Sec. 14A – curative in nature, but the expenditure cannot be assumed as non apportionable
ITAT Mumbai held In the case of HDFC Bank Limited vs. DCIT that in case of composite business yielding two streams of income, taxable and tax-exempt, apportionment of the expenses of the business would be required to be made in terms of sec. 14A r/w r. 8D, which rule is mandatory. Not so doing would be to defeat and, rather, contrary to the clear mandate of section 14A.
Discount on issue of shares to employee under ESOP is an allowable expenditure u/s 37
Also the judgment of Biocon Ltd vs. Dy. CIT  25 ITR (Trib) 602 (Bang) (SB) in which it was held that discount on the issue of shares to employee under the ESOP is an allowed expenditure u/s 37 is binding on us. No decision taking a contrary view by any higher appellate forum has been brought to our notice. In this decision, the tribunal explains that the discounted sum, i.e., which could be realized by the company on shares issued under ESOP, stands foregone by it only with a view to retain the employees, allowed by way of compensating them for their services. The extent of the amortized expense that could be allowed, i.e., with reference to time, also discussed by the tribunal that it should be amortized on a straight line basis over the vesting period, unless of course the vesting is not uniform. However, the discount will be calculated difference, i.e., the excess of the public issue price over the price charged to the employees that would qualify as a discount in-as-much as that is the value foregone by it with reference to an arm’s length transaction.
Facts of the Case
In this appeal, 3 grounds were raised as below:
First ground is related to disallowance of sum of Rs.366 lacs u/s.14A r/w rule 8D of the Income Tax Rules, 1962.
Second ground is related to disallowance of the amortized Employee Stock Options Plan (ESOP) expenses of the sum of Rs.821.33 lacs.
Third ground is alternate to second ground. It was claimed that equity shares other than ESOP shares have been issued during the year. So no disallowance of ESOP expenses is required.
Contention of the Assessee
The assessee’s contention of its tax-free investments, i.e., investments yielding tax-free income, being funded by the assessee’s own capital, so that no disallowance of interest, i.e., on a proportionate basis, would arise in terms of r. 8D(2)(ii).
Further his contention was that it had sufficient balance in the current deposit account/s, on which no interest is suffered, and which can or must therefore be considered as applied toward tax-free investments, i.e., yielding or liable to yield income which does not form part of the total income and, thus, not taxable. Further, the said investments include securities which are eligible for being considered as stock-in-trade of the assessee’s business, acquired in the regular course of its business, so that it would not attract disallowance u/s.14A, as held in CIT vs. India Advantage Securities Ltd. (in IT Appeal No. 1131 of 2013 dated 13.04.2015; CCI Ltd. vs. Jt. CIT  71 DTR 141(Kar) [206 Taxmann 563], which decision is in fact in line with that by the Apex Court in CIT vs. Indian Bank Ltd.  56 ITR 77 (SC).
With regard to ground no. 2, the ld counsel of the assessee relied on the subsequent decision by the special bench of the Tribunal in the case of Biocon Ltd vs. Dy. CIT  25 ITR (Trib) 602 (Bang) (SB), warranted in view of the conflicting decisions in the matter by different benches of the Tribunal. The tribunal, after considering the contrary decisions and examining the issues involved, held the discount on the issue of shares to employees under the ESOP as an expenditure deductible u/s.37(1) of the Act.
Contention of the Revenue
The ld counsel of the revenue submitted that that the capital raised by the assessee was specifically to meet the capital adequacy norms and, therefore, could not be presumed or inferred as having been invested in shares, including preference shares and PSU bonds, so as to be excluded while reckoning the disallowance under rule 8D.
The Revenue would, on the other hand, rely on the decision in the case of Godrej & Boyce v. Dy. CIT  328 ITR 81 (Bom), submitting that no infirmity in the impugned order has been pointed out. The argument as to the relevant securities representing the stock-in-trade of its business stands advanced by the assessee before the Tribunal for the first time. The decision in the case of India Advantage Securities Ltd. IT Appeal No. 1131 of 2013 dated 13.04.2015 upholds, in effect, the disallowance u/s.14A by estimating the same at 10% of the dividend income, i.e., as confirmed by the tribunal and, further, clarifies the issue raised before it as not raising any substantial question of law.
Ground no. 2 disallowed by the revenue on the ground of it being a notional and, in any case, capital expenditure. As per the Revenue, it is patently clear, firstly, that the same, even if realized, would go to form the issuer’s capital. The same, therefore, represents a loss of capital. No loss in actual terms has been suffered by the company by offering the shares at a discount, which is what an expenditure/loss essentially is, in-as-much as the shares are only rights therein issued by a company. The demand for shares would also depend on their issue price, while their market value itself represents the equilibrium of supply and demand forces there-for. The loss being reckoned with reference to the market price and not issue price, the loss to the extent of the difference between the two, is purely notional. Apart from thus representing a possible loss of capital, the expenditure is purely notional, having no basis on any actual or cognizable loss, not even stipulated or prescribed for being booked under an accounting theory or by any Accounting Standard, even as it is the provisions of the Act, i.e., the relevant law, that would prevail in the matter, as is the settled law.
