The assessee was an Indian company listed on a stock exchange in India. During the assessment year (AY) 2001-02, it granted stock options to it employees for 332,250 shares whereby shares with a face value of Rs 10 were to be issued at Rs 595 per share. The market price of the shares as on the date of grant was Rs. 738.95 per share.
The assessee claimed the difference between the market price and the issue price to its employees as employee compensation in its books of accounts. The charge to its financial statements was deferred over the vesting period (5 years) as deferred employees compensation.
The assessee claimed the deferred revenue expenditure in its return of income which was disallowed by the assessing officer (AO) on the basis that no liability had arisen or been paid by the assessee during the year. The Commissioner of Income–tax (Appeals) (CIT(A)) held that the deduction is allowable in the year in which the option is exercised by the employees i.e. when the liability became certain and not proportionately over the vesting period as claimed by the assessee.
The assessee and the revenue, both filed an appeal before the Income Tax Appellate Tribunal (ITAT).
Contentions of the Revenue
- The assessee had neither incurred any expenditure nor had any liability to pay.
- To the extent of receipt of a lower amount towards share premium, the loss could be said to be a notional loss.
- The share premium received by the assessee was not its income and hence if the assessee received a lower amount by way of share premium, the assessee does not incur any expenditure so as to claim the same as allowable.
- The Security Exchange Board of India (SEBI) guidelines are not conclusive to determine the allow ability of expenses for income-tax purposes.
- Hence, the assessee is not entitled to claim a deduction for such expenses.
Contentions of the Assessee
- The shares were issued under Employees Stock Option Plan (ESOP) Scheme framed as per the SEBI guidelines, and the charge to the financial statements over the period of vesting is in keeping with the guidelines.
- The grant of shares during the year is a benefit provided to the employees and hence is an allowable deduction for income-tax purposes.
- Once grants are issued by the assessee to its employees under the ESOP, the liability crystallizes in the hands of the assessee.
- The fact that, at a subsequent date, the employees may not exercise the option would only have the effect of remission / cessation of the liability at a future date. This would not imply that the liability of the assessee would crystallize as and when options are exercised by the employees, as held by the CIT(A).Since the liability towards employee compensation can be estimated with reasonable certainty, under the mercantile system of accounting followed by the assessee, a liability towards the said compensation has definitely arisen.
- In this connection, reliance was placed on the following rulings wherein it has been held that an incurred liability which is payable in the future is allowable if it is quantified on a reasonable basis:
– Calcutta Co. Ltd. vs. CIT, 36 ITR 1 (SC);
– Metal Box Company vs. Their Workmen, 73 ITR 53 (SC); and
– Bharat Earthmovers vs. CIT, 245 ITR 428 (SC).
- Reliance was also placed on the decision in SSI Ltd. vs. DCIT, 85 TTJ 1049 (Chennai ITAT) wherein an identical issue had been held in favour of the assessee.
Ruling of the ITAT :- The ITAT followed its decision in earlier years i.e. in AY 2002-03 and 2003-04, and reproduced those paras.
- Issuing shares at below market price does not result in incurring any expenditure; rather it amounts to short receipt of share premium.
- The requirement by SEBI Guidelines to recognize a cost does not automatically lead to a deduction for the income-tax purposes.
- The facts of the present case differed from the facts of the decisions relied upon by the assessee wherein the assessees was required to discharge some liability at a future date. In the present case, the assessee does not have to discharge any liability by making any payment.
- The decision in SSI Ltd was distinguishable on facts and the Tribunal in that case did not deliberate on the issue of whether the loss is notional in nature.
Conclusion :- The ITAT dismissed the appeal of the Revenue and the assessee by holding that the discount on stock options was notional in nature and was not deductible either in the year of grant or in the year when the option is exercised by the employees. In reaching the conclusion, the main consideration by the ITAT was the argument that the difference between market price and grant price is only a notional expenditure. Where ESOPs are granted by overseas parent companies and the difference between market price and grant price is charged to the Indian subsidiary, the allow ability of expenditure would require further evaluation.