ESOP payments held to be revenue expenditure as they were business purpose

1. During the assessment proceedings,the AO found that the assessee had earned dividend income of Rs.82,46,614/- (Rs.54.55 lakhs from equity shares and Rs.27.91 lakhs from preference shares),and that the assessee had made no disallowance in the return of income u/s 14A of the Act. Without prejudice the assessee had made a disallowance of Rs. 19.39 lakhs u/s 14 A read with rule 8D. The assessee submitted that in case disallowance under section 14 A was to be made it should be restricted to Rs. 19.87 Lacs only. However, the AO held that the contention of the assessee regarding strategic investment was not acceptable, that investment in shares/ preference shares required experience and professional skills. AOmade a disallowance of Rs. 2.22 crores (Rs. 2.41 crores minus Rs. 19.39 lakhs) u/s 14 A read with rule 8D of the rules. As per the AO, the assessee was not able to reconcile the difference pointed out by him with regard to AIR information. He made addition. The assessee claimed that ESOP payment made by it to its employees be treated as revenue expenditure on the ground that it was nothing but compensation paid to the employees. AO rejected the claim of the assessee holding that ESOP discounts were incurred in relation to the issue of shares to the employees, that same were not relatable to profits and gains arising or accruing from business/trade, that ESOP discount did not diminish trading/business receipts of the issuing company, that the company did not suffer any pecuniary detriment,, that the discount was not incurred towards satisfaction of any trading liability, that share premiums received on issue of shares were items of capital receipt, that there was no specific provision for such direction under section 30 -36.

2. CIT(A) upheld the disallowance made by the AO. CIT(A) directed the AO to re-examine theAIR data. CIT(A) held that payment made by the subsidiary company to its holding company for granting of ESOP was a revenue expenditure.

3. On appeal, the ITAT held as under:

4. We have heard the rival submissions and perused the material before us we find that while deciding the appeals for the earlier years (ITA////- AY, dated) the tribunal has observed as under:...

5. Thus, it is the requirement of law that the assessing officer needs to record his satisfAction on incorrectness of the assessee's claim in the return. Assessing officer has not recorded the same in this case. Therefore, considering the above as well as following the rule of consistency, we are of the opinion that this issue should also be remanded to the file of the assessing officer for fresh adjudication. Assessing officer is directed to record his satisfAction in accordance with law. Further he is directed to attend to the arguments relating to the claim that the impugned investments are for holding control and management of the related companies. Assessing officer is also directed to attend to all the written submissions of the assessee made before CIT (A) to and considered the relevant judgement before deciding the issue. Assessing officer shall grant a reasonable opportunity of being heard of the assessee. Accordingly, ground number one is allowed for statistical purposes."Respectfully following the above order of the tribunal for the earlier years,first ground of appeal is decided in favour of the assessee, in part...Respectfully,following the above order ground number 2, raised by the assessee is restored back to the file of the AO for fresh adjudication. He is directed to afford a reasonable opportunity of hearing to the assessee. The assessee would produce all the necessary evidences and reconcile the difference. In our opinion direction given by the FW were quite reasonable.Therefore we don't see any infirmity in his order. Ground number two stands partly allowed in favour of the assessee....

6. With regard to the observations of the CIT(Appeals) that the ESOP actually benefits only the parent company, we are of the view that the expenditure in question is wholly and exclusively for the purpose of the business of the assessee and the fact that the parent company is also benefited by reason of a motivated work force would be no ground to deny the claim of the assessee for deduction, which otherwise satisfies all the conditions referred to in section 37(1) of the Act. The decision of the Hon'ble Supreme Court in the case of Sassoon J. David & Co. (P) Ltd. (supra) and the Hon'ble Karnataka High Court decision in the case of Mysore Kirloskar Ltd. (supra) clearly support the plea of the assessee in this regard.

7.We are of the view that in the facts and circumstances of the present case, the expenditure in question was wholly and exclusively for the purpose of the business of the assessee and had to be allowed as deduction as a revenue expenditure. Respectfully, following the above order, we hold that the order of the FAA does not suffer from any legal infirmity. So, confirming his order, we decide ground no.3 against the AO.”