ITAT Allows Section 35D & ESOP Claims, But Upholds Disallowance of Share Issue Expenses

Navi General Insurance Limited Vs Assessment Unit (ITAT Bangalore)

ITAT Allows Section 35D & ESOP Claims, But Upholds Disallowance of Share Issue Expenses

The Bangalore ITAT partly allowed the appeal of Navi General Insurance Ltd. for AY 2021-22, granting relief on deduction of preliminary expenses under section 35D and ESOP expenses, while confirming the disallowance of share issue expenses as capital expenditure.

The assessee had claimed deduction of ₹1.74 crore under section 35D, representing one-fifth of pre-operative expenses incurred for obtaining the IRDAI licence and commencing insurance operations. The Tribunal noted that the same claim had already been accepted by the Department in the preceding four years and held that the Revenue could not disallow the fifth and final instalment without disturbing the allowance granted in the initial years. Relying on the Karnataka High Court decision in Subex Ltd., the Tribunal directed deletion of the disallowance.

The Tribunal also deleted the disallowance of ₹68.95 lakh towards ESOP expenses. It observed that the holding company had granted stock options to employees of the assessee and subsequently recovered the related cost from the assessee. Since the expenditure pertained to the assessee’s own employees, had been incurred wholly and exclusively for business purposes, and represented employee compensation, the reimbursement could not be treated as a notional expense. Accordingly, the deduction was held allowable under section 37(1).

However, the Tribunal upheld the disallowance of ₹18.57 lakh incurred towards issue of share capital. Rejecting the argument that the capital was raised merely to meet working capital and IRDA solvency requirements, the Tribunal relied on the Supreme Court ruling in Brooke Bond India Ltd. and held that expenditure incurred for raising share capital remains capital in nature irrespective of the purpose for which the funds are utilised. Since such expenditure expands the capital base of the company, it cannot be allowed as a revenue deduction.

FULL TEXT OF THE ORDER OF ITAT BANGALORE

1. This appeal is filed by NAVI GENERAL INSURANCE LIMITED [the Assessee / Appellant] against the appellate order passed by the National Faceless Appeal Centre (NFAC), Delhi dated 06-Jun-2025 for the Assessment Year 2021-22 wherein the appeal filed by the assessee against the assessment order passed by Assessment Unit of the Income Tax Department u/s. 143(3) r.w.s. 144E3 of the Income Tax Act, 1961 [the Act] dated 29.12.2022 was dismissed.

2. The Assessee is in appeal before us raising the following grounds of appeal: –

The following Grounds of Appeal are without prejudice to and independent of the other.

1. The order of the National Faceless Appeal Centre (‘NFAC’) is opposed to law and facts of the case.

2. Disallowance of ‘Pre-operative Expenses’ deduction claimed under the provisions of section 35D of the Act:

Disallowance of Deduction under Section 35D

2.1. The NFAC has erred in confirming the addition made by the Ld. AO by disallowing the deduction of pre-operative expenses amounting to Rs. 1,73,79,089, duly claimed in the return of income.

2.2. The NFAC has erred in disallowing the claim under Section 35D(2) without appreciating that the expenditure was necessarily incurred to obtain the Insurance and Regulatory Development Authority of India (IRDAI) licence, which was a pre-condition to commence business operations.

2.3. The Ld. AO/NFAC has erred in making a double disallowance, failing to appreciate that the said pre-operative expenses of Rs. 6,02,10,657 for AY 2016-17 and Rs. 2,66,84,786 for AY 2017­18 had already been disallowed by the Appellant in the respective year’s income tax return.

Principle of Consistency

2.4. The NFAC has erred in disregarding the fact that the deduction under Section 35D has been claimed on a pro-rata basis since AY 2017-18, and the same has been verified and accepted by the tax authorities during the AY 2018-19 assessments proceedings.

2.5. The NFAC has failed to appreciate the principles laid down by various judicial precedents wherein, it has been held that where the claim of the taxpayer is allowed in the previous assessment years, then such claim cannot be disallowed in the subsequent assessment year without change in the facts.

