ITAT Delhi Allows Rs. 4.24 Crore ESOP Deduction Under Section 37(1)

ACIT Vs Hero Fincorp Ltd. (ITAT Delhi)

SEO Title: ITAT Delhi Allows ESOP Deduction and Section 57 Expenses to Hero Fincorp

Summary: The Revenue challenged the order dated 23.12.2025 passed by the CIT(A)/NFAC for AY 2021-22, whereby the assessee’s appeal was allowed and various additions made in assessment were deleted. The Revenue’s second appeal before the ITAT was confined to two issues: deduction of ESOP expenditure of Rs. 4.24 crores under Section 37(1) of the Income-tax Act, 1961 and deduction of Rs. 54,34,253/- under Section 57 in respect of expenses claimed against interest income from an Alternative Investment Fund.

Hero Fincorp Ltd had implemented ESOP 2017 for attracting, retaining and rewarding employees and creating a sense of ownership. The scheme was approved by shareholders on 09.06.2017 and covered 26,39,703 options. The fair value of the options was computed using the Black Scholes Option Pricing Model and the ESOP expenditure was amortised over the vesting period. During the relevant year, Rs. 4.24 crores was debited under employee benefit expense in the audited financial statements. The Revenue contended that the expenditure was notional and involved no actual cash outflow.

The Tribunal considered the judicial authorities on ESOP expenditure, including CIT v. Biocon Ltd., the Special Bench decision in Biocon Ltd., PVR Ltd. v. CIT and Principal CIT v. New Delhi Television Ltd. The Tribunal noted that the Karnataka High Court and Delhi High Court decisions establish that ESOP discount is an allowable business expenditure under Section 37(1), and that Section 37(1) does not require an actual cash payout. The liability arising in the vesting period was regarded as an ascertained liability rather than a contingent liability. The Tribunal also noted that the Assessing Officer had allowed the ESOP claim in AYs 2018-19, 2019-20 and 2020-21 and applied the rule of consistency. It consequently held that the assessee was entitled to deduction of Rs. 4.24 crores under Section 37(1).

On the second issue, the assessee had invested Rs. 83 crores in KKR India Debt Opportunities Fund II, a Category II AIF. During the relevant year, it received interest income of Rs. 2,61,64,640/- on a gross basis. The assessee claimed expenses under Section 57, contending that the expenses had a direct nexus with earning the interest income. The Assessing Officer disallowed Rs. 54,34,253/- out of the claimed expenses on the ground that the expenditure was composite and was not wholly and exclusively incurred for earning income under the head “Income from Other Sources”.

The Tribunal noted that the CIT(A) had examined the detailed submissions and tabulations and found that the interest income had been offered to tax on a gross basis, after which the related expenses were claimed under Section 57. Relying on the principle in CIT v. Rajendra Prasad Moody and the Tribunal’s decision in Bhavin A Shah v. ACIT, the Tribunal held that expenditure having a direct nexus with earning interest income is allowable under Section 57(iii). It also noted that identical expenditure claimed in AY 2022-23 had been allowed by the Assessing Officer.

Both issues were therefore decided against the Revenue and in favour of the assessee. The Revenue’s appeal was dismissed. (Indian Kanoon)

Cases Discussed

• Principal Commissioner of Income-tax v. New Delhi Television Ltd. — Delhi High Court
• PVR Ltd. v. CIT — Delhi High Court
• CIT v. Biocon Ltd. — Karnataka High Court
• Biocon Ltd. v. DCIT — Bangalore ITAT Special Bench
• Madras High Court in CIT v. PVP Ventures Ltd. [2012] 23 taxmann.com 286/211 Taxman 554
• CIT v. Lemon Tree Hotels Ltd. — Delhi High Court
• Bharat Earth Movers v. CIT — Supreme Court
• Rotork Controls India (P.) Ltd. v. CIT [2009] 314 ITR 62 (SC)
• CIT v. Woodward Governor (India) (P.) Ltd. — Supreme Court
• CIT v. Rajendra Prasad Moody — Supreme Court
• Bhavin A Shah v. ACIT(2017) 81 com 176 (Ahmedabad Trib)

FULL TEXT OF THE JUDGMENT/ORDER OF ITAT DELHI

1. This appeal is directed against the impugned order dated 23.12.2025 passed in appeal No NFAC/2020-21/10201698 by the Id. Commissioner of Income Tax(Appeals)/NFAC(Delhi) (hereinafter referred to as the “CIT(A) u/s. 250 of the Income Tax Act, 1961 (hereinafter referred to as the “Act”) for the A.Y. 2021-22, wherein Id CIT(A) has allowed assessee’s appeal, deleting all the additions made by the assessing officer.

2.(i) The brief facts of the case are that the assessee is a Public Ltd. Company engaged in the business of financing, leasing and bill discounting. Assessee company filed its return of income for A.Y. 2021-22 on 10.03.2022 and revised return of income on 31.03.2022, disclosing total income of Rs. 4,50,01,86,740/- and claimed refund of Rs. 10,15,97,310/-. The case of assessee was selected for scrutiny under CASS. Statutory notices u/s 143(2) and 142(1) of the Act and show cause notices were issued to the assessee, seeking details in respect of investment/expenses made in Alternative Investment Fund(AIF) owned and maintained by KKR Capital Market India Pvt Ltd. (KKR India Debt Opportunities Fund II) etc. The assessee furnished his reply stating that during F.Y. 2018-19, it made investment of Rs. 83 crores in KKR India Debt Opportunities Fund II, which is registered as Category (II) AIF with SEBI. The details were furnished as under:-

(ii) Assessee further explained that it offered net interest income of Rs. 47,68,755/- after deducting the total amount of expenses amounting to Rs. 2,13,95,885/- from the gross receipts of Rs. 2,61,64,640/-, emphasizing that the expenses of Rs. 2,13,95,885/- were incurred for the purpose of earning interest income, which is allowable as deduction u/s 57 of the Act. However, assessing officer was not satisfied with the explanation of assessee and disallowed assessee’s claim of deduction to the extent of Rs. 54,34,253/- out of claim of Rs. 2,13,95,885/- and added to the income shown under the head “Other Sources”.

(iii) The assessing officer noticed that assessee has debited Rs. 4.24 crores towards employees’ share based payment expenses in its audited financial notes and claimed as allowable expenses. Assessee’ expenditure with ESOP discount represents consideration for services rendered by employees and hence, is deductible business expenditure, however, the assessing officer was not satisfied and disallowed u/s 37 of the Act and added to the income of the assessee. This apart, other additions in respect of bad debt written off amounting to Rs. 5,32,08,837/-, bogus purchases amounting to Rs. 1,12,000/- and unexplained expenditure to the extent of Rs. 1,62,000/- were also disallowed and added in the income of the assessee, vide assessment order dated 29.12.2022 passed u/s 143(3) of the Act.

