My company issued shares to employees under an ESOP at below market price. Can we deduct the discount, even though no cash went out?
Yes, on this decision. The Karnataka High Court held that the discount on issue of shares under an employees stock option plan - the difference between the market price on the date of grant and the offer price - is allowable under section 37(1). Section 37(1) permits deduction of expenditure laid out or expended and does not require a payout, nor does it envisage expenditure in cash; expenditure includes a loss. Because the options vest at 25 per cent a year, the liability arises in the accounting year and only its quantification is deferred, so it is an ascertained and not a contingent liability. The Revenue's appeal was dismissed.
Decided by the High Court (High Court of Karnataka at Bengaluru - Alok Aradhe and H.T. Narendra Prasad JJ; judgment by Alok Aradhe J) on 2020-11-11, reported as I.T.A. No. 653 of 2013, High Court of Karnataka, assessment year 2004-05. It bears on section 37(1), section 260A, section 17(2)(iiia), section 201 of the Income Tax Act 1961, in Deductions & Disallowances matters.
This is the High Court authority employers rely on for the ESOP discount, and it confirms the Special Bench of the Tribunal that decided the point. Its value lies in the two objections it answers. On expenditure, it holds that absorbing the difference between the issue price and the market value is expenditure incurred, and that the primary object of the exercise is not to waste capital but to earn profits by securing consistent services of the employees, so it is not a short receipt of capital. On timing, it applies Bharat Earth Movers and Rotork Controls: a business liability which has arisen in the accounting year is deductible even though it has to be quantified and discharged later, and on exercise of the option all that happens is quantification. It also confines Infosys Technologies, which the department habitually cites, to its own context of a proceeding for failure to deduct tax at source.
Binding within that High Court's jurisdiction. Persuasive elsewhere.
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The assessee manufactures enzymes and pharmaceutical ingredients. For assessment year 2004-05 it returned income of Rs 50,65,18,080 on 31 October 2004 and the case was taken up for scrutiny. It had floated an employees stock option plan and constituted a trust, transferring its shares to the trust at face value, and its employees could exercise the option to buy within the time and on the terms of the scheme. It claimed the difference between market price and allotment price as a discount and as expenditure under section 37. By order dated 29 December 2006 the Assessing Officer rejected the claim, holding that no expenditure had been incurred and that in any event it was contingent. The Commissioner (Appeals) dismissed the appeal on 13 November 2009. Before the Tribunal a Division Bench referred to a Special Bench the question whether the discount on issue of employee stock options is allowable in computing business income. By order dated 16 July 2013 the Special Bench held that the difference between market value and the value at which shares are allotted is part of the remuneration paid to compensate employees for continuity of service, that it is allowable under section 37, and that it is not contingent. The Revenue appealed under section 260A, and the appeal was admitted on 7 March 2014 on three substantial questions of law. Under the scheme in question the options vested over four years at 25 per cent a year.
The substantial questions of law were answered against the Revenue and in favour of the assessee and the appeal was dismissed. Section 37(1) permits deduction of expenditure laid out or expended and contains no requirement of a payout; it does not envisage incurrence of expenditure in cash. The expression expenditure also includes a loss, so issuing shares at a discount, where the assessee absorbs the difference between the issue price and the market value, is expenditure incurred for the purposes of section 37(1). The primary object is not to waste capital but to earn profits by securing consistent services of the employees, so the discount cannot be construed as a short receipt of capital. Because the options vested at 25 per cent a year, at the end of the first year the employee had a definite right to 25 per cent of the shares and the assessee was bound to allow that vesting; the liability had therefore arisen in the accounting year, and the determination of the actual benefit on exercise of the option is only quantification at a future date. The discount is an ascertained and not a contingent liability. Deduction of the discount over the vesting period accords with the books prepared under the SEBI guidelines of 1999.
The Court read section 37(1) and took from it that the condition is expenditure laid out or expended, not a disbursement of cash. It then described what an employee stock option is, taking the definition from the Companies Act, 1956: a right given to whole time directors, officers or employees to purchase or subscribe at a future date at a predetermined price, the discount being the difference between the market price at grant and the offer price, and the employee being obliged to serve through the vesting period to become eligible. Applying the settled rule that a business liability arising in the accounting year is deductible even though it has to be quantified and discharged later, it agreed with the Tribunal's reliance on Bharat Earth Movers and Rotork Controls. It then dealt with the authorities cited by the Revenue. Infosys Technologies was a proceeding under section 201 for failure to deduct tax at source, where the point was that there had been no cash inflow to the employees; it says nothing about allowability in the employer's hands, and it concerned years before section 17(2)(iiia) was inserted with effect from 1 April 2000, so the law now recognises a real benefit in the employee's hands. Gajapathy Naidu, Morvi Industries and Keshav Mills were held to support the assessee, since a definite legal liability had been incurred and, on the mercantile system, the discount was rightly debited. The Court expressed respectful agreement with PVP Ventures and Lemon Tree Hotels, and noted that from assessment year 2009-10 the Assessing Officer had himself allowed the deduction, so on Radhasoami Satsang the Revenue could not take a different stand for the year in question.
