "contingent contract" as "a contract to do or not do something, if some event, collateral to such contract does not happen". We need to determine as to whether the liability arising on the assessee-company for issuing shares at a discounted premium can be characterized as a contingent liability in the light of the definition of contingent contract. From the stand point of the company, the options under ESOP 2000 vest with the employees at the rate of 25% only on putting in service for one year by the employees. Unless such service is rendered, the employees do not qualify for such options. In other words, rendering of service for one year is sine qua non for becoming eligible to avail the benefit under the scheme. Once the service is rendered for one year, it becomes obligatory on the part of the company to honor its commitment of allowing the vesting of 25% of the option. It is at the end of the first year that the company incurs liability of fulfilling its promise of allowing proportionate discount, which liability would be actually d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the case of Bharat Earth Movers (supra) to the provision for leave encashment has been nullified. However, the principle laid down in the said judgment is absolutely intact that a liability definitely incurred by an assessee is deductible notwithstanding the fact that its quantification may take place in a later year. The mere fact that the quantification is not precisely possible at the time of incurring the liability would not make an ascertained liability a contingent. 9.3.4 Almost to the similar effect, there is another judgment of the Hon'ble Supreme Court in the case of Rotork Controls India (P.) Ltd. v. CIT [2009] 314 ITR 62/180 Taxman 422. In that case, the assessee-company was engaged in selling certain products. At the time of sale, the company provided a standard warranty that in the event of certain part becoming defective within 12 months from the date of commissioning or 18 months from the date of dispatch, whichever is earlier, the company would rectify or replace the defective parts free of charge. This warranty was given under certain conditions stipulated in the warranty clause. The assessee made a provision for warranty at ₹ 5.18 lakh towards the wa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... therto claimed as deduction is required to be reversed and offered for taxation in such later year. We, therefore, hold that the discount in relation to options vesting during the year cannot be held as a contingent liability. C. Fringe benefit 9.4.1 There is another important dimension of this issue. Chapter XII-H of the Act consisting of sections 115W to 115WL with the caption : "Income- Tax on Fringe Benefits" has been inserted by the Finance Act, 2005 w.e.f. 1.4.2006. Memorandum explaining the provisions of the Finance Bill, 2005 highlights the details of the Fringe Benefits Tax. It provides that : 'Fringe benefits as outlined in section 115WB, mean any privilege, service, facility or amenity directly or indirectly provided by an employer to his employees (including former employees) by reason of their employment.' Charging section 115WA of this Chapter provides that : "In addition to the income-tax charged under this Act, there shall be charged for every assessment year………..fringe benefit tax in respect of fringe benefits provided or deemed to have been provided by an employee to his employees during the previous year…&hell ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or the year in which right to receive was finally acquired. In the same manner, an expense becomes deductible when liability to pay arises irrespective of its actual discharge. The incurring of liability and the resultant deduction cannot be marred by mere reason of some difficulty in proper quantification of such liability at that stage. The very point of incurring the liability enables the assessee to claim deduction under mercantile system of accounting. We have noticed the mandate of the Hon'ble Supreme Court in Bharat Earth Movers (supra) that if a business liability has definitely arisen in an accounting year, then the deduction should be allowed in that year itself notwithstanding the fact that such liability is incapable of proper quantification at that stage and is dischargeable at a future date. It follows that the deduction for an expense is allowable on incurring of liability and the same cannot be disturbed simply because of some difficulty in the proper quantification. A line of distinction needs to be drawn between a situation in which a liability is not incurred and a situation in which the liability is incurred but its quantification is not possible at the mate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the employee after rendering one year's service, the company also incurs equal obligation at the end of the first year for which it becomes entitled to rightfully claim deduction u/s 37(1) of the Act. Similarly at the end of the second year of service by the employees, the company can claim deduction for discounted premium in respect of further 25 shares so on and so forth till fourth year when the last tranche of discounted premium in respect of 25 shares becomes available for deduction. It, therefore, transpires that a company under the mercantile system can lawfully claim deduction for total discounted premium representing the employees cost over the vesting period at the rate at which there is vesting of options in the employees. 