3. Aggrieved, assessee preferred an appeal before Id CIT(A), who deleted all the additions made by the assessing officer.

4. Aggrieved, revenue has preferred this second appeal only against the deletion of two additions on the grounds as under:

“1. That on the facts and in the circumstances of the case and in law, the Ld. CIT(A) has erred in allowing the assessee’s claim of ESOP expenditure amounting to Rs. 4.24 crores under Section 37(1) of the Income-tax Act, 1961, ignoring the findings recorded by the Assessing Officer that the said expenditure was notional in nature and did not involve any actual outflow of funds.

2. That on the facts and in the circumstances of the case and in law, the Ld. CIT(A) has erred in deleting the disallowance of Rs. 54,34,253/- made under Section 57 of the Income-tax Act, 1961, without appreciating that the expenditure claimed was composite in nature and not incurred wholly and exclusively for earning income under the head “Income from Other Sources”

……………………………………………………………………………………………”

5. Perused the records and heard Id CIT (DR) for the appellant revenue and Id authorized representatives for the appellant assessee.

6. The main points for determination under appeal are as to whether Id CIT(A) has erred in deleting the — (i) addition of ESOP expenditure amounting to Rs. 4.24 crores u/s 37(1) of the Act, ignoring the fact that the said expenditure was notional in nature and did not involve any actual outflow of funds? (ii) disallowance of Rs. 54,34,253/- made u/s 57 of the Act, ignoring the fact that the expenditure was composite in nature and not incurred wholly and exclusively for earning income under the head “income from other sources”?

7. Ld CIT (DR) for the appellant revenue has submitted that the assessing officer had rightly disallowed the said ESOP expenditure amounting to Rs. 4.24 crores as the same was notional in nature and did not involve actual outflow of funds. The said ESOP expenditure being capital gains in nature, should not have been allowed by the Id CIT(A).

8. Ld representative for the respondent assessee has submitted that assessee company had implemented the employee stock option plan 2017 (ESOP) to attract, retain, reward, provide employees and create a sense of ownership among them all. The scheme was approved by share holders on 09.06.2017 and covered Rs. 26,39,703/-options. The fair value of options was computed using the Black Scholes Option Pricing Model. The ESOP expenditure were debited in audited financial statements and amortized over the vesting period. The impugned ESOP expenditure of Rs. 4.24 crores was duly debited under “employee benefit expense” in the audited financial statements. Ld AR has further submitted that the ESOP expenditure were allowed by the revenue in earlier A.Ys. 2018-19, 2019-20 and 2020-21. Ld AR submits that as per the consistent tracks, ESOP stock debited to the profit and loss account and claimed as employees’ compensation expenditure incurred wholly and exclusively for business purpose, hence, allowable as revenue expenditure u/s 37(1) of the Act. Assessee has submitted ESOP scheme, financial statement disclosure, ESOP working and valuation report, still the assessing officer wrongly disallowed the expenditure. Ld AR submits that the impugned order passed by Id CIT(A) has rightly been passed by deleting the disallowance of ESOP made by the assessing officer. Ld AR has referred:

(i) PCIT v. New Delhi Television Ltd (2018), 99 com 401 (Del-HC)

(ii) PVR Ltd. v. CIT (2022) 145 com 331 (Del-H.C.)

(iii) CIT v. Biocon Ltd, (2020) 121 com 351 (Karnataka-H.C.)

(iv) Biocon Ltd. v. DCIT (2013) (35) com 335 (Bangalore — Trib) (Special Bench) in support of his arguments.

9. The issue of claim of ESOP expenditures is no more res integra. In New Delhi Television Ltd. (supra), Hon’ble Delhi High Court, while interpreting section 37(1) of the Act reads as under:-

“2. Learned counsel for the assessee appearing on advance notice, on the other hand, urges that there is no infirmity with the approach of the Income-tax Appellate Tribunal and that this Court had on July 12, 2016 given reasons for not entertaining the appeal which was not dismissed merely on the ground of delay. The previous order of the Court records inter alia as follows:

“7. As far as this issue is concerned, it is pointed out by the learned counsel for the assessee that the issue stands covered in favour of the assessee and against the Revenue by the order of this Court dated August 18, 2015 in I.T.A. No. 107 of 2015 (CIT v. Lemon Tree Hotels Ltd.). The Court had affirmed the order of the Income-tax Appellate Tribunal deciding the issue in favour of the assessee in the said case where the addition made by the Assessing Officer by way of disallowance of the expenses debited as cost of ESOP in profit and loss account was deleted by the Income-tax Appellate Tribunal.

8. In the present case, the Income Tax Appellate Tribunal has by the impugned order restored the matter to the file of the Assessing Officer for re-adjudication. The impugned order of the Income-tax Appellate Tribunal is consistent with what has been held by this Court in Lemon Tree Hotels (supra). Consequently, no substantial question of law arises as far as this issue is concerned.”

3. In Lemon Tree Hotels Ltd. (Supra) (referred to by the previous order), the court had relied upon a ruling of the Division Bench of the Madras High Court in CIT v. PVP Ventures Ltd. [2012] 23 taxmann.com 286/211 Taxman 554. In PVP Ventures Ltd. (supra), the Madras High Court, after considering the SEBI’s claim held as follows (page 314 of 1 ITR-OL):

“As regards the second issue which is now canvassed before this Court, viz., On the issue of expenditure of Rs. 66.82 lakhs towards the issue of shares to the employees stock option is concerned, the Tribunal pointed out that the shares were issued to the employees only for the interest of the business of the assessee to induce employees to work in the best interest of the assessee. The allotment of shares was done by the assessee in strict compliance with SEBI regulations, which mandate that the difference between the market prices and the price at which the option is exercised by the employees is to be debited to the profit and loss… the Tribunal in its order stated that it was a benefit conferred on the employee. So far as the company is concerned, once the option was given and exercised by the employee, the liability in this behalf got ascertained. This was recognised by the SEBI and the entire employees stock option plan was governed by the guidelines issued by the SEBI. On the facts thus found, the Tribunal held that it was not a case of contingent liability depending on the various factors on which the assessee had no control. The expenditure in this behalf was an ascertained liability, thus the expenditure incurred being on lines of the SEBI Guidelines, there could be no interference in the relief granted by the assessing authority for the expenditure arising on account of the employees’ stock option plan. This expenditure incurred as per the SEBI Guidelines and granted by the Officer could not be considered as erroneous one calling for the exercise of jurisdiction under section 263 of the Act.”