2.6. The Ld. AO/NFAC failed to appreciate the facts that a full and true disclosure of the said expenditure was made during the course of assessment proceedings, which has been disregarded by the NFAC without any material reasons.

Alternative Claim under Section 37

2.7. Notwithstanding the above, the NFAC has erred in not considering the fact that the said expenses are revenue in nature and has been incurred wholly and exclusively for the purpose of business, thereby satisfying the twin test laid down under section 37 of the Act for claim of deduction.

3. Disallowance of Employee Stock Option Plan (‘ESOP’] expenses:

3.1. The NFAC has erred in confirming the disallowance of the expenses incurred by the Appellant of Rs. 68,95,039 in relation to ESOP.

3.2. The NFAC has grossly erred in ignoring the fact that the said expense is incurred wholly and exclusively for the purpose of business and satisfies the conditions laid down under section 37 of the Act for its allowability.

3.3. The NFAC has erred in concluding that the cost incurred towards ESOP scheme is not verifiable and failed to appreciate that it is in fact revenue in nature, being part of compensation payable to employees.

3.4. The NFAC ought to have appreciated that ESOP expense is recharged by holding company of Appellant since it pertains to employees of the Appellant and is not a notional expenditure.

3.5. The NFAC erred in stating that the reimbursement of ESOP expenses is transfer of profits from the Appellant to parent company without appreciating the fact that the reimbursement represents the compensation paid to the employees of the Appellant by way of shares of the holding company of the Appellant

3.6. The NFAC has erred in not appreciating the fact that such expenses are required to be accounted for on accrual basis and amortized over the vesting period of the stock options, in accordance with Guidance Note on Accounting for Share-based payment (Revised 2020) issued by the Institute of Chartered Accountants of India.

3.7. The NFAC has failed to appreciate the principles laid down by various judicial precedents wherein, it was held that expenditure incurred on account of ESOP is an allowable expenditure as the same is incurred wholly and exclusively for the purpose of business of the taxpayer.

4. Disallowance of Share issue expenses

4.1. The NFAC has erred in disallowing share issue expenses of Rs. 18,57,400 incurred by the Appellant under section 37 of the Act.

4.2. The NFAC has erred in concluding that the expenditure incurred by the Appellant towards issuance of share capital is a capital expenditure without appreciating the nature of business of the Appellant and the fact that infusion of capital was towards working capital requirements.

4.3. The NFAC has failed to appreciate the fact that the share issue expenses have been incurred wholly and exclusively for the purpose of business and has no enduring benefit to the Appellant.

4.4. The NFAC ought to have appreciated that as the end use of the funds raised from equity was utilised for transactions in the revenue field, the expenditure incurred for raising such funds would also be revenue in nature.

4.5. The NFAC has failed to appreciate the principles laid down by various judicial precedents wherein, it has been held that expenditure incurred for increase in share capital utilized for the purpose of meeting the working funds to carry on its business, shall be allowed as deductible expenditure.

5. Erred in initiating penalty proceedings under section 270A of the Act:

5.1. The NFAC legally erred in confirming the penalty proceedings initiated by the Ld. AO under Section 270A of the Act on the Appellant for underreporting in consequence of misreporting of income.

The Appellant craves leave to add, to amend, to alter, to withdraw, to modify and/or to substitute any or all the foregoing grounds of appeal and to submit such statements, documents and papers as may be considered necessary either at or before the appeal hearing.

3. Briefly stated the facts of the case show that assessee is a company engaged in general insurance business, filed its return of income on 4.3.2022 at a loss of Rs.11,82,76,023. The return was picked up for complete scrutiny and necessary notices were issued.