Section 37 does not envisage incurrence of expenditure in cash.
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Handle my notice → Ask a CA on WhatsAppYes, on this decision. The Karnataka High Court held that the discount on issue of shares under an employees stock option plan - the difference between the market price on the date of grant and the offer price - is allowable under section 37(1). Section 37(1) permits deduction of expenditure laid out or expended and does not require a payout, nor does it envisage expenditure in cash; expenditure includes a loss. Because the options vest at 25 per cent a year, the liability arises in the accounting year and only its quantification is deferred, so it is an ascertained and not a contingent liability. The Revenue's appeal was dismissed. This was decided by the High Court (High Court of Karnataka at Bengaluru - Alok Aradhe and H.T. Narendra Prasad JJ; judgment by Alok Aradhe J) and bears on section 37(1), section 260A, section 17(2)(iiia), section 201 of the Income Tax Act 1961. It is reported as I.T.A. No. 653 of 2013, High Court of Karnataka, assessment year 2004-05. This is the High Court authority employers rely on for the ESOP discount, and it confirms the Special Bench of the Tribunal that decided the point. Its value lies in the two objections it answers. On expenditure, it holds that absorbing the difference between the issue price and the market value is expenditure incurred, and that the primary object of the exercise is not to waste capital but to earn profits by securing consistent services of the employees, so it is not a short receipt of capital. On timing, it applies Bharat Earth Movers and Rotork Controls: a business liability which has arisen in the accounting year is deductible even though it has to be quantified and discharged later, and on exercise of the option all that happens is quantification. It also confines Infosys Technologies, which the department habitually cites, to its own context of a proceeding for failure to deduct tax at source. If it applies to you, the first step is this: Tie the deduction to the vesting schedule. Show what percentage vests in the year and that the company is bound to allow it, so that the liability has arisen and only quantification remains.
The assessee manufactures enzymes and pharmaceutical ingredients. For assessment year 2004-05 it returned income of Rs 50,65,18,080 on 31 October 2004 and the case was taken up for scrutiny. It had floated an employees stock option plan and constituted a trust, transferring its shares to the trust at face value, and its employees could exercise the option to buy within the time and on the terms of the scheme. It claimed the difference between market price and allotment price as a discount and as expenditure under section 37. By order dated 29 December 2006 the Assessing Officer rejected the claim, holding that no expenditure had been incurred and that in any event it was contingent. The Commissioner (Appeals) dismissed the appeal on 13 November 2009. Before the Tribunal a Division Bench referred to a Special Bench the question whether the discount on issue of employee stock options is allowable in computing business income. By order dated 16 July 2013 the Special Bench held that the difference between market value and the value at which shares are allotted is part of the remuneration paid to compensate employees for continuity of service, that it is allowable under section 37, and that it is not contingent. The Revenue appealed under section 260A, and the appeal was admitted on 7 March 2014 on three substantial questions of law. Under the scheme in question the options vested over four years at 25 per cent a year. The matter was decided on 2020-11-11 by the High Court (High Court of Karnataka at Bengaluru - Alok Aradhe and H.T. Narendra Prasad JJ; judgment by Alok Aradhe J). On those facts the High Court held as follows. The substantial questions of law were answered against the Revenue and in favour of the assessee and the appeal was dismissed. Section 37(1) permits deduction of expenditure laid out or expended and contains no requirement of a payout; it does not envisage incurrence of expenditure in cash. The expression expenditure also includes a loss, so issuing shares at a discount, where the assessee absorbs the difference between the issue price and the market value, is expenditure incurred for the purposes of section 37(1). The primary object is not to waste capital but to earn profits by securing consistent services of the employees, so the discount cannot be construed as a short receipt of capital. Because the options vested at 25 per cent a year, at the end of the first year the employee had a definite right to 25 per cent of the shares and the assessee was bound to allow that vesting; the liability had therefore arisen in the accounting year, and the determination of the actual benefit on exercise of the option is only quantification at a future date. The discount is an ascertained and not a contingent liability. Deduction of the discount over the vesting period accords with the books prepared under the SEBI guidelines of 1999.
The Court read section 37(1) and took from it that the condition is expenditure laid out or expended, not a disbursement of cash. It then described what an employee stock option is, taking the definition from the Companies Act, 1956: a right given to whole time directors, officers or employees to purchase or subscribe at a future date at a predetermined price, the discount being the difference between the market price at grant and the offer price, and the employee being obliged to serve through the vesting period to become eligible. Applying the settled rule that a business liability arising in the accounting year is deductible even though it has to be quantified and discharged later, it agreed with the Tribunal's reliance on Bharat Earth Movers and Rotork Controls. It then dealt with the authorities cited by the Revenue. Infosys Technologies was a proceeding under section 201 for failure to deduct tax at source, where the point was that there had been no cash inflow to the employees; it says nothing about allowability in the employer's hands, and it concerned years before section 17(2)(iiia) was inserted with effect from 1 April 2000, so the law now recognises a real benefit in the employee's hands. Gajapathy Naidu, Morvi Industries and Keshav Mills were held to support the assessee, since a definite legal liability had been incurred and, on the mercantile system, the discount was rightly debited. The Court expressed respectful agreement with PVP Ventures and Lemon Tree Hotels, and noted that from assessment year 2009-10 the Assessing Officer had himself allowed the deduction, so on Radhasoami Satsang the Revenue could not take a different stand for the year in question. In the words reproduced by the source cited on this page: "Section 37 does not envisage incurrence of expenditure in cash."