4. The Special Bench ruling in Biocon Ltd. (supra) considered the matter rather elaborately and also examined all the previous decisions. It scrutinised different accounts of ESOPs and the points of time when they could have vested. The observations of the Special Bench in this regard, inter alia, are as follows (page 623 of 25 ITR (Trib)):

“When we consider the facts of the present case in the backdrop of the ratio laid down by the Hon’ble Supreme Court in Bharat Earth Movers v. CIT [2000] 245 ITR 428 and Rotork Controls India (P.) Ltd. v. CIT [2009] 314 ITR 62 (SC), it becomes vivid that the mandate of these cases is applicable with full force to the deductibility of the discount on incurring of liability on the rendition of service by the employees. The factum of the employees becoming entitled to exercise options at the end of the vesting period and it is only then that the actual amount of discount would be determined, is akin to the quantification of the precise liability taking place at a future date, thereby not disturbing the otherwise liability which stood incurred at the end of the each year on availing of the services.

As regards the contention of the learned Departmental representative about the contingent liability arising on account of the options lapsing during the vesting period or the employees not choosing to exercise the option, we find that normally it is provided in the schemes of ESOP that the vested options that lapse due to non-exercise and/or unvested options that get cancelled due to resignation of the employees or otherwise, would be available for grant at a future date or would be available for being re-granted at a future date. If we consider it at micro level qua each individual employee, it may sound contingent, but if view it at macro level qua the group of employees as a whole, it loses the tag of ‘contingent’ because such lapsing options are up for grabs to the other eligible employees. In any case, if some of the options remain unvested or are not exercised, the discount hitherto 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

….Act 2005, with effect from April 1, 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’. Section 115WB gives meaning to the expression ‘fringe benefits’. Sub­section (1) provides that for the purposes of this Chapter, ‘fringe benefits’ means any consideration for employment as provided under clauses (a) to (d). Clause (d), which is relevant for our purpose, states that: ‘any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer free of cost or at concessional rate to his employees (including former employee or employees)’ shall be taken as fringe benefit. The Explanation to this clause clarifies that for the purposes of this clause, (i) ‘specified security’ means the securities as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and, where employees’ stock option has been granted under any plan or scheme thereof, includes the securities offered under such plan or scheme. Thus it is discernible from the above provisions of the Act that the Legislature itself contemplates the discount on premium under ESOP as a benefit provided by the employer to its employees during the course of service. If the Legislature considers such discounted premium to the employees as a fringe benefit or ‘any consideration for employment’, it is not open to argue contrary. Once it is held as a consideration for employment, the natural corollary which follows is that such discount (i) is an expenditure; (ii) such expenditure is on account of an ascertained (not contingent) liability; and (iii) it cannot be treated as a short capital receipt. In view of the foregoing discussion, we are of the considered opinion that discount on shares under the ESOP is an allowable deduction.

II. If yes, then when and how much?

Having seen that the discount under ESOP is a deductible expenditure under section 37(1), the next question is that ‘when’ and for ‘how much’ amount should the deduction be granted?

The assessee is a limited company and hence it is obliged to maintain its accounts on mercantile basis. Under such system of accounting, an item of income becomes taxable when a right to receive it is finally acquired notwithstanding the fact that when the income is actually received. Even if such income is actually received in a later year, its taxability would not be evaded for 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 [2000] 245 ITR 428 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 material time. Whereas in the first case, there cannot be any question of allowing deduction, in the second case, deduction has to be allowed for a sum determined on some rational basis representing the amount of liability incurred.”

5. Having regard to the above discussion, especially that the previous order dated July 12, 2016 in ITA No. 366 of 2016 had considered the same items of expenditure, under section 34, we are of the opinion that no question of law arises. The appeal is accordingly dismissed.”

10. In PVR Ltd.(Supra), the Hon’ble Delhi High Court held as under:

“2. During the pendency of the present appeal, the Karnataka High Court in CIT v. Biocon Ltd. [2020] 121 tammann.com 351/[2021] 276 Taxman 1/430 ITR 151 has upheld the judgment of the Special Bench of the Tribunal deciding the aforesaid question of law in favour of the assessee. The relevant portion of the aforesaid judgment is reproduced hereinbelow :-

“2. The shares of the company were transferred to the trust at the face value and the employees of the assessee were allowed to exercise the option to buy the shares within the time prescribed under the scheme subject to terms and conditions mentioned therein. The assessee claimed the difference of market price and allotment price as a discount and claimed the same as an expenditure under section 37 of the Act. The Assessing Officer rejected the claim on the ground that the assessee has not incurred any expenditure and the expenditure is contingent in nature and therefore, the assessee is not entitled to claim the difference between the market price and the allotment price as an expenditure under section 37 of the Act. The assessee thereupon filed an appeal before the Commissioner of Income-tax (Appeals) who by an order dated 13-11-2009 dismissed the appeal preferred by the assessee.

6. We have considered the submissions made by learned counsel for the parties and have perused the record. The singular issue, which arises for consideration in this appeal is whether the tribunal is correct in holding that discount on the issue of ESOPs i.e., difference between the grant price and the market price on the shares as on the date of grant of options is allowable as a deduction under section 37 of the Act. Before proceeding further, it is apposite to take note of section 37(1) of the Act, which reads as under:

Section 37(1) says that any expenditure (not being expenditure of 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 expnded 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”.

7. Thus, from perusal of section 37(1) of the Act, it is evident that the aforesaid provision permits deduction for the expenditure laid out or expnded and does not contain a requirement that there has to be a pay out. If an expenditure has been incurred, provision of section 37(1) of the Act would be attracted. It is also pertinent to note that section 37 does not envisage incurrence of expenditure in cash.

8. Section 2(15A) of the Companies Act, 1956 defines ’employees stock option’ to mean option given to the whole time directors, officers or the employees of the company, which gives such directors, officers or employees, the benefit or right to purchase or subscribe at a future rate the securities offered by a company at a free determined price. In an ESOP a company undertakes to issue shares to its employees at a future date at a price lower than the current market price. The employees are given stock options at discount and the same amount of discount represents the difference between market price of shares at the time of grant of option and the offer price. In order to be eligible for acquiring shares under the scheme, the employees are under an obligation to render their services to the company during the vesting period as provided in the scheme. On completion of the vesting period in the service of the company, the option vest with the employees.

9. In the instant case, the ESOPs vest in an employee over a period of four years i.e., at the rate of 25%, which means that at the end of first year the employee has a definite right to 25% of the shares and the assessee is bound to allow the vesting of 25% of the options. It is well settled in law that if a business liability has arisen in the accounting year, the same is permissible as deduction, even though, liability may have to quantify and discharged at a future date. On exercise of option by an employee, the actual amount of benefit has to be determined is only a quantification of liability, which takes place at a future date. The tribunal has therefore, rightly placed reliance on decisions of the Supreme Court in Bharat Movers supra and Rotork Controls India P. Ltd., supra and has recorded a finding that discount on issue of ESOPs is not a contingent liability but is an ascertained liability.