Held by ITAT
Ground no. 1
The assessee’s contention of the relevant securities as representing it’s stock-in-trade, stands raised for the first time, i.e., before the tribunal. Earlier stand of the assessee was that it has not incurred any expenditure on account of interest as it had sufficient interest free funds (capital) with it.
Dividend income, in the case of a dealer in shares is of the same species as the share trading income, arise as it does from the same principal activity of trading in shares, which yields two types of income, i.e., the profit on the purchase and sale of shares, and by way of dividend income on the shares held as stock-in-trade for the time being. Like-wise, for a bank (or any other assessee) who may deal in shares or other tax-free investments as a part of its regular business activity. The same composite business yielding two streams of income, taxable and tax-exempt, apportionment of the expenses of the business would be required to be made in terms of sec. 14A r/w r. 8D, which rule is mandatory from the current year. Not so doing would be to defeat and, rather, contrary to the clear mandate of section 14A.
The issue of apportionment gets settled as per Walfort Share and Stock Brokers P. Ltd.  326 ITR 1 (SC) , even as noted in Godrej & Boyce. Co. Ltd. v. Dy. CIT  328 ITR 81 (Bom) , both binding precedents for us, and it is therefore immaterial whether the shares are held as investment or stock-in-trade, both being assets of a composite business giving rise to two sets of income This also represents the view of the tribunal per its larger bench decision in Daga Capital Management Pvt. Ltd. ,which stands impliedly approved by the Hon’ble Court in Godrej & Boyce.. Unless, therefore, a decision by a larger Bench of the Hon’ble jurisdictional High Court, taking a different view, is brought to our notice, we are legally obliged to follow the same.
The foregoing discussion is in fact preemptory in the absence of any claim, much less a finding, at any stage prior to the tribunal, of the relevant securities as forming a part of the assessee’s stock-in-trade. There is also no material before us to hold so, nor in fact any plea for admission of any additional evidence, which would in fact require furnishing such evidence in the first place. The said discussion is thus without prejudice to our finding the assessee’s argument, in the wake of this factual matrix, as not maintainable at the threshold.
As regards the claim of adequacy of capital or interest-free funds, we have already clarified of there being no finding of fact qua the specific source/s of financing, even as the Hon’ble Court has in Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT  328 ITR 81 (Bom), clarified that even the fact that the assessee has utilized its own funds in making the investments would not be dispositive of the question as to whether the assessee has incurred expenditure in relation to earning of such income. Even if, therefore, as explained by it, the assessee had utilized its own funds for making investments which have resulted in income which does not form part of the total income under the Act, the expenditure which is incurred in the earning of that income would have to be disallowed, which is to be determined by the A.O.
This is, it may be noted, in view of the rule of apportionment legislated by section 14A, enunciated by the Hon’ble Court, following the Apex Court in Walfort Share and Stock Brokers P. Ltd.  326 ITR 1 (SC), also considered in Dhanuka and Sons vs. CIT CIT  339 ITR 319 (Cal).
In the facts of the present case, it is the admitted position that the investment in securities has been made out of common pool of funds. Funds in the business, it may be appreciated, are always in a state of flux, so that the proximate or the immediate source of funds may not and, in any case, not generally, reflect the real or the effective source. The same can be assessed on the basis of a fund flow statement (for the period) coupled with the legal obligations incident, if any. In fact, the challenge in such a case would be to determine the source of the repayment of such (dedicated) loans, i.e., the cash profit generated or, again, the common pool of funds, including of course such profits. No case for financing by any dedicated source stands made out.
In our view, in fact, the Hon’ble High Court in Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT  328 ITR 81 (Bom), which also considers the decision in East India Pharmaceutical Works Ltd. v. CIT  224 ITR 627 (SC), has settled this aspect of the matter as well, even clarifying with regard to the play provided in the form of the satisfaction of the A.O., per sub sections (2) and (3) of sec. 14A.
Accordingly, we uphold the application of section 14A r/w rule 8D in the facts and circumstances of the case, dismissing the assessee’s Ground no. 1.
Ground no. 2
The decision by the Special Bench in the case of Biocon Ltd vs. Dy. CIT  25 ITR (Trib) 602 (Bang) (SB) in which it was held that discount on the issue of shares to employee under the ESOP is an allowed expenditure u/s 37 is binding on us. No decision taking a contrary view by any higher appellate forum has been brought to our notice. In this decision, the tribunal explains that the discounted sum, i.e., which could be realized by the company on shares issued under ESOP, stands foregone by it only with a view to retain the employees, allowed by way of compensating them for their services. The extent of the amortized expense that could be allowed, i.e., with reference to time, also discussed by the tribunal that it should be amortized on a straight line basis over the vesting period, unless of course the vesting is not uniform
However, we observe that though thereby the tribunal approves of deduction of the discount (on ESOP shares) in principle, it does not mandate the discount to be worked out in a particular manner, which, i.e., the quantum of the discount, and as would be apparent, is even otherwise a purely factual matter. True, the tribunal in that case has confirmed the working of the discount with reference to the market value of the shares. This, as apparent from its reading, is for the reason that that was the only value against which the issue price of shares under ESOP was benchmarked, representing the value which the shares would otherwise fetch for the company.
