ITAT Allows Final Section 35D Deduction Since Revenue Accepted Claim in Earlier Years; ESOP Recharge Held Deductible Because It Represents Genuine Employee Compensation: ITAT
The ITAT Bangalore in Navi General Insurance Ltd. vs. Assessment Unit, Income Tax Department, Delhi partly allowed the assessee’s appeal concerning deductions claimed for AY 2021-22. It held that the fifth and final installment of amortized preliminary expenses under Section 35D could not be disallowed when the Revenue had consistently accepted the same claim in earlier years without disturbing the original allowance. Relying on judicial precedents, the Tribunal observed that the department could not selectively deny the last year’s deduction absent any finding that the initial allowance was erroneous. On ESOP recharge expenses, the Tribunal ruled that reimbursement made to the holding company under a group ESOP scheme constituted genuine employee compensation because the beneficiaries were employees of the assessee and the expenditure was incurred wholly and exclusively for business purposes. However, the Tribunal upheld the disallowance of share issue expenses, reiterating that such expenditure retains its capital character irrespective of whether the funds are raised for working capital or regulatory solvency requirements.
Core Issue: The principal issues before the Tribunal were whether the assessee was entitled to the fifth-year deduction of amortized preliminary expenses under section 35D after the claim had been accepted in earlier years, whether ESOP recharge paid to the holding company in respect of the assessee’s employees was allowable as business expenditure, and whether share issue expenses incurred for raising additional share capital were deductible as revenue expenditure.
Facts: The assessee, engaged in the business of general insurance, filed its return declaring a loss. During assessment proceedings, it claimed deduction of ₹1.73 crore under section 35D being one-fifth of preliminary and pre-operative expenses incurred for obtaining the IRDAI licence and commencing business operations. The assessee pointed out that the same expenditure had been amortized and allowed by the department in earlier years. The assessee also claimed deduction of ₹68.95 lakh towards ESOP recharge paid to its holding company under a group ESOP scheme, contending that the expenditure related to its own employees and represented employee compensation. Further, it claimed deduction of ₹18.57 lakh incurred towards share issue expenses, submitting that the capital was raised to meet working capital and regulatory solvency requirements of the insurance business.
AO and CIT(A) Findings: The Assessing Officer disallowed the section 35D claim holding that the expenditure did not fall within the eligible categories prescribed under section 35D(2) and that acceptance of the claim in earlier years did not automatically entitle the assessee to deduction in subsequent years. The CIT(A) confirmed the disallowance. In respect of ESOP expenses, the Assessing Officer held that the shares were issued by the holding company and not by the assessee and therefore the reimbursement was not an allowable expenditure. The CIT(A) affirmed the addition. Regarding share issue expenses, the Assessing Officer treated the expenditure as capital in nature relying upon the Supreme Court decisions in Brooke Bond India Ltd. and Punjab State Industrial Development Corporation Ltd., and the CIT(A) upheld the disallowance.
ITAT Findings: The Tribunal observed that the preliminary expenditure had been incurred long ago and the assessee had been claiming deduction on a pro-rata basis over the statutory period prescribed under section 35D. The department had accepted and allowed the claim from AY 2017-18 onwards and only the fifth and final installment was sought to be disallowed. The Tribunal held that once the claim had been accepted in the initial years, it was not open to the Revenue to deny the final year’s deduction without disturbing the allowance granted in the earlier years or demonstrating that the original allowance was erroneous. Following the principle laid down by the Karnataka High Court in Subex Ltd., the Tribunal deleted the disallowance and allowed the claim under section 35D. Since the claim was allowed under section 35D, the alternative plea under section 37 was not examined.
On the issue of ESOP recharge, the Tribunal found that the stock options were granted by the holding company under a group scheme, but the employees benefiting from the scheme were employees of the assessee. The cost attributable to such employees was charged to and reimbursed by the assessee. The Tribunal held that the expenditure represented employee compensation incurred wholly and exclusively for the assessee’s business. Merely because the shares were issued by the holding company and the cost was recovered through a recharge mechanism, the expenditure could not be treated as notional. The Tribunal also noted that the employees had been subjected to tax on the ESOP benefit, which reinforced the conclusion that the expenditure was genuine employee-related expenditure. Accordingly, the disallowance was deleted.
However, with regard to share issue expenses, the Tribunal held that the issue was squarely covered by the binding judgments of the Supreme Court in Brooke Bond India Ltd. and Punjab State Industrial Development Corporation Ltd. The Tribunal rejected the argument that the expenditure should be treated as revenue expenditure because the funds were raised for working capital or to satisfy solvency requirements prescribed by IRDAI. It held that irrespective of the purpose for which the funds were utilized, the expenditure was directly connected with expansion of the company’s capital base and therefore retained the character of capital expenditure. Consequently, the disallowance of share issue expenses was upheld.
Cases Relied Upon: The Tribunal relied upon Subex Ltd. v. CIT, DCIT v. Gujarat Narmada Valley Fertilizers Co. Ltd. and PCIT v. Deep Industries Ltd. for allowing the section 35D claim. For ESOP expenditure, reliance was placed on Biocon Ltd. v. DCIT and SAP India Pvt. Ltd. v. DCIT. For share issue expenses, the Tribunal followed the binding decisions of Brooke Bond India Ltd. v. CIT and Punjab State Industrial Development Corporation Ltd. v. CIT.
Held: The appeal was partly allowed. The disallowances relating to amortized preliminary expenses under section 35D and ESOP recharge expenditure were deleted, whereas the disallowance of share issue expenses was sustained as capital expenditure. The ground challenging initiation of penalty proceedings was dismissed as premature.
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