PVR Ltd. Vs CIT (Delhi High Court)
The Delhi High Court considered whether the Income Tax Appellate Tribunal had erred in holding that the difference between the price at which stock options were offered to employees under the appellant’s ESOP and ESPS schemes and the prevailing market price on the date of grant was not allowable as revenue expenditure under Section 37(1) of the Income Tax Act, 1961.
During the pendency of the appeal, the Karnataka High Court in Commissioner of Income Tax vs. Biocon Ltd. upheld the decision of the Special Bench of the Tribunal on the same issue in favour of the assessee. The Karnataka High Court noted that the assessee had claimed the difference between the market price and the allotment price of shares issued under the ESOP as expenditure under Section 37. The Assessing Officer had rejected the claim on the grounds that no expenditure had been incurred and that the liability was contingent. However, the Karnataka High Court held that Section 37(1) permits deduction of expenditure incurred and does not require an actual cash outflow. It observed that the provision does not contemplate that expenditure must be incurred in cash.
The Karnataka High Court further explained that under an ESOP, employees are granted options to acquire shares at a predetermined price lower than the prevailing market price, subject to completion of the vesting period. It held that once employees render the required services during the vesting period, the corresponding business liability arises. Although the exact amount of benefit is determined upon exercise of the option, such determination represents only quantification of an already accrued liability. Accordingly, the liability is an ascertained liability and not a contingent liability. It also held that the expression “expenditure” under Section 37(1) includes a loss and that issuing shares at a discount, where the company bears the difference between the issue price and the market value, constitutes expenditure incurred for business purposes. The Court observed that the object of the ESOP was to secure consistent services from employees and not to waste capital, and therefore it could not be treated as a short receipt of capital.
