1 IN HIGH COURT OF KARNATAKA AT BENGALURU DATED THIS 11TH DAY OF NOVEMBER 2020 PRESENT HON BLE MR. JUSTICE ALOK ARADHE AND HON BLE MR. JUSTICE H.T.NARENDRA PRASAD I.T.A. NO.653 OF 2013 BETWEEN: 1. COMMISSIONER OF INCOME-TAX LTU JSS TOWERS BSK III STAGE BANGALORE. 2. DY. COMMISSIONER OF INCOME-TAX LTU JSS TOWERS BSK III STAGE BANGALORE ... APPELLANTS (BY SRI.K.V.ARAVIND, ADV.,) AND: M/S BIOCON LTD. 20TH KM, HOSUR ROAD ELECTRONIC CITY HEBBAGODI BANGALORE - 560 100. ... RESPONDENT (BY SRI.T.SURYANARAYANA, ADV.) --- 2 THIS ITA IS FILED UNDER SECTION 260-A OF I.T. ACT, 1961 ARISING OUT OF ORDER DATED 16.07.2013 PASSED IN ITA NO.248/BANG/2010 FOR ASSESSMENT YEAR 2004-05, PRAYING TO: (I) FORMULATE SUBSTANTIAL QUESTIONS OF LAW STATED ABOVE. (II) ALLOW APPEAL AND SET ASIDE ORDERS PASSED BY ITAT, BANGALORE IN ITA NO.248/BANG/2010 DATED 16.07.2013 CONFIRMING ORDER OF APPELLATE COMMISSIONER AND CONFIRM ORDER PASSED BY DEPUTY COMMISSIONER OF INCOME TAX, LTU, BANGALORE. THIS ITA COMING ON FOR FINAL HEARING, THIS DAY, ALOK ARADHE J., DELIVERED FOLLOWING: JUDGMENT This appeal under Section 260A of Income Tax Act, 1961 (hereinafter referred to as Act for short) has been preferred by revenue. subject matter of appeal pertains to Assessment year 2004-05. appeal was admitted by bench of this Court vide order dated 07.03.2014 on following substantial questions of law: (i) Whether on facts and in circumstances of case and in law tribunal was right in holding that discount on issue of ESOP is allowable deduction in computing income under head profits and gains of business? 3 (ii) Whether on facts and in circumstances of case and in law tribunal was right in holding that difference between market price of shares at time of grant of option and offer price amounts to discount and same has to be treated as remuneration to employees for their continuity of service? (iii) Whether on facts and in circumstance of case and in law tribunal committed error in not in not examining scheme of ESOP from which it is clear that employees will not get any right in shares till completion of period prescribed and expenditure claimed is contingent and recorded perverse finding? 2. Facts leading to filing of this appeal briefly stated are that assessee is company engaged in business of manufacture of Enzymes and Pharmaceuticals Ingredients. assessee filed its return of income for Assessment Year 2004-05 on 4 31.10.2004 declaring total income of Rs.50,65,18,080/-. case was selected for scrutiny by Assessing Officer. Assessing Officer by order dated 29.12.2006 inter alia held that assessee has floated scheme viz., Employees Stock Option Plans (ESOP) and under scheme had constituted Trust. shares of company were transferred to trust at face value and employees of assessee were allowed to exercise option to buy shares within time prescribed under scheme subject to terms and conditions mentioned therein. assessee claimed difference of market price and allotment price as discount and claimed same as expenditure under Section 37 of Act. Assessing Officer rejected claim on ground that assessee has not incurred any expenditure and expenditure is contingent in nature and therefore, assessee is not entitled to claim difference between market price and allotment price as expenditure under Section 37 of 5 Act. assessee thereupon filed appeal before Commissioner of Income Tax (Appeals) who by order dated 13.11.2009 dismissed appeal preferred by assessee. 3. assessee thereupon filed appeal before Income Tax Appellate Tribunal (hereinafter referred to as 'the tribunal' for short). division bench of tribunal made reference to special bench. special bench referred question 'whether discount on issue of employees for options is allowable as deduction in comnputing income under head 'profits and gains' of business'?. Special bench of tribunal by order dated 16.07.2013 while answering reference inter alia held different amount of between market value and face value at which shares are allotted are part of remuneration, which are paid to employees in order to compensate them for continuity of their services to company and therefore, same is allowable as expenditure 6 under Section 37 of Act. It was further held that expenditure is not contingent in nature. appeal preferred by assessee was directed to be placed before division bench for decision in light of findings recorded by special bench. In aforesaid factual background, revenue has filed this appeal. Learned counsel for revenue submitted that expenses claimed by assessee towards ESOP was neither incurred nor accrued during Assessment Year 2004-05 and therefore, same could not be claimed as deduction under Section 37 of Act. It is further submitted that expenses towards ESOP is contingent and not crystallized liability which was enforceable during Assessment Year 2004-05 and since, assessee is following mercantile system of accounting, expenditure is not allowable during year. It was also submitted that expenditure claimed by assessee is not real and same is hypothetical, notional and imaginary. It is also urged that shares