In the present case, however, the assessee-bank has issued shares to the public at large as well; the ESOP shares being in fact a mere fraction of the total shares issued during the yea . Clearly, therefore, it is the difference between the issue price of the shares to the two segments, i.e., to the public and its’ employees, which would mark or signify the extent of the value foregone or the discount allowed by the assessee on the latter issue. The ld. AR, on this being expressed by the Bench, would, while admitting that this aspect of the matter was not in controversy in Biocon Ltd. , submit that the subscription price of the shares issued to the public is wholly irrelevant, for what has been foregone by the assessee-bank is the value it could have realized, i.e., the price at which the shares are traded on the bourses. We are wholly in disagreement. A company does not incur any expenditure when it issues shares to the public at less than their going market price, an exercise aimed at raising capital from the market, at terms best suited to its interests and prospects, given the obtaining facts and circumstances. The question of the expenditure being incurred for business purpose thus just does not arise. The share issue to the employees under ESOP would therefore have to be considered as a segment of this issue, i.e., as a part/species of the public identified as its employees and, therefore, entitled to a discount on the regular price. Would, one may ask, the company issue shares to its employees at a price in excess of that at which it issues them to the public? And, even hypothetically assuming it to be so, does it thereby intend to incentivize or penalize its employees? It is this special, favourable treatment to its employees, i.e., vis-à-vis public at large, or the body of its ‘other than employee’ share applicants, which enables the value foregone to be considered as an ‘expense’, being only toward encouraging and retaining the employees – representing a talent or resource, in its service. That is, the reason for the difference or discount being considered as an expense per se, and of it being suffered for a business purpose, is one and the same, or in any case intrinsically linked, so that one would not survive without the other. It is thus only the second difference, i.e., the excess of the public issue price over the price charged to the employees that would qualify as a discount in-as-much as that is the value foregone by it with reference to an arm’s length transaction. From the employee’s stand-point as well, that is the benefit that gets extended to them, i.e., for being an employee, so as to elicit his loyalty, and for which discount stands, in effect, allowed in the first place.
It may be argued, as was indeed before us, as to what if there is no public issue?
We have in this regard clarified that it is the purpose for which the value, capital in nature, is foregone, which enables it to assume the character of a revenue expense, besides defining its business purpose, so as to be admissible u/s. 37(1) of the Act. In evidence of the value foregone, a public issue of shares at the relevant time, or even in proximity, provides an unimpeachable basis in the form of a comparable transaction, for determining the same, i.e., the value foregone or the discount allowed. Even accounting theory subscribes to booking only the discount qua the issue price. SEBI guidelines, prescribing a method in the matter, is largely irrelevant in-as-much as it is the provisions of law that would hold (refer: Southern Technologies Ltd. vs. Jt. CIT  320 ITR 577 (SC)) and, secondly, the matter as to the quantum of discount, is purely factual, to be decided on the basis of evidence/s and material on record. The SEBI guidelines – which are essentially disclosure norms, aimed at protection of investor interest,are with reference to the shares issued under ESOP. Besides not operating to detract from the provisions of law, which would prevail, what is relevant and material for our purpose is not the ESOP scheme per se, but the deductibility of the discount allowed on the shares issued to a segment of the public, i.e., employees, ostensibly for business purpose/s.
In view of the foregoing, we direct the allowance of the discount on the shares issued to the employees, as held by the larger bench of the tribunal in Biocon Ltd. vs. Dy. CIT  25 ITR (Trib) 602 (Bang) (SB), subject to the same being reckoned with reference to issue price of the shares issued to the public during the relevant year. All other parameters, including the adjustment to the discount, shall be in terms of the said order, having regard to the terms and conditions of the assessee’s employee issue. We accordingly, partly allowed this ground of appeal.
Ground no. 3
With regard to third ground of appeal, we are unable to understand the purpose of argument in-as-much as the ESOP expenses are only in relation to ESOP shares, i.e., shares issued to the employees under an optional scheme designed to benefit them. It is a share issue nevertheless, and the expenses thereon, share issue expenses all the same. They thus bear the same character. We have already answered in ground no. 2 that no doubt the ‘expenditure’ inures in the form of a shortfall in the capital raised, the purpose in foregoing the same is to allow an incentive to its employees, i.e., a business purpose, so that the capital to that extent stands deployed thus, and further clarified that it is only the stated business purpose which qualifies the same to be considered as an expense and, in any case, as a revenue expenditure.
Accordingly, appeal of the assessee partly allowed.