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Indian tax: Indian tribunal rules ESOP cost non-deductible


In a significant development, the Delhi Bench of the Income-tax Appellate Tribunal ("ITAT"), which is the second appellate authority in the Indian judicial hierarchy has held that discount on stock options is not deductible in the hands of the employer either in the year of grant or in the year when the option is exercised by the employees since it is notional in nature.


Ranbaxy Laboratories Ltd ("the tax payer ") is an Indian Company listed on a stock exchange in India. The tax payer had granted stock options to its employees and claimed the difference between the market price and the issue price to employees ("grant price") as employee compensation in the books of accounts. The charge to financial statements was deferred over the vesting period (5 years) in accordance with the guidelines prescribed by the Securities and Exchange Board of India ("SEBI Guidelines") and claimed as a deduction in the return of income. This claim was disallowed by the Assessing Officer (AO) on the ground that no liability had arisen or been paid by the tax payer during the year.

On appeal before the Commissioner of Income-tax (Appeals) (CIT (A)), who is the first appellate authority, it was held that the deduction is allowable in the year in which the option is exercised by the employees i.e. when the liability became certain and is not to be prorated over the vesting period.

Ruling of the ITAT

The ITAT held the difference in price as non-deductible on account of the following elements:
- The difference between market price and grant price represents share discount,
- The amount is not an actual expenditure incurred by the tax payer, and
- SEBI guidelines are not a prerogative for determining allowability or otherwise of an item for income tax purposes.

In reaching the conclusion for denial of expenditure claimed by the tax payer on account of discount on stock options, the main observation by the ITAT was that the difference between market price and grant price was only a notional expenditure.

However, where ESOPs are granted by overseas parent companies and the difference between market price and grant price is charged to the Indian subsidiary, the deductibility of expenditure has not yet come up for judicial scrutiny. In this context, it may be interesting to note that in an earlier decision the Chennai Bench of the ITAT has held that expenses on ESOP being in accordance with SEBI guidelines is not a contingent liability and hence is a deductible expenditure.
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