4. During the course of assessment proceedings, the Id. AO found that assessee has incurred expenditure of Rs.1,73,79,089 u/s. 35D of the Act. The Id. AO noted that assessee did not furnish the complete working of such deduction and calculation u/s. 35D(3) of the Act. The assessee claimed that such expenditure was incurred in FY 2016-17 and 2017-18, therefore 1/5th of such expenditure is claimed during the year. The assessee also furnished requisite expenditure before him. The Id. AO held that details of expenses shown by the assessee are not covered under the provisions of section 35D(2) of the Act and assessee has failed to substantiate the allowability of these expenses. Further the Id. AO noted that though assessee’s claim was allowed for AY 2018-19, he held that merely acceptance of claim in a particular year does not necessarily extend the benefit in next year. Further the claim of deduction u/s. 37 of the Act also cannot be allowed for the reason that the claim of assessee is either u/s. 35D and if it fails u/s. 37(1). Thus, assessee itself is not sure about the same. Accordingly, disallowance was made.

5. On appeal, the Id. CIT(A) vide para 3.5 of his appellate order confirmed the same.

6. The assessee challenges the same as per ground No.2 of the appeal before us.

7. The Id. AR, Shri Ketan Ved, CA, submitted a paper book filed on issues and judicial precedents. His argument was that the claim made by the assessee u/s. 35D of the Act has been accepted by the Income Tax Department u/s. 35 of the Act and assessee is granted such deduction for AY 2017-18 to 2020-21. Further the issue is squarely covered in favour of the assessee by the decision of Hon’ble Karnataka High Court in the case of Subex Ltd. v. CIT, 132 com 96 and SLP filed by the Revenue against the said decision has also been dismissed by the Hon’ble Supreme Court. He further relied upon the decision of Hon’ble Gujarat High Court in the case of DCIT v. Gujarat Narmada Valley Fertilizers Co. Ltd., 33 taxmann.com 117 and PCIT v. Deep Industries Ltd., 67 taxmann.com 6. Accordingly, he submitted that the claim of the assessee is allowable.

8. The Id. Sr. DR, Shri Subramanian, JCIT relied upon the order of the Id. AO.

9. We have carefully considered the rival contentions and find that assessee company was incorporated and has incurred expenditure amounting to Rs.8,68,95,632 out of which it claimed a pro-rata deduction of Rs.1,73,79,126 u/s. 35D of the Act being 1/5th of total expenditure incurred. The claim of the assessee has admittedly been accepted by the Revenue from 2017-18 to 2020-21 but disputed in the 5th year only. Thus, for the earlier 4 years, claim of assessee was allowed u/s. 35D of the Act which is not disputed only in 5th year. When the issue is determined as allowable in the first year itself and same deduction is to be allowed year to year for the next 4 years, allowing it in the first year without disturbance, but disallowing it in the 5th year without showing the reason that assessee should not have been allowed in all the earlier 4 years, is not justified. The Hon’ble Karnataka High Court in Subex Ltd. vs. Commissioner of Income-tax-III [2021] 132 taxmann.com 96 (Karnataka)/[2022] 285 Taxman 350 (Karnataka)/[2021] 439 ITR 495 (Karnataka)[01-10-2021] where in it is held that here assessee’s claim under section 35D for amortization of preliminary expenses was granted by Assessing Officer for earlier assessment year 2007-08, such claim could not be disallowed in subsequent assessment year 2008-09 by Commissioner through his revisionary powers without disturbing decision in initial year and the Hon’ble Gujarat High Court decisions also cover the issue in favour of the assessee. Accordingly, we direct the Id. AO to delete the disallowance u/s. 35D of the Act of Rs.1,73,79,126 u/s. 35D of the Act.

10. As we have already allowed the claim of the assessee u/s. 35D, there is no requirement to consider the alternative submissions made by the assessee to allow the same u/s. 37(1) of the Act. As such, on principle, it should fail for the reason that expenditure is not incurred by the assessee during this year. However, the claim is allowable u/s. 35D of the Act, but not u/s. 37(1) of the Act. Thus, ground No.2 is allowed accordingly.

11. The 3rd ground of appeal is with respect to disallowance of Employees Stock Option Plan [ESOP] expenses incurred by the assessee. The facts show that the parent company of the assessee had issued ESOP to the various employees of the assessee as per the Scheme dated 19.12.2019. The assessee has claimed this expense as a debit and allowable expenses u/s. 37(1) of the Act. Thus, same was reimbursed by the assessee to its parent.