10.5 From the above discussion it is lucid that at the event of granting options, the company does not incur any obligation to issue the shares at discounted premium. Mere granting of option does neither entitle the employee to exercise such option nor allow the company to claim deduction for the discounted premium. It is during the vesting period that the company incurs obligation to issue discounted shares at the time of exercise of option ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to employees at the option price of ₹ 10 as against the market price of such shares at ₹ 110 on that date. Further suppose that the vesting period is four years with equal vesting @ 25% at the end of each year. Total discount comes to ₹ 100 (Rs. 110 - ₹ 10). These Guidelines provide for claiming deduction in the accounts for a total discount of ₹ 100 divided over the vesting period of four years on straight line basis at the rate of ₹ 25 each. The case of S.S.I. Ltd. (supra) deals with a controversy relating to one of the vesting years. The tribunal entitled the assessee to proportionate deduction. Thus it is evident that the view taken by the tribunal in that case not only matches with the SEBI Guidelines but also the 'accrual concept' in the mercantile system of accounting, thereby allowing deduction at the stage of incurring of liability. 10.8 Reverting to the questions of 'when' and 'how much' of deduction for discount on options is to be granted, we hold that the liability to pay the discounted premium is incurred during the vesting period and the amount of such deduction is to be found out as per the terms of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tative amount of deduction earlier claimed on the basis of the market price at the time of grant of option ceases to be admissible and hence needs to be reversed. The ld. AR stated that the discount in respect of the unvested/lapsing options has been reversed on the happening of such events and the overall employee cost has been correspondingly reduced. We find that the SEBI Guidelines also provide that the discount written off in respect of unvested options and the options lapsing at the end of the exercise period shall be reversed at the appropriate time. As the accounting treatment directed through the Guidelines accords with the taxation principle of not allowing deduction for the amount of discount on unvested/lapsing options and further the assessee has admitted to have offered such amount as income in the relevant years, we stop here by holding that the amount of discount claimed as deduction earlier in respect of unvested/lapsing options, has to be taxed as income on the happening of such events. 11.1.4 Now we take up the second situation in which the options are exercised by the employees after putting in service during the vesting period. In such a scenario, the actual ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ount actually paid. The position that such amount was or was not taxable during some of the years in the hands of the employees is not relevant in considering the occasion and the amount of benefit accruing to the employee under ESOP. Any exemption or the deductibility of an allowance or benefit to employee from taxation does not obliterate the benefit itself. It simply means that the benefit accrued to the assessee but the same did not attract tax. The position has now been clarified beyond doubt by the legislature that the ESOP discount, which is nothing but the reward for services, is a taxable perquisite to the employee at the time of exercise of option, and its valuation is to be done by considering the fair market value of the shares on the date on which the option is exercised. 11.1.5 The other side of the coin is the amount of remuneration to the employees in the hands of the company. We have noticed earlier that an expense becomes deductible on the incurring of liability under the mercantile system of accounting. Although the stage of taxability of perquisite in the hands of the employee may differ from the stage of the deductibility of expense in the hands of the compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iscount 100 100 120 80 11.1.7 From the above table it can be noticed that the market price of the shares at the time of grant of option was ₹ 110 against the option price of ₹ 10, which resulted in discount at ₹ 100. With the vesting period of four years with the equal vesting, the company can rightly claim deduction at the rate of ₹ 25 each at the end of first, second, third and fourth year of vesting. But this total deduction for discount of ₹ 100 over the vesting period needs to be adjusted at the time of exercise of option by the employee when the shares are issued. In Situation I, the market price of shares at the time of exercise of option is at ₹ 110, which is similar to the market price at the time of grant of option. As the total amount of discount of ₹ 100 over the vesting period is actually quantified at ₹ 100, no further adjustment to the discount is required at the time of exercise of option. In Situation II, the market price of the share at the time of exercise of option has gone up to ₹ 130. The amount of real compensation to employee is ₹ 120 as against the tentative compensation of ₹ 100 per sh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has held that the interest payable on capital borrowed by the assessee for purchase of plant and machinery before the commencement of business should be capitalized on the basis of accepted accountancy rule. Similarly in the case of U.P. State Industrial Development Corpn. (supra), the Hon'ble Apex Court held in the case of an underwriter that it would be right to consider the net investment, that is the purchase price less the underwriting commission received by the underwriter as investment as against treating the gross amount by taking into consideration the principles of commercial accounting. He stated that since there is no specific provision in the Act providing for the treatment of discount on ESOP in the computation of total income, the accounting principles formulated by way of the SEBI Guidelines are required to be followed. 11.2.2 In the oppugnation, the learned Departmental Representative submitted that the SEBI Guidelines cannot mandate the deductibility or otherwise of an amount under the provisions of the Act. He relied on the judgments of the Hon'ble Supreme Court in Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) and Godhra Electricity Co. Ltd. ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ditions, gain deductibility under section 37(1). To put it in simple words, this section is a specific provision for granting deduction in respect of the unspecified or the general categories of expenses. Discount on ESOP is a general expense and hence covered by the specific provision of section 37. The contention of the ld. AR that there is no provision in the Act dealing with the deductibility of ESOP discount, is therefore, devoid of any merit. This concludes the question of granting of deduction of discount during the vesting period. 11.2.5 The SEBI Guidelines have been taken shelter of to contend that there is no requirement for the adjustment of discount at the time of exercise of options. Primarily, we are unable to trace the proposition anywhere from the Act that the accounting principles are also determinative of the tax liability. The jurisprudence is rather the other way around. In Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra), the Hon'ble Supreme Court has laid down in so many words that the taxing principles cannot walk on the footsteps of the accounting principles. At this juncture, it would be useful to have a glimpse at the following observations of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the case of Challapalli Sugars Ltd. (supra), was also taken up before the Hon'ble Supreme Court in the case of Tuticorin Alkalis Chemicals & Fertilizers Ltd (supra). Dealing with the same, the Hon'ble Supreme Court held that : "The question in Challapalli Sugars Ltd.'s case (supra) was about computation of depreciation and development rebate under the Indian Income-tax Act, 1922. In order to calculate depreciation and development rebate it was necessary to find out "the actual cost" of the plant and machinery purchased by the company. This court held that "cost" is a word of wider connotation than "price". There was a difference between the price of a machinery and its cost. This court thereafter pointed out that the expression "actual cost" had not been defined in the Act. It was, therefore, necessary to find out the commercial sense of the phrase. ………….The judgment in Challapalli Sugar Ltd's case (supra), goes to show that the court was not in any way departing from legal principles because of any opinion expressed by the Institute of Chartered Accountants." From the above observations ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alt with a situation in which the market price of the shares at the time of exercise of option is more or less than the market price at the time of grant of option. It is a situation which has also not been dealt with by the Guidelines. Accordingly, the aforenoted taxation principle of granting deduction for the additional discount and reversing deduction for the short amount of discount at the time of exercise of option, needs to be scrupulously followed. 11.3 We, therefore, sum up the position that the discount under ESOP is in the nature of employees cost and is hence deductible during the vesting period w.r.t. the market price of shares at the time of grant of options to the employees. The amount of discount claimed as deduction during the vesting period is required to be reversed in relation to the unvesting/lapsing options at the appropriate time. However, an adjustment to the income is called for at the time of exercise of option by the amount of difference in the amount of discount calculated with reference the market price at the time of grant of option and the market price at the time of exercise of option. No accounting principle can be determinative in the matter of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h the above parties. According to the Assessing Officer, above parties falls under the definition of persons given in section 40A(2)(b) of the Act and it was not possible to ascertain whether such expenditure was excessive/unreasonable having regard to the fair market value of goods, services or facilities for which payment is made for the legitimate needs of the business or profession in terms of section 40A(2)(a) of the Act and accordingly disallowed 25% of the above amount, which was worked out to ₹ 81,85,383/-. Before the Ld. CIT-A, the assessee filed memorandum of understanding entered into with aforesaid group companies but in absence of an application under Rule 46A of the Income Tax Rules, 1962, same was not admitted. The Ld. CIT-A further observed that the said MOU did not specify the amount of space, which was made available to the assessee under the agreement and only specified amount of rent, electricity and water charges to be paid with assessee and therefore the claim of the assessee that payment was neither unreasonable nor excessive could not be verified and the companies being related group companies in the same management and thus being covered under section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 15% as against depreciation claimed by the assessee @ 60%. 7.1 As regards to this issue, the learned counsel for the assessee submitted that the issue is squarely covered by the following decisions of the Hon'ble Delhi High Court: * CIT Vs. BSES Rajdhani Powers Ltd. in ITA No. 1266/2010 (Del.) * CIT Vs. Orient Ceramics & Industries Ltd.: 358 ITR 49 (Del.) * CIT Vs. Citicorp Maruti Finance Ltd., ITA No. 1712 and 1714/2010 (Del. H.C.) 7.2 On the other hand, Ld. Sr. DR relied on the orders of the lower authorities. 7.3 We have heard the rival submissions and perused the relevant material on record. The Hon'ble High Court in the case of BSES Rajdhani Powers Ltd. (supra) held that the computer accessories are peripherals such as, scanners and server etc. form an integral part of the computer system and the same cannot be used without the computer. Thus, they are entitled to depreciation at the higher rate of 60%. The relevant portion of the order reads as under: "3. However, upon a perusal of the file, we find that the higher rate of depreciation was allowed both by the Commissioner of Income Tax (Appeals) "CIT(A)"] and the Tribunal. In fact, the Tribunal in its impugned or ..... X X X X Extracts X X X X X X X X Extracts X X X X
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