Discount on issue of ESOP is allowable deduction: Karnataka HC

PCIT Vs SAP India Pvt. Ltd. (Karnataka High Court)

Background: The Revenue filed an appeal under Section 260A of the Income Tax Act, 1961, challenging the order dated 19.04.2023 passed by the Income Tax Appellate Tribunal (ITAT), Bangalore in IT(TP)A No.874/Bang/2022 for the Assessment Year (AY) 2017-18.

The appellant (Revenue) raised the following substantial questions of law:

1. Whether the ITAT was correct in holding that the discount on the issue of Employee Stock Option Plans (ESOPs) is an allowable deduction under “profits and gains of business”?
2. Whether the ITAT erred in deleting the disallowance in respect of ESOP discounts, despite the fact that the discount represents the fair market value over the face value of a capital receipt, making any shortfall in the share premium tantamount to a capital loss, which cannot be debited under the profit and loss account?
3. Whether the ITAT was correct in law in allowing the assessee’s claim for ESOP-related expenses, despite the fact that the expenditure was notional, contingent on the completion of the vesting period by employees, and not an allowable expenditure under Section 37(1) of the Income Tax Act?

Facts of the Case: The assessee, SAP India Pvt. Ltd., primarily engaged in sub-licensing, distribution, and after-sale support for SAP-SE products, filed revised returns for AY 2017-18. During scrutiny, the Assessing Officer (AO) disallowed the deduction claimed for the discount on the issuance of ESOPs, treating it as a revenue expenditure. The Dispute Resolution Panel (DRP) affirmed the AO’s disallowance.

The assessee then appealed to the ITAT, which allowed the claim, relying on its earlier decision in Novo Nordisk India (P) Ltd. (2014). The Revenue, aggrieved by this, filed the present appeal before the Karnataka High Court.

Submissions and Findings:

1. Revenue’s Argument: The Revenue argued that ESOP-related expenses are not allowable under Section 37(1) as they are notional and contingent. Furthermore, it contended that any shortfall in the receipt of share premiums is a capital loss and not deductible under “profits and gains of business.” The DRP had supported this view by referring to relevant legal provisions.
2. Assessee’s Counter-Argument: The assessee, represented by learned counsel, relied on the Karnataka High Court’s decision in CIT, LTU v. Biocon Ltd. (2020), where it was held that discounts on ESOPs are allowable expenses under Section 37(1) of the Income Tax Act.
3. Court’s Ruling: The Court noted that the Tribunal’s reliance on Biocon Ltd. had not been disputed by the Revenue. In light of the binding precedent established in Biocon Ltd., the Court found no merit in the Revenue’s arguments. Since no substantial question of law arose, the appeal was dismissed.

Conclusion:
The Karnataka High Court, upholding the ITAT’s order, reiterated that discounts on the issuance of ESOPs are allowable deductions under Section 37(1) of the Income Tax Act, in line with the decision in Biocon Ltd. The appeal by the Revenue was dismissed as devoid of merit.

FULL TEXT OF THE JUDGMENT/ORDER OF KARNATAKA HIGH COURT

The present appeal is filed under Section 260A of the Income Tax Act, 1961¹ by the Revenue challenging the order dated 19.4.2023 passed in IT(TP)A No.874/Bang/2022 by the Income Tax Appellate Tribunal, Bangalore², for the Assessment Year³ 2017-18.

2. In its memorandum of appeal, the appellant sought to urge the following substantial questions of law:

“1) Whether on facts and in circumstances of the case and in law, the Hon’ble ITAT is correctly holding that the discount on the issue of ESOP is an allowable deduction in computing the income under the heads profit and gains of the business.

2) Whether on facts and in circumstances of the case and in law, the Hon’ble ITAT is justified in law in deleting the disallowance in respect of ESOP discount, even when the said amount representing discount i.e., expenses of fair market value over the face value of the capital receipt and consequently, any shortfall in receipt of such share premium is tantamount to capital loss and cannot be debited under profit and loss account.

3) Whether on facts and in circumstances of the case and in law, the Hon’ble ITAT is correct in law in allowing Assessee claim even though expenditure claimed by the assessee is notional and it is clear from the scheme of ESOP that the employees will not get any right in the share till completion of the period prescribed and expenditure claim is contingent, this is not an allowable expenditure under Section 37(1) of the Act.”

3. The relevant facts necessary for consideration of the present appeal are that the assessee is primarily engaged in sub-licensing, distribution and after sale support for products of SAP-SE. The assessee filed revised returns for AY 2017-18 and the said return was selected for scrutiny. A reference was made under Section 92CA of the IT Act to the Transfer Pricing Officer⁴. Vide order dated 22.1.2021, the TPO recommended an amount of `178,54,75,146/- relating to TP adjustment. Subsequently, the Assessing Officer⁵ passed a draft assessment order on 26.9.2021. Against which, the assessee filed objections before the Dispute Resolution Panel⁶. The DRP issued directions vide order dated 13.6.2022. Being aggrieved, the assessee preferred appeal IT(TP)A No.874/Bang/2022 before the Tribunal. The Tribunal by order dated 19.4.2023 partly allowed the appeal. Being aggrieved, the present appeal is filed by the Revenue.

4. Heard the submissions of Sri Sushal Tiwari, learned counsel for the appellant/Revenue and Sri Nageswar Rao, learned counsel for the respondent/assessee.

5. The primary contention put forth by the revenue is with regard to ESOP expenses of the assessee which was disallowed by the AO as well as the DRP. It is forthcoming that the assessee had claimed a deduction in the computation of income on account of “ESOP cost borne by the company”. The AO had held that the same tantamounted to revenue expenditure and hence, disallowed the same. The DRP affirmed the view taken by the AO. However, the Tribunal relying on the judgment of a coordinate Bench of the Tribunal in the case of Novo Nordisk India (P) Ltd.,⁷ allowed the contention of the assessee regarding disallowance of ESOP expenses.

6. Learned counsel for the respondent has further placed reliance on the judgment of a coordinate Bench of this Court in the case of Commissioner of Income Tax, LTU v. Biocon Ltd.,⁸ wherein this Court has also held the discount on issue of ESOP was allowable expense under Section 37(1) of the IT Act.

7. Although learned counsel for the Revenue does not dispute the proposition of law as held by the Tribunal and as laid down by the coordinate Bench of this Court in the case of Biocon Ltd.,⁸, it is sought to be contended that the relevant material has not been placed by the assessee to claim the said deduction. The DRP while considering the said aspect has noticed various legal provisions and disallowed the same. However, the position of law as relied on by the Tribunal not having been disputed, considering a question of fact in the present appeal does not arise and hence the contention sought to be put forth by the Revenue in the present appeal is liable to be rejected.

8. It is clear and forthcoming that the Revenue had sought to contend in the present appeal that the expenditure towards ESOP is not an allowable expenditure as per Section 37(1) of the IT Act. However, this Court in the case of Biocon Ltd.,⁸ having categorically held that the same is an allowable expenditure, there is no merit in the contention sought to be put forth by the Revenue.

9. In view of the aforementioned, and as no substantial question of law would arise, it is not a case for admission, the appeal is dismissed as being devoid of merit.

Note:-

¹ Hereinafter referred to as the ‘IT Act’

² Hereinafter referred to as the ‘Tribunal’

³ Hereinafter referred to as the ‘AY’

⁴ Hereinafter referred to as the ‘TPO’

⁵ Hereinafter referred to as the ‘AO’

⁶ Hereinafter referred to as the ‘DRP’

⁷ (2014) 63 SOT 242 (Bang)

⁸ (2020) 121 taxmann.com 351 (Karnataka)