10. From perusal of section 37(1), which has been referred to supra, it is evident that an assessee is entitled to claim deduction under the aforesaid provision if the expenditure has been incurred. The expression ‘expenditure’ will also include a loss and therefore, issuance of shares at a discount where the assessee absorbs the difference between the price at which it is issued and the market value of the shares would also be expenditure incurred for the purposes of section 37(1) of the Act. The primary object of the aforesaid exercise is not to waste capital but to earn profits by securing consistent services of the employees and therefore, the same cannot be construed as short receipt of capital. The tribunal therefore, in paragraph 9.2.7 and 9.2.8 has rightly held that incurring of the expenditure by the assessee entitles him for deduction under section 37(1) of the Act subject to fulfillment of the condition.”

3. This Court in Pr. CIT v. New Delhi Television Ltd. [2018] 99 com 401/[2017] 398 ITR 57 (Delhi) has followed the judgment passed by the Special Bench in Biocon Ltd. (supra).

4. The subsequent appeals being ITA 107/2015 and ITA 214/2019 filed by the Commissioner of Income-tax on similar issues have been dismissed by this Court following the judgment of the Karnataka High Court in Biocon Ltd. v. Dy. CIT [2021] 125 com 164/278 Taxman 121/431 ITR 326.

5. Consequently, following the judgment of the Karnataka High Court in Biocon Ltd. (supra), 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.”

11. In Biocon Ltd (supra), the Hon’ble Karnataka High Court held as under:

“2. Facts leading to filing of this appeal briefly stated are that the assessee is a company engaged in the business of manufacture of Enzymes and Pharmaceuticals Ingredients. The assessee filed its return of income for the Assessment Year 2004-05 on 31-10-2004 declaring total income of Rs. 50,65,18,080/-. The case was selected for scrutiny by the Assessing Officer. The Assessing Officer by an order dated 29-12-2006 inter alia held that assessee has floated a scheme viz., Employees Stock Option Plans (ESOP) and under the scheme had constituted the Trust. The shares of the company were transferred to the trust at the face value and the employees of the assessee were allowed to exercise the option to buy the shares within the time prescribed under the scheme subject to terms and conditions mentioned therein. The assessee claimed the difference of market price and allotment price as a discount and claimed the same as an expenditure under section 37 of the Act. The Assessing Officer rejected the claim on the ground that the assessee has not incurred any expenditure and the expenditure is contingent in nature and therefore, the assessee is not entitled to claim the difference between the market price and the allotment price as an expenditure under section 37 of the Act. The assessee thereupon filed an appeal before the Commissioner of Income Tax (Appeals) who by an order dated 13-11-2009 dismissed the appeal preferred by the assessee.

3. The assessee thereupon filed an appeal before the Income-tax Appellate Tribunal (hereinafter referred to as ‘the tribunal’ for short). The division bench of the tribunal made a reference to the special bench. The special bench referred the question ‘whether discount on the issue of employees for options is allowable as deduction in computing the income under the head ‘profits and gains’ of business’? The Special bench of the tribunal by an order dated 16-7-2013 while answering the reference inter alia held different amount of between the market value and the face value at which shares are allotted are part of remuneration, which are paid to the employees in order to compensate them for the continuity of their services to the company and therefore, the same is allowable as an expenditure under Section 37 of the Act. It was further held that the expenditure is not contingent in nature. The appeal preferred by the assessee was directed to be placed before the division bench for decision in the light of findings recorded by the special bench. In the aforesaid factual background, the revenue has filed this appeal. Learned counsel for the revenue submitted that the expenses claimed by the assessee towards ESOP was neither incurred nor accrued during Assessment Year 2004-05 and therefore, the same could not be claimed as deduction under section 37 of the Act. It is further submitted that expenses 9 towards ESOP is contingent and not crystallized liability which was enforceable during Assessment Year 2004-05 and since, the assessee is following mercantile system of accounting, the expenditure is not allowable during the year. It was also submitted that expenditure claimed by the assessee is not real and same is hypothetical, notional and imaginary. It is also urged that the shares are not handed over to the employees and the aforesaid exercise is liable for termination in any situation either at the instance of the employer or the employee. It is also urged that in a case where mercantile system of accounting is followed unless a legal liability is incurred, the expenditure is not allowable as accrued. It is also contended that in the instant case, as the control of shares remains with the assessee for the period of scheme, the assessee has neither assumed any liability nor has incurred the same. It is also argued that the tribunal has failed to appreciate that no amount was paid to claim the same as expenditure under section 37(1) of the Act. It is also urged that the tribunal has failed to appreciate mercantile system of accounting. In support of aforesaid submissions, reliance has been placed on decisions of Supreme Court in CIT v. Infosys Technologies Ltd. [2008] 166 Taxman 204/297 ITR 167, Morvi Industries Ltd. v. CIT [1971] 82 ITR 835, Keshav Mills Ltd. v. CIT [1953] 23 ITR 230 (SC) and CIT v. A. Gajapathy Naidu [1964] 53 ITR 114.

4. On the other hand, learned counsel for the assessee submitted that discount on the issue of ESOPs is not a contingent liability but is an ascertained one. It is further submitted that ESOPs vest over a period of 4 years at the rate of 24%, which means that at the end of first year the employee has a definite right to 25% of the shares and the assessee is bound to allow the vesting of 25% of the options. In this connection, our attention has been invited to paragraphs 9.3.1 to 9.3.6 of the order passed by the tribunal and reliance has been placed on decision of the Supreme Court in Bharat Earth Movers v. CIT [2000] 112 Taxman 61/245 ITR 428 (SC), Rotork Controls India (P.) Ltd v. CIT [2009]180 Taxman 422/314 ITR 62 (SC). It is also argued that for the purposes of section 37(1) of the Act, it is sufficient if the expenditure has been incurred and therefore, issuance of shares at a discount were the assessee absorbs the difference between price at which it is issued and the market value of the shares would also be an expenditure incurred for the purpose of section 37 of the Act. Our attention has been invited to the findings recorded by the tribunal in paragraphs 9.2.7 to 9.2.8 of the tribunal and reliance has been placed on decisions in ‘Madras Industrial Investment Corpn. Ltd. v. CIT [1997] 91 Taxman 340/225 ITR 802 (SC), CIT v. Woodward Governor (India) (P.) Ltd., [2009] 179 Taxman 326/312 ITR 254 (SC). It is also urged that discount on issue of ESOPs is only a form of compensation paid to the employee and if not a short capital receipt. It is also urged that deduction of discount on ESOP over the vesting period is in accordance with the accounting in the books of account, which were prepared in Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999. In support of aforesaid submission reliance has been placed on decision in CIT v. UP State Industrial Development Corpn. [1997] 92 Taxman 45/225 ITR 703 (SC), Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 (SC). It is also urged that the decision relied on by the revenue does not support its case and the issue with regard to deduction of ESOP has been decided by different High Courts. In this connection, reference has been made to CIT v. PVP Ventures Ltd. [2012] 23 taxmann.com 286/211 Taxman 554 (Mad.), CIT v. Lemon Tree Hotels Ltd. IT Appeal No. 107/2015 dated 18-8-2015, Pr. CIT v. Lemon Tree Hotels Ltd., [2019] 104 taxmann.com 26 (Delhi). It is also pointed out that from the Assessment Year 2009-10, the Assessing Officer has accepted the claim of the assessee and has permitted ESOP expenses as deduction. Therefore, the revenue cannot be now permitted to alter its stand.