12. The Id. AO disallowed the above expenditure holding that in fact Option is not exercised by the employees, no shares are issued and therefore there is no tax incidence in the hands of the employees. Thus, it was stated that till this Option is exercised, no shares are allotted and transaction has not taken place, therefore deduction is not allowable. Even otherwise, the Id. AO was of the view that shares have been issued by the holding company, out of its reserve by utilization of share premium account, thus it is not a case of simple reimbursement of cost. Accordingly, Rs.68,95,039 was disallowed.

13. The issue was agitated before the Id. CIT(A), who confirmed the action of the Id. AO.

14. The Id. AR submits that this issue is covered in favour of the assessee by the decision of the Coordinate Bench in the case of SAP India P. Ltd. v. DCIT, ITA No.704/BANG/2023 wherein it is held that such compensation cost is allowable u/s. 37(1) of the Act. It was further stated that the ESOP expenses claimed by the assessee are also covered by the decision of Hon’ble Karnataka High Court in the case of Biocon Ltd. v. DCIT, 430 ITR 151. Thus, the disallowance made by the Id. AO deserves to be deleted.

15. The Id. DR supporting the case of the Id. AO, stated that ESOP expenses which are reimbursed by the assessee to its parent company are not the expense of the assessee. Same is also not allowable as deduction u/s. 37(1) of the Act. Further his claim that merely because tax is deducted from the employees, same does not become expenditure allowable in the hands of the assessee, it is neither paid to those employees directly nor incurred in liability to pay them. It was also submitted that there is no obligation to the assessee to pay this sum to its foreign entity and therefore expenditure is correctly disallowed u/s. 37(1) of the Act.

16. We have carefully considered the rival contentions. The facts clearly show that the holding company of the assessee has issued ESOP in favour of the group employees pursuant to ESOP Scheme. According to the ESOP Scheme, the employees employed by the assessee pertain to the Group, relevant cost of difference between the fair market value and issue of shares was charged by the parent company to the assessee company, as these employees are employed by the assessee. The assessee reimbursed the same and claimed the same as an allowable expenditure. We find that assessee has incurred the expenditure during the year for its own employees The employees have paid tax on this and tax is duly deducted irrespective of the fact that who is the person responsible for deduction of such ax. Thus, these expenses have been incurred by the assessee with respect to the benefit of its employees. It is not the case that employees were not employed by the assessee. Merely because it is charged by the holding company to the assessee, it cannot be said to be notional expenditure Such concept if to be raised, may be in the case of holding company, but in the case of subsidiary company which has merely paid the charges pertaining to its employees. It is not the case that assessee has not incurred any expenditure, because assessee has remitted the sum to its holding company and the expenditure is also incurred wholly and exclusively on the employees of the company. Thus, we reverse the findings of the Id. lower authorities and direct the Id. AO to delete the disallowance of cost of recharge of assessee’s employees of ESOP expense of parent company claimed by the assessee as deductible expenditure. Accordingly ground No.3 of the appeal of the assessee is allowed.

17. Ground No.4 of the appeal is with respect to disallowance of share issue expenditure. The fact shows that assessee has incurred the share issue expenditure amounting to Rs. 18,57,400 and claimed the same as deductible expenditure u/s. 37(1) of the Act. The Id. AO held that same is not allowable to the assessee as the same is capital expenditure and covered by the decision of the Hon’ble Supreme Court in the case of Brooke Bond India Ltd. vs. Commissioner of Income-tax [1997] 91 Taxman 26 (SC)/[1997] 225 ITR 798 (SC)/[1997] 140 CTR 598 (SC)[27-02-1997]. The assessee submitted that shares were issued by the assessee to fund its working capital requirement and therefore it is not hit by the decision of the Hontle Supreme Court. The assessee further relied upon the decision of Navi Mumbai SEZ P. Ltd. [2015] 54 taxmann.com 259 and further the decision of ACIT v. P C Jewellers Ltd. [2022] 137 taxmann.com 71 wherein the decision of Hon’ble Supreme Court was considered. It is also the case of the assessee that the decision of the Hontle Supreme Court in the case of Punjab State Industrial Development Corporation Ltd. v. CIT, 225 ITR 792 and Brooke Bond India Ltd. 91 taxmann.com 26 has already been considered in the above said decision and therefore the disallowance is not correct.

