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July 11, 2022

Discount on issue of ESOP is an allowable expenditure under Section 37(1)

by CA Shivam Jaiswal in Income Tax, Legal Court Judgement

Discount on issue of  ESOP is an allowable expenditure under Section 37(1)

Facts and Issue of the case

Ground 1: Disallowance of expenditure claimed towards Employee Stock Option Scheme (ESOP) under section 37(1) of the Income-tax Act, 1961 (Act) amounting to Rs 1,84,75,816.

(i) In not appreciating that the ESOP cost is incurred wholly and exclusively for the purpose of business and is in the nature of revenue expenditure and thereby, deductible under section 37(1) of the Act.

(ii) In erroneously concluding that the Appellant has not incurred any expenditure but has forgone the benefit or income by receiving lesser amount of premium without appreciating the fact that the amount paid by the Appellant is merely towards the recharge of stock option units granted to its employees by group entity and no shares are issued by the Appellant.

Ground 2: In Initiating penalty under section 271(1Xc) of the Act for disallowance made in respect of expenditure claimed towards ESOP cost.

On the facts and circumstances of the case, the learned Assessing Officer erred in initiating penalty proceedings under section 271(1)(c) of the Act for the disallowance made in respect of expenditure claimed towards ESOP cost in the Final Assessment Order.

Ground 3: Erroneously dismissing the appeal filed by the Appellant with the Commissioner of Income Tax (Appeals)-20 [now migrated to the Commissioner of Income Tax (Appeals), National Faceless Appeal Centre) on the ground that the appeal is infructuous since the Appellant has opted for the Vivad Se Vishwas Scheme (VSV),

(i) In erroneously concluding that the appeal by the Appellant filed against the CIT(A) Order is settled under the Direct tax Vivad se Vishwas Act 2020, and consequentially, erroneously dismissing the appeal by treating it as infructuous.

The facts of the case are that the assessee is company filed its return of income on 17.11.2016 for AY 2016-17 declaring total income of Rs. 2,38,13,60,120/-.The case was selected for scrutiny and notices were issued under section 143(2) of the Income Tax Act, 1961. In response to the aforesaid notices, Authorized Representative (AR) of the assessee furnished the details as called for. The assessee-company is engaged in the business of rendering front office and back office support to the Morgan Stanley group of companies globally. The assessee-company has shown income under the heads “Business & Profession”, “Capital Gains” and “Income from Other Sources”. During the course of assessment proceedings, the assessee was given a show-cause notice regarding allowability of claim towards the cost of Employees/Options Plans (ESOP) pertaining to the prior period. During the course of assessment proceedings, the assessee was again given a show-cause notice regarding dis-allowability of claim towards the cost of Employees/Options Plans (ESOP) treating the same as being capital in nature.

Observation by the court

The court had perused the order passed by ld. CIT(A) who has gone beyond the facts raised in the appeal by the assessee and returned finding against the facts on record. Appellant has entered into an agreement with MSDW International Employee Services LLC, an associated enterprise towards granting stock option to its employees. MSDW makes awards, stock option to selected employee of appellant which are convertible into shares of M/s Morgan Stanley in accordance with the MS EICP. The amount incurred by MSDW towards stock option cost is rechargeable to the appellant by way of debit note. MS Group has implemented and Equity Incentive Compensation Plan (EICP) to attract, retain and motivate employees of appellant and to compensate them for their contribution to the growth of appellant. The shares of MS are listed on New York Stock Exchange and are tradable in open market.

MSDW makes a settlement with appellant in consideration of the stock units and subsequently charge the cost incurred by on a cost basis to appellant. Appellant makes payment to MSDW on the basis of the market price of the shares as on the date of allotment of shares to the employees of appellant, a deduction for the same is claimed in the year of payment. Hence, there is no question of prior period expenses claimed. The expenses payable (stock option cost) to MSDW for the stock units are accrued MSAS over the life of the stock units (i.e. between grant and conversion) based on the market pr of the underlying shares on the date of grant of the stock units. The provision debited to the pr and loss account over the life of the stock units (including foreign exchange fluctuation loss, disallowed while computing the total income for MSAS (kindly refer to Annexure F of tax audit report furnished as Annexure 4 of our submission dated 15 May 2018). MSAS makes payment to MSDW on the basis of the market price of the shares as on date of allotment of shares to the employees of MSAS. A deduction for the same is claimed in year of payment. These shares allotted to employees are taxable as perquisite in the hands of employees and taxes are withheld on the same by MSAS and deposited into the Indian Government Treasury .

The court had considered and put reliance on explanatory circular on fringe benefit tax arising on allotment or transfer of specified securities or sweat equity shares. CBDT Circular mentioned (supra) is misplaced by the AO, whereas it clearly deals with the issue under consideration and segregate the situation in two parts i.e. allowable and disallowable. Facts of the assessee fall in the category of allowable one and this Circular is binding in nature over the Income Tax Authorities.

 As discussed in the preceding paragraph, issue raised in this case by the assessee as to allowability of ESOP cost being in the nature of Revenue expenditure has already been decided by the Special Bench of Tribunal in case of Biocon Ltd. 144 ITD 21 (Bangalore). The Co-ordinate Bench of Tribunal also in case of Goldman Sachs (I) Securities Pvt. Ltd. (supra), decided the issue in favour of the assessee by holding that discount on issue of ESOP is allowable as deduction under the head “Profits & Gains of Business or Profession”. So the expenditure claimed by the assessee on account of ESOP under section 37(1) of the Act is allowable. So, the impugned order passed by ld. CIT(A) directing the AO to delete the disallowance.

Ground No.2 is consequential in nature and based on the findings given against ground no.1, hence, no separate adjudication is required.Ground No.3 is also allowed treating order of ld. CIT(A) as absurd and passed without considering the facts and law applicable.

Conclusion

The appeal of the assesse is allowed by the court.

Morgan-Stanley-Advantage-Services-Pvt.-Ltd-Vs-CIT-ITAT-Mumbai

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