5. By way of rejoinder reply, learned counsel for the revenue submitted that judgment of the Supreme Court in Bharat Earth Movers is no applicable to the fact situation of the case as in the aforesaid decision the Supreme Court was dealing with statutory liability pending fixation of liability, whereas, in the instant case, the assessee has a liability, therefore, the aforesaid decision of the Supreme Court does not apply. It is also pointed out that in Rotork Controls India, the Supreme Court was dealing with allowability of provision as deduction and it has been held that subject to compliance of certain conditions on matching principle, the deduction is permissible. It has further been held in the aforesaid decision that income from sale of goods is subjected to tax, therefore, the corresponding expenditure is to be allowed in the same year. The aforesaid decision is also of no assistance to the assessee as the assessee has not incurred any expenditure.

6. We have considered the submissions made by learned counsel for the parties and have perused the record. The singular issue, which arises for consideration in this appeal is whether the tribunal is correct in holding that discount on the issue of ESOPs i.e., difference between the grant price and the market price on the shares as on the date of grant of options is allowable as a deduction under section 37 of the Act. Before proceeding further, it is apposite to take note of section 37(1) of the Act, which reads as under:

Section 37(1) says that any expenditure (not being expenditure of 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 expnded 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”.

7. Thus, from perusal of section 37(1) of the Act, it is evident that the aforesaid provision permits deduction for the expenditure laid out or expended and does not contain a requirement that there has to be a pay out. If an expenditure has been incurred, provision of section 37(1) of the Act would be attracted. It is also pertinent to note that section 37 does not envisage incurrence of expenditure in cash.

8. Section 2(15A) of the Companies Act, 1956 defines ’employees stock option’ to mean option given to the whole time directors, officers or the employees of the company, which gives such directors, officers or employees, the benefit or right to purchase or subscribe at a future rate the securities offered by a company at a free determined price. In an ESOP a company undertakes to issue shares to its employees at a future date at a price lower than the current market price. The employees are given stock options at discount and the same amount of discount represents the difference between market price of shares at the time of grant of option and the offer price. In order to be eligible for acquiring shares under the scheme, the employees are under an obligation to render their services to the company during the vesting period as provided in the scheme. On completion of the vesting period in the service of the company, the option vest with the employees.

9. In the instant case, the ESOPs vest in an employee over a period of four years i.e., at the rate of 25%, which means at the end of first year the employee has a definite right to 25% of the shares and the assessee is bound —> to allow the vesting of 25% of the options. It is well settled in law that if a business liability has arisen in the accounting year, the same is permissible as deduction, even though, liability may have to quantify and discharged at a future date. On exercise of option by an employee, the actual amount of benefit has to be determined is only a quantification of liability, which takes place at a future date. The tribunal has therefore, rightly placed reliance on decisions of the Supreme Court in Bharat Movers supra and Rotork Controls India P. Ltd., supra and has recorded a finding that discount on issue of ESOPs is not a contingent liability but is an ascertained liability.

10. From perusal of section 37(1), which has been referred to supra, it is evident that an assessee is entitled to claim deduction under the aforesaid provision if the expenditure has been incurred. The expression ‘expenditure’ will also include a loss and therefore, issuance of shares at a discount where the assessee absorbs the difference between the price at which it is issued and the market value of the shares would also be expenditure incurred for the purposes of section 37(1) of the Act. The primary object of the aforesaid exercise is not to waste capital but to earn profits by securing consistent services of the employees and therefore, the same cannot be construed as short receipt of capital. The tribunal therefore, in paragraphs 9.2.7 and 9.2.8 has rightly held that incurring of the expenditure by the assessee entitles him for deduction under section 37(1) of the Act subject to fulfilment of the condition.

11. The deduction of discount on ESOP over the vesting period is in accordance with the accounting in the books of account, which has been prepared in accordance with Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999.

12. So far as reliance place by the revenue in the case of Infosys Technologies Ltd.(supra) is concerned, it is noteworthy that in the aforesaid decision, the Supreme Court was dealing with a proceeding under section 201 of the Act for non-deduction of tax at source and it was held that there was no cash inflow to the employees. The aforesaid decision is of no assistance to decide the issue of allowability of expenses in the hands of the employer. It is also pertinent to mention here that in the decision rendered by the Supreme Court in the aforesaid case, the Assessment Years in question was 1997-98 to 1999-2000 and at that time, the Act did not contain any specific provisions to tax the benefits on ESOPs. Section 17(2)(iiia) was inserted by Finance Act, 1999 with effect from 1-4-2000. Therefore, it is evident that law recognizes a real benefit in the hands of the employees. For the aforementioned reasons, the decision rendered in the case of Infosys Technologies is of no assistance to the revenue. The decisions relied upon by the revenue in A. Gajapathy Naidu, Morvi Industries Ltd. and Keshav Mills Ltd.(supra) support the case of assessee as the assessee has incurred a definite legal liability and on following the mercantile system of accounting, the discount on ESOPs has rightly been debited as expenditure in the books of account. We are in respectful agreement with the view taken in PVP Ventures Ltd. And Lemon Tree Hotels Ltd. ‘case (supra).”