18. The Id. CIT(A) confirmed the action of the Id. AO disallowing the above sum.

19. The Id. AR vehemently stated that the share issue expenditure of Rs.18,57,400 is incurred by the assessee for working capital of the assessee and therefore the decision of the Hon’ble Supreme Court does not apply, and decision of the Coordinate Benches should be applied. On further query, he also submitted that this issue was made by the assessee to raise funds to meet the business operations and fulfil the solvency requirements of the company as per IRDA. Thus, the equity shares are issued to meet the working capital requirements and hence following those decisions, the above of the assessee should be allowed.

20. The Id. DR vehemently contested the above claim and stated that the decision of the Hon’ble Supreme Court in the case of Brooke Bond India Ltd. has categorically held that any expenditure incurred for meeting the enhancement of the share capital of the company, be it for any purpose, is capital expenditure. He further submitted that the decision of various Coordinate Benches cited before the Bench does not apply to the facts of the case and even otherwise when the decision of the Hon’ble Supreme Court has categorically denied deduction, distinguishing such decision of the highest Court of the land on flimsy ground is to be avoided. Thus, he prays that the decision of the Hon’ble Supreme Court deserves to be applied and orders of the Id. lower authorities needs to be upheld.

21. We have carefully considered the rival contentions and perused the orders of the Id. lower authorities. We find that honourable supreme court in Brooke Bond India Ltd. vs. Commissioner of Income-tax [1997] 91 Taxman 26 (SC)/ [1997] 225 ITR 798 (SC)/ [1997] 140 CTR 598 (SC) [27-02-1997] has held that:-

“6. Dr. Pal has, however, submitted that this decision does not cover a case, like the present case, where the object of enhancement of the capital was to have more working funds for the assessee to carry on its business and to earn more profit and that in such a case the expenditure that is incurred in connection with issuing of shares to increase the capital has to be treated as the revenue expenditure. In this connection, Dr. Pal has invited our attention to the submissions that were urged by the learned counsel for the assessee before the MC as well as before the Tribunal. It is no doubt true that before the AAC as well as before the Tribunal it was submitted on behalf of the assessee that increase in the  capital was to meet the need for working funds for the  assessee-company. But the statement of case sent by the Tribunal does not indicate that a finding was recorded to the effect that the expansion of the capital was under taken by the assessee in order to meet the need for more working funds for the assessee. We, therefore, cannot proceed on the basis that the expansion of the capital was undertaken by the assessee for the purpose of meeting the need for working funds for the assessee to carry on its business. In any event, the above quoted observations of this Court in Punjab State Industrial Development Corpn. Ltd. ‘s case (supra)clearly indicate that though the increase in the capital results in expansion of the capital base of the company and incidentally that would help in the business of the company and may also help in the profit making, the expenses incurred in that connection still retain the character of a capital expenditure since the expenditure is directly related to the expansion of the capital base of the company.”

Thus, even the share capital raised for working capital, expenses on such raising of capital is also capital expenditure as it expands the capital base of the assessee permanently.

22. Even otherwise the object of increase in capital as stated to meet the capital adequacy ratio, this itself suggests that expenditure is to increase the capital base only. Thus, decision relied up on of various coordinate benches do not apply . Hence the ratio of decision of Honourable Supreme Court squarely applies to the case of the assessee.

23. When the Supreme Court decides a principle it would be the duty of the High Court or a subordinate court to follow the decision of the Supreme Court. A judgment of the High Court which refuses to follow the decision and directions of the Supreme Court or seeks to revive a decision of the High Court which had been set aside by the Supreme Court is a nullity. Thus, ground no 4 of the appeal is dismissed.

24. Ground no 1 is general in nature and ground no 5 is premature and hence dismissed.

25. In the result, appeal filed by the Assessee is partly allowed.

Order was pronounced in the open court on 05th June 2026.