are not 7 handed over to employees and aforesaid exercise is liable for termination in any situation either at instance of employer or employee. It is also urged that in case where mercantile system of accounting is followed unless legal liability is incurred, expenditure is not allowable as accrued. It is also contended that in instant case, as control of shares remains with assessee for period of scheme, assessee has neither assumed any liability nor has incurred same. It is also argued that tribunal has failed to appreciate that no amount was paid to claim same as expenditure under Section 37(1) of Act. It is also urged that tribunal has failed to appreciate mercantile system of accounting. In support of aforesaid submissions, reliance has been placed on decisions of Supreme Court in 'COMMISSIONER OF INCOME-TAX, BANGALORE VS. INFOSYS TECHNOLOGIES LTD.', (2008) 166 TAXMAN 204 (SC), 'MORVI INDUSTRIES LTD VS. 8 COMMISSIONER OF INCOME-TAX', (1971) 82 ITR 835 (SC), 'KESHAV MILLS LTD. VS. COMMISSIONER OF INCOME-TAX', (153) 23 ITR 230 (SC), 'COMMISSIONER OF INCOME-TAX VS. A. GAJAPATHY NAIDU', (1964) 53 ITR 114 (SC). 4. On other hand, learned counsel for assessee submitted that discount on issue of ESOPs is not contingent liability but is ascertained one. It is further submitted that ESOPs vest over period of 4 years at rate of 24%, which means that at end of first year employee has definite right of 25% of shares and assessee is bound to allow vesting of 25% of options. In this connection, our attention has been invited to paragraphs 9.3.1 to 9.3.6 of order passed by tribunal and reliance has been placed on decision of Supreme Court in 'BHARAT EARTH MOVERS VS. CIT', (2000) 112 TAXMAN 61 (SC), 'ROTORK CONTROLS INDIA PVT. LTD VS. CIT', (2009) 180 TAXMAN 422 (SC). It is 9 also argued that for purposes of Section 37(1) of Act, it is sufficient if expenditure has been incurred and therefore, issuance of shares at discount were assessee absorbs difference between price at which it is issued and market value of shares would also be expenditure incurred for purpose of Section 37 of Act. Our attention has been invited to findings recorded by tribunal in paragraphs 9.2.7 to 9.2.8 of tribunal and reliance has been placed on decisions in 'MADRAS INDUSTRIAL INVESTMENT CORPN. LTD. VS. CIT', (1997) 225 ITR 802 (SC), 'CIT VS. WOODWARD GOVERNOR (INDIA) PVT. LTD.', (2009) 179 TAXMAN 326 (SC). It is also urged that discount on issue of ESOPs is only form of compensation paid to employee and if not short capital receipt. It is also urged that deduction of discount on ESOP over vesting period is in accordance with accounting in books of accounts, which were prepared in Securities And 10 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 VS. UP STATE INDUSTRIAL DEVELOPMENT CORPORATION', (1997) 92 TAXMAN 45 (SC), 'CHALLAPALLI SUGARS LTD. VS. CIT', (1975) 88 ITR 167 (SC). It is also urged that decision relied on by revenue does not support its case and issue with regard to deduction of ESOP has been decided by different High Courts. In this connection, reference has been made to 'CIT VS. PVP VENTURES LTD.', (2012) 23 TAXMANN.COM 286 (MAD), 'CIT VS. LEMON TREE HOTELS LIMITED', ITA NO.107/2015 DECIDED ON 18.08.2015,'CIT VS. LEMON TREE HOTELS LIMITED', (2019) 104 TAXMANN.COM 26 (DEL). It is also pointed out that from Assessment Year 2009-10, Assessing Officer has accepted claim of assessee and has permitted ESOP expenses 11 as deduction. Therefore, revenue cannot be now permitted to alter its stand. 5. By way of rejoinder reply, learned counsel for revenue submitted that judgment of Supreme Court in Bharat Earth Movers is no applicable to fact situation of case as in aforesaid decision Supreme Court was dealing with statutory liability pending fixation of liability, whereas, in instant case, assessee has liability, therefore, aforesaid decision of Supreme Court does not apply. It is also pointed out that in Rotork Controls India, 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, deduction is permissible. It has further been held in aforesaid decision that income from sale of goods is subjected to tax, therefore, corresponding expenditure is to be allowed in same year. aforesaid decision is also of no assistance to 12 assessee as assessee has not incurred any expenditure. 6. We have considered submissions made by learned counsel for parties and have perused record. singular issue, which arises for consideration in this appeal is whether tribunal is correct in holding that discount on issue of ESOPs i.e., difference between grant price and market price on shares as on date of grant of options is allowable as deduction under Section 37 of Act. Before proceeding further, it is apposite to take note of Section 37(1) of Act, which reads as under: Section 37(1) says that any expenditure (not being expenditure of nature described in sections 30 to 36 and not being in nature of capital expenditure or personal expenses of assessee), laid out or expended wholly and exclusively for purposes of business or profession shall be allowed in computing income chargeable 13 under head, Profits and Gains of Business or Profession . 