12. In Biocon Ltd. (Special Bench) (supra), the Banglore-Trib held as under:

“7. We have heard Shri H. Padam Chand Khincha for the appellant-assessee; Shri Rohit Jain for the Intervener, M/s. Bharti Airtel: Shri Sachin Kumar B.P. for the Intervener, M/s. Advinus Therapeatics Limited; and Shri K.R. Pradeep for the Intervener, M/s. NDTV Media Limited, (all the four counsel are hereinafter collectively referred to as the Id. AR’). We have also heard Shri S.K. Ambastha, the Id. CIT representing the Revenue. The moot question is as to whether the Discounted premium on ESOP also called as the Discount on issue of ESOP or the Employee stock option compensation expense or the Employees compensation expense or simply the Discount etc., is an allowable deduction in the computation the income under the head “Profits and gains of business or profession”? This larger question can be answered in the following three steps, viz.,

I. Whether any deduction of such discount is allowable?

II. If yes, then when and how much?

III. Subsequent adjustment to discount

8. We will take up these three steps one by one for consideration and decision.

1. WHETHER ANY DEDUCTION OF SUCH DISCOUNT IS ALLOWABLE?

9.1 The crux of the arguments put forth by the Id. AR is that discount under ESOP is nothing but employees cost incurred by the assessee for which deduction is warranted. On the other hand, the Revenue has set up a case that no deduction can be allowed as such discount is not only a short capital receipt but also a contingent liability.

A. Is discount under ESOP a short capital receipt?

9.2.1 The Id. DR stated that the question of deduction u/s 37 can arise only if the assessee incurs any expenditure, which thereafter satisfies the requisite conditions of the sub-section (1). He submitted that the word “expenditure” has 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. He supported his view by relying on the order passed by the Delhi Bench of the Tribunal in Ranbaxy Laboratories Ltd. v. Addl. CIT [2010] 39 SOT 17 (URO). It was stated that the Tribunal in that case has held that since the receipt of share premium is not taxable, any short receipt of such premium on issuing options to employees will be notional loss and not actual loss for which any liability is incurred. The learned Departmental Representative contended that the Mumbai bench of the Tribunal in the case of VIP Industries v. Dy. CIT [IT Appeal No.7242 (Mum.) of 2008 has also taken similar view vide its order dated 17.09.2010.]

9.2.2 Per contra, the learned AR submitted that it is not a case of any short receipt of share premium but that of compensation given to employees. He supported the admissibility of deduction of the amount of discount on the strength of the order passed by the Chennai bench of the tribunal in the case of S.S.I. Ltd. (supra) granting deduction of such discount by treating it as an employee cost. He submitted that the above view taken by the Chennai Bench has been approved by the Hon’ble Madras High Court in CIT v. PVP Ventures Ltd. [2012] 211 Taxman 554/23 taxmann.com 286. The learned AR argued that PVP Ventures Ltd. (supra) is a solitary judgment rendered by any High Court on the issue and hence the same needs to be followed in preference to any contrary Tribunal order. It was also pointed out that the Chennai bench’s view has been subsequent followed by the Chandigarh Bench of the Tribunal in Asstt. CIT v. Spray Engineering Devices Ltd. [2012] 23 taxmann.com 267/53 SOT 70 (URO).

9.2.3 Let us examine the facts of the case of Ranbaxy Laboratories Ltd. (supra), which has been strongly relied by the learned Departmental Representative. It deals with a situation in which the assessee granted stock option to its employees. The shares were to be issued at Rs. 559 per share as against the face value of Rs. 10 and the market price on the date of grant at Rs. 738.95 per share. The assessee treated the difference between Rs. 738.95 and Rs. 595 as employees compensation in the books of account and charged the same to its Profit and loss account by spreading it over the vesting period. It was one of the years of the vesting period for which the assessee claimed deduction that came up for consideration before the Tribunal. It was held by the Tribunal that the market price of Rs. 738.55 per share would have resulted in realization of higher share premium. Since the assessee did not account for the difference between Rs. 738.55 and Rs. 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 submissions, it is of the utmost importance to understand the concept of ESOP. Section 2(15A) of the Indian Companies Act, 1956 defines “employee stock option” to mean ‘the option given to the whole-time Directors, Officers or employees of a company, which gives such Directors, Officers or employees, the benefit or right to purchase or subscribe at a future date, the securities offered by the company at a predetermined price”. In an ESOP, the given company undertakes to issue shares to its employees at a future date at a price lower than the current market price. This is achieved by granting stock options to its employees at discount. The amount of discount represents the difference between market price of the shares at the time of the grant of option and the offer price. In order to be eligible for acquiring the shares under the ESOP, the concerned employees are obliged to render services to the company during the vesting period as given in the scheme. On the completion of the vesting period in the service of the company, such options vest with the employees. The options are then exercised by the employees by making application to the employer for the issue of shares against the options vested in them. The gap between the completion of vesting period and the time for exercising the options is usually negligible. The company, on the exercise of option by the employees, allots shares to them who can then freely sell such shares in the open market subject to the terms of the ESOP. Thus it can be seen that it is during the vesting period that the options granted to the employees vest with them. This period commences with the grant of option and terminates when the options so granted vest in the employees after serving the company for the agreed period. By granting the options, the company gets a sort of assurance from its employee for rendering uninterrupted services during the vesting period and as a quid pro quo it undertakes to compensate the employees with a certain amount given in the shape of discounted premium on the issue of shares.

9.2.5 The core of the arguments of the Id. DR in this regard is two-fold. First, that it is not an expenditure in itself and secondly, it is a short capital receipt or at the most a sort of capital expenditure. In our considered opinion both the legs of this contention are legally unsustainable.

9.2.6 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 amounting to Rs. 100 from issue of shares to public, gives Rs. 60 as incentive to its employees, such incentive of Rs. 60 would be remuneration to employees and hence deductible. In the same way, if the company, instead, issues shares to its employees at a premium of Rs. 40, the discounted premium of Rs. 60, being the difference between Rs. 100 and Rs. 40, is again nothing but a different mode of awarding remuneration to employees their continued services. In both the cases, the object is to compensate employees to the tune of Rs. 60. It follows that the discount on premium under ESOP is simply one of the modes of compensating the employees for their services and is a part of their remuneration. Thus, the contention of the Id. DR that by issuing shares to employees at a discounted premium, the company got a lower capital receipt, is bereft of an force. The sole object of issuing shares to employees at a discounted premium is to compensate them for the continuity of their services to the company. By no stretch of imagination, we 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 Id. 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). There is absolutely no doubt that section 37(1) talks of granting deduction for an ‘expenditure’, and the Hon’ble Supreme Court in Indian Molasses Co. (P.) Ltd. (supra) has described ‘expenditure’ to mean what is ‘paid out or away’ and is something which has gone irretrievably. However, it is pertinent to note that this section does not restrict paying out of expenditure in cash. Section 43 contains the definition of certain terms relevant to income from profits of business or profession covering sections 28 to 41. Section 37 obviously falls under Chapter IV-D. Sub-section (2) of section 43 defines “paid” to mean:

“actually paid or incurred according to the method of accounting upon the basis of which the profits or gains are computed under the head ‘profits and gains of business or profession’.” When we read the definition of the word ‘paid’ u/s 43(2) in juxtaposition to section 37(1), the position which emerges is that it is not only paying of expenditure but also incurring of the expenditure which entails deduction u/s 37(1) subject to the fulfilment of other conditions. At this juncture, it is imperative to note that the word ‘expenditure’ has not been defined in the Act. However, sec. 2(h) of the Expenditure Act, 1957 defines ‘expenditure’ as: ‘Any sum of money or money’s worth spent or disbursed or for the spending or disbursing of which a liability has been incurred by an assessee. When section 43(2) of the Act is read in conjunction with section 37(1), the meaning of the term ‘expenditure’ turns out to be the same as is there in the aforequoted part of the definition under section 2(h) of the Expenditure Act, 1957, viz., not only ‘paying out’ but also ‘incurring’. Coming back to our context, it is seen that by undertaking to issue shares at discounted premium, the company does not pay anything to its employees but incurs obligation of issuing shares at a discounted price ona future date in lieu of their services, which is nothing but an expenditure u/s 37(1) of the Act.

9.2.8 Though discount on premium is nothing but an expenditure u/s 37(1), it is worth noting that the Hon’ble Supreme Court in the case of CIT v. Woodward Governor India (P.) Ltd. [2009] 312 ITR 254/179 Taxman 326 has gone 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 cover both. Therefore, the expression “expenditure” as used in section 37 made in the circumstances of a particular case, covers an amount which is really a “loss” even though the said amount has not gone out from the pocket of the assessee’. From the above enunciation of law by the Hon’ble Summit Court, there remains no doubt whatsoever that the term ‘expenditure’ in certain circumstances can also encompass ‘loss’ even though no amount is actually paid out. Ex consequenti, the 9/19 alternative argument of the Id. DR that discount on shares is ‘loss’ and hence can’t be covered u/s 37(1), also does not hold water in the light of the above judgment. In view of the above discussion, we, with utmost respect, are unable to concur with the view taken in Ranbaxy Laboratories Ltd. (supra).

B. Is discount a Contingent liability?

9.3.1 The learned Departmental Representative supported the impugned order by contending that the entitlement to ESOP depends upon the fulfilment of several conditions laid down under the scheme. It is only when all such conditions are fulfilled and the employees render services during the vesting period that the question of any ascertained liability can arise. He submitted that during the entire vesting period, it is only a contingent liability and no deduction is admissible under the provisions of the Act for a contingent liability. The options so granted may lapse during the vesting period itself by reason of termination of employment or some of the employees may not choose to exercise the option even after rendering the services during the vesting period. It was, therefore, argued that the discount is nothing but a contingent liability during the vesting period not calling for any deduction. In the opposition, the learned AR submitted that the amount of discount claimed by the assessee as deduction is not a contingent liability but an ascertained liability. He stated that in the ESOP 2000, there is a vesting period of four years, which means that the options to the extent of 25% of the total grant would vest with the eligible employees at the end of first year after rendering unhindered service for one year and it would go on till the completion of four years.

9.3.2 It is a trite law and there can be no quarrel over the settled legal position that deduction is permissible 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 discharged at the end of the fourth year when the options are exercised by the employees. Now the question arises as to whether the liability at the end of each year can be construed as a contingent one?

9.3.3 The Hon’ble Supreme Court in Bharat Earth Movers v. CIT [2000] 245 ITR 428/112 Taxman 61 dealt with the deductibility or otherwise of provision for liability towards encashment of earned leave. In that case, the company floated beneficial scheme for its employees for encashment of leave. The earned leave could be accumulated up to certain days. The assessee created provision of Rs. 62.25 lakh for encashment of accrued leave and claimed deduction for the same. The Assessing Officer held it to be a contingent liability and hence not a permissible deduction. When the matter finally came up before the Hon’ble Supreme Court, it was held that the provision for meeting the liability for encashment of earned leave by the employee was an admissible deduction. In holding so, the Hon’ble Apex Court observed that: “the law is settled: if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.” From the above enunciation of law by the Hon’ble Supreme Court, it is manifest that a definite business liability arising in an accounting year qualifies for deduction even though the liability may have to be quantified and discharged at a future date. We consider it our earnest duty to mention that the legislature has inserted clause (f) to section 43B by providing that “any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee” shall be allowed as deduction in computing the income of the previous year in which such sum is actually paid. With this legislative amendment, the application of the ratio decidendi in 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 Rs. 5.18 lakh towards the warranty claim likely to arise on the sales effected by the assessee. The Assessing Officer disallowed the same on the ground that the liability was merely a contingent liability and hence not allowable as deduction u/s 37 of the Act. When the matter finally came up before the Hon’ble Supreme court, it entitled the assessee to deduction on the “accrual” concept by holding that a provision is recognized when: “(a) an enterprise has a present obligation as a result of a past event; (b) it is probable that an outflow of resources will be required to settle the obligation and (c) a reliable estimate can be made of the amount of the obligation”. Resultantly, the provision was held to be deductible.

9.3.5 When we consider the facts of the present case in the backdrop of the ratio laid down by the Hon’ble Supreme Court in Bharat Earth Movers (supra) and Rotork Controls India (P.) Ltd. (supra), it becomes vivid that the mandate of these cases is applicable with full force to the deductibility of the discount on incurring of liability on the rendition of service by the employees. The factum of the employees becoming entitled to exercise options at the end of the vesting period and it is only then that the actual amount of discount would be determined, is akin to the quantification of the precise liability taking place at a future date, thereby not disturbing the otherwise liability which stood incurred at the end of the each year on availing the services.

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………. ringe benefit tax in respect of fringe benefits provided or deemed to have been provided by an employee to his employees during the previous year………………. .”. Section 115WB gives meaning to the expression ‘Fringe Benefits’. Sub-section (1) provides that for the purposes of this Chapter, ‘fringe benefits’ means any consideration for employment as provided under clauses (a) to (d). Clause (d), which is relevant for our purpose, states that ‘any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer free of cost or at concessional rate to his employees (including former employee or employees)’ shall be taken as fringe benefit. Explanation to this clause clarifies that for the purposes of this clause, (i) “specified security” means the securities as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and, where employees’ stock option has been granted under any plan or scheme thereof, includes the securities offered under such plan or scheme. Thus it is discernible from the above provisions of the Act that the legislature itself contemplates the discount on premium under ESOP as a benefit provided by the employer to its employees during the course of service. If the legislature considers such discounted premium to the employees as a fringe benefit or ‘any consideration for employment’, it is not open to argue contrary. Once it is held as a consideration for employment, the natural corollary which follows is that such discount (i) is an expenditure; (ii) such expenditure is on account of an ascertained (not contingent) liability; and (iii) it cannot be treated as a short capital receipt. In view of the foregoing discussion, we are of the considered opinion that discount on shares under the ESOP is an allowable deduction.