It was decided by the High Court on 2020-11-11 and is reported as I.T.A. No. 653 of 2013, High Court of Karnataka, assessment year 2004-05. Binding within that High Court's jurisdiction. Persuasive elsewhere. A High Court decision binds the assessing officer, the Commissioner (Appeals) and the Income Tax Appellate Tribunal within that state, and is persuasive elsewhere. If your assessment is in a different jurisdiction, check whether your own High Court has taken the same view before relying on it. On section 37(1), section 260A, section 17(2)(iiia), section 201, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. The substantial questions of law were answered against the Revenue and in favour of the assessee and the appeal was dismissed. Section 37(1) permits deduction of expenditure laid out or expended and contains no requirement of a payout; it does not envisage incurrence of expenditure in cash. The expression expenditure also includes a loss, so issuing shares at a discount, where the assessee absorbs the difference between the issue price and the market value, is expenditure incurred for the purposes of section 37(1). The primary object is not to waste capital but to earn profits by securing consistent services of the employees, so the discount cannot be construed as a short receipt of capital. Because the options vested at 25 per cent a year, at the end of the first year the employee had a definite right to 25 per cent of the shares and the assessee was bound to allow that vesting; the liability had therefore arisen in the accounting year, and the determination of the actual benefit on exercise of the option is only quantification at a future date. The discount is an ascertained and not a contingent liability. Deduction of the discount over the vesting period accords with the books prepared under the SEBI guidelines of 1999. It arises in Deductions & Disallowances matters, on section 37(1), section 260A, section 17(2)(iiia), section 201 of the Income Tax Act 1961, and was decided by High Court of Karnataka at Bengaluru - Alok Aradhe and H.T. Narendra Prasad JJ; judgment by Alok Aradhe J. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Amortise the discount over the vesting period in the books, consistently with the SEBI employee stock option guidelines, and put that accounting treatment before the officer. Answer the contingency argument with Bharat Earth Movers and Rotork Controls rather than with the accounting standard alone. If the department has allowed the deduction in other years, say so; the Court applied the consistency principle from Radhasoami Satsang against the Revenue here.
Still good law. Two citedby hits and one of them is a clean application. In DCIT v Mahindra Lifespace Developers Ltd (ITAT Mumbai, 23 February 2021) the Bench held in its own findings that the Bangalore Special Bench in Biocon 'has been subsequently approved by the Hon'ble Karnataka High Court in the case of CIT vs. Biocon Ltd., reported in 121 Taxmann.com 351 dated 11/11/2020 wherein it was held that discount on issue of ESOP was allowable as deduction u/s.37(1)', and 'Respectfully following the said decision' dismissed the Revenue's ESOP grounds. In Novozymes South Asia Pvt Ltd v ACIT (ITAT Bangalore, 29 June 2021) the judgment is discussed but on facts involving shares of a foreign parent, so treat that one with care. No Supreme Court challenge to the judgment could be traced, and the Delhi High Court has since taken the same view that the ESOP discount is deductible revenue expenditure under section 37(1). Nothing overruling or doubting it was found. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The judgment turns on the particular scheme, in which options vested at 25 per cent a year and the shares had been routed through a trust at face value. It does not decide how the deduction is computed where options lapse, are forfeited, or are repriced, nor what happens on a reversal in a later year, and it does not deal with the amount at which the discount is to be measured beyond accepting the market price at grant less the offer price. The batch line gave no reporter citations, so the appeal number is used. The harvested text carries a few transcription errors, so the quotation used here is from a clean sentence. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The substantial questions of law were answered against the Revenue and in favour of the assessee and the appeal was dismissed. Section 37(1) permits deduction of expenditure laid out or expended and contains no requirement of a payout; it does not envisage incurrence of expenditure in cash. The expression expenditure also includes a loss, so issuing shares at a discount, where the assessee absorbs the difference between the issue price and the market value, is expenditure incurred for the purposes of section 37(1). The primary object is not to waste capital but to earn profits by securing consistent services of the employees, so the discount cannot be construed as a short receipt of capital. Because the options vested at 25 per cent a year, at the end of the first year the employee had a definite right to 25 per cent of the shares and the assessee was bound to allow that vesting; the liability had therefore arisen in the accounting year, and the determination of the actual benefit on exercise of the option is only quantification at a future date. The discount is an ascertained and not a contingent liability. Deduction of the discount over the vesting period accords with the books prepared under the SEBI guidelines of 1999.
TaxSphere, “CIT v Biocon Ltd”, https://taxnotice.vittsphere.com/caselaw/case/cit-v-biocon-ltd/ (validity last checked 2026-08-29)
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