7. Thus, from perusal of Section 37 (1) of Act, it is evident that aforesaid provision permits deduction for expenditure laid out or expnded and does not contain requirement that there has to be pay out. If expenditure has been incurred, provision of Section 37(1) of 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 Companies Act, 1956 defines 'employees stock option' to mean option given to whole time directors, officers or employees of company, which gives such directors, officers or employees, benefit or right to purchase or subscribe at future rate securities offered by company at free determined price. In ESOP company undertakes to issue shares to its employees at future date at price lower than current market price. 14 employees are given stock options at discount and same amount of discount represents difference between market price of shares at time of grant of option and offer price. In order to be eligible for acquiring shares under scheme, employees are under obligation to render their services to company during vesting period as provided in scheme. On completion of vesting period in service of company, option vest with employees. 9. In instant case, ESOPs vest in employee over period of four years i.e., at rate of 25%, which means at end of first year, employee has definite right to 25% of shares and assessee is bound to allow vesting of 25% of options. It is well settled in law that if business liability has arisen in accounting year, same is permissible as deduction, even though, liability may have to quantify and discharged at future date. On 15 exercise of option by employee, actual amount of benefit has to be determined is only quantification of liability, which takes place at future date. tribunal has therefore, rightly placed reliance on decisions of Supreme Court in Bharat Movers supra and Rotork Controls India P. Ltd., supra and has recorded finding that discount on issue of ESOPs is not contingent liability but is ascertained liability. 10. From perusal of Section 37(1), which has been referred to supra, it is evident that assessee is entitled to claim deduction under aforesaid provision if expenditure has been incurred. expression 'expenditure' will also include loss and therefore, issuance of shares at discount where assessee absorbs difference between price at which it is issued and market value of shares would also be expenditure incurred for purposes of Section 37(1) of Act. primary object of aforesaid exercise is not to waste capital but to earn profits by securing 16 consistent services of employees and therefore, same cannot be construed as short receipt of capital. tribunal therefore, in paragraph 9.2.7 and 9.2.8 has rightly held that incurring of expenditure by assessee entitles him for deduction under Section 37(1) of Act subject to fulfillment of condition. 11. deduction of discount on ESOP over vesting period is in accordance with accounting in books of accounts, 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 revenue in case of CIT VS. INFOSYS TECHNOLOGIES LTD. is concerned, it is noteworthy that in aforesaid decision, Supreme Court was dealing with proceeding under Section 201 of Act for non deduction of tax at source and it was held that there 17 was no cash inflow to employees. aforesaid decision is of no assistance to decide issue of allowability of expenses in hands of employer. It is also pertinent to mention here that in decision rendered by Supreme Court in aforesaid case, Assessment Year in question was 1997-98 to 1999- 2000 and at that time, Act did not contain any specific provisions to tax benefits on ESOPs. Section 17(2)(iiia) was inserted by Finance Act, 1999 with effect from 01.04.2000. Therefore, it is evident that law recognizes real benefit in hands of employees. For aforementioned reasons, decision rendered in case of Infosys Technologies is of no assistance to revenue. decisions relied upon by revenue in Gajapathy Naidu, Morvi Industries and Keshav Mills Ltd. supra support case of assessee as assessee has incurred definite legal liability and on following mercantile system of accounting, discount on ESOPs has rightly been debited as expenditure in books of 18 accounts. We are in respectful agreement with view taken in PVP Ventures Ltd. And Lemon Tree Hotels Ltd. Supra. 13. It is also pertinent to mention here that for Assessment Year 2009-10 onwards Assessing Officer has permitted deduction of ESOP expenses and in view of law laid down by Supreme Court in Radhasoami Satsang vs. CIT, (1992) 193 ITR 321 (SC), revenue cannot be permitted to take different stand with regard to Assessment Year in question. In view of preceding analysis, substantial questions of law framed by bench of this court are answered against revenue and in favour of assessee. In result, we do not find any merit in this appeal, same fails and is hereby dismissed. Sd/- JUDGE Sd/- JUDGE ss Commissioner of Income-tax, LTU, Bangalore / Dy. Commissioner of Income-tax, LTU, Bangalore v. Biocon Ltd.