II. IF YES, THEN WHEN AND HOW MUCH?

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 computation of total income under the Act. The question before the special bench is thus answered in affirmative by holding that discount on issue of Employee Stock Options is allowable as deduction in computing the income under the head ‘Profits and gains of business or profession’.”

13. In PVR Ltd. v. CIT(supra), Hon’ble Delhi High Court has followed the dictum laid down by Hon’ble Karnataka High Court in CIT v. Biocon Ltd(supra).

14. In the instant case, under the scheme ESOP 2017, computation of fair value of options, using Black Scholes Option Pricing Model and the detailed working disclosed in the audited financial statements have not been disputed by the revenue. Respondent assessee has duly debited ESOP expenditure of Rs. 4.24 crores during the year under consideration under “model benefit expense” in the audited financial statements. It is pertinent to mention that the assessing officer has allowed assessee’s claim of ESOP expenses in the earlier A.Ys. 2018­19, 2019-20 and 2020-21. Respectfully following the decisions cited hereinabove, and in view of rule of consistency, we hold that the assessee is entitled to the claim deduction of ESOP expenses u/s 37(1) of the Act. The first point is accordingly determined in negative against the revenue and in favour of the assessee.

15. As regards the second point relating to the disallowance of Rs. 54,34,253/-, the main concern of revenue is that the expenditure claimed was composite in nature and not incurred wholly and exclusively for earning income under head “income from other sources”.

16. Ld representative for AR submits that assessee has made investment in KKR India Debt Opportunities Fund II (Fund) which is registered as category (ii) AIF with SEBI and covered u/s 115UB of the Act, which provides that income accruing or arising or received by a person being a unit holder of an alternative investment fund out of investment made in Venture Capital Company (VCC), Venture Capital Fund (VCF) would be taxed in his hands and would be exempt in the hands of AIF. In terms of section 115 UB(2), the person responsible for crediting by making payment of the income on behalf of VCC or VCF shall furnish to the recipient, a statement in Form 64C giving details of the nature of the income paid or credited during the previous year (Form 64C) is part of assessee’s paper book at page no. 243 to 249. Explanation to the aforesaid section provides that any income which has been included in the total income of the person in a previous year on account of it having accrued or arisen in the said previous year would not be included in the total income of such person in the previous year in which such income is actually paid to him by VCC or VCF. During the relevant previous year, the assessee received income in the nature of “interest” and “net capital gains” from the alternative investment fund as per following details:-

Ld AR for the appellant assessee has explained that the expenses, with respect to the purchase consideration, brokerage, GST, SEBI fee and transaction charges were already deducted while computing the capital gains and only the resultant capital gains were distributed to the assessee. Similarly the question of acquisition of the securities and the accrued interest pertaining to the NCD’s sale during the year under consideration were part of expenses and were deducted while computing the capital gains and only the resultant net capital gains were remitted to the assessee. The interest, on the other hand, distributed to the assessee on a gross basis without deduction of any expenditure.

17. Ld CIT(A) has, after examining assessee’s detailed submissions and informations contained in the tabulation forms, recorded that the assessee has offered to tax interest income u/s 56 on gross basis and thereafter claimed expenses u/s 57 of the Act. Since expenses are having direct nexus with interest income earned, hence rightly allowed the deduction.

18. In CIT vs. Rajendra Prasad Moody(1978) 115 ITR 519 (SC), Hon’ble Apex Court while interpreting section 57 (iii) held that expenditure incurred wholly and exclusively for the purpose of earning income is allowable as deduction under section 57. In the instant case, the total expense being expenditure having direct nexus with the earning of interest income will be allowable as deduction u/s 57 of the Act.

19. In Bhavin A Shah v. ACIT(2017) 81 com 176 (Ahmedabad Trib) has held as under:-

“8. We find that there is no dispute, as evident from the stand taken by the Assessing Officer in remand report and as recorded by the CIT(A) in paragraph 6.2 of his order, that “expenses were incurred for earning of income but”, the objection of the Assessing Officer was that “25% of total expenses is hypothetical and on the higher side considering the nature of transactions”. Once it is an undisputed position that the expenses were incurred for earning of income, the mere fact that the expenses are high or that the expenses are claimed only in part cannot be reason enough to make the disallowance. We have noted that the related securities were held by Credit Suisse and UBS and that these entities have charged the assessee for “safekeeping of securities………. and their administration”. The copies of invoices, as also letter confirming the charges, are filed before us, and we find no infirmities in these documents. The expenses so incurred by the assessee are in the nature of expenses incurred on portfolio manager. As the expenses so incurred by the assessee admittedly related to the safekeeping and administration of securities in question, income from which has been offered to tax by the assessee, we do not find any reason to disallow the partial claim of the assessee to the extent of 25%, as claimed, of the expenses so incurred by the assessee. The Assessing Officer has not brought on record any material to establish, or even indicate, that the claim of 25%, or for that purpose even any part of these expenses, is inadmissible. If the expenses are on the higher side, that does not imply the expenses are fictitious or inadmissible. There is reasonable evidence of the expenses having been incurred as copies of related bank documentation is placed on record before us. When the assessee is earning income from foreign securities held by its portfolio managers abroad, and duly offering it to tax as ‘income from other sources’, the safekeeping and administration fee, paid in respect of such securities to its portfolio managers, cannot be declined deduction under section 57(iii). The nexus between earning of dividend and interest income and incurring of these expenses is clear, and since, in our opinion, these expenses are incurred for the purposes of earning income taxable as ‘income from other sources’, the deduction for expenses is duly admissible under section 57(iii) of the Act. We, therefore, uphold the plea of the assessee. The Assessing Officer is, accordingly, directed to grant deduction of Rs 1,79,506.”

20. In Bhavin A Shah (supra), the fees paid to particular fund managers was allowed as deduction against interest and dividend income in terms of section 57 of the Act. It, thus, becomes clear that particular fund management fee, being expenditure incurred wholly and exclusively for the purpose of earning interest income is unambiguously allowable as deduction u/s 57(iii) of the Act.

21. It is also brought to the notice of the bench that the identical expenditure was claimed by the assessee u/s 57 of the Act in subsequent A.Y. 2022-23 and the same was duly allowed by the assessing officer. We agree with the findings of Id CIT(A) that since the expenses are having direct nexus with the interest income earned, the same is allowable as deduction u/s 57 of the Act. The second point is also determined in negative against the appellant revenue and in favour of the respondent assessee.

22. In the result, revenue’s appeal is dismissed.

Order pronounced in the Open Court on – 24.08.2026