ITAT Allows ESOP Expenditure Under Section 37(1) For ESOPs Granted By Foreign Holding Company To Employees Of Indian Subsidiary

ITAT allows ESOP expenditure under Section 37(1) for ESOPs granted by foreign holding company to employees of Indian subsidiary

The Bangalore bench of the Income Tax Appellate Tribunal (‘ITAT’) has held that ESOP expenditure cross-charged by a foreign holding company to its Indian subsidiary is allowable as a deduction under section 37(1) of the Income-tax Act, 1961 ('Act'). The Tribunal reiterated that ESOP discount constitutes employee compensation and gives rise to an ascertained liability during the vesting period and that the possibility of future forfeiture, non-exercise of options, or issuance of a valuation report after the financial year-end does not render the liability contingent or hypothetical.

BRIEF FACTS OF THE CASE¹

• Zepto Private Limited ('Assessee') claimed deduction of INR 7.01 Crore towards ESOP expenditure for AY 2022-23. The stock options were granted by its Singapore holding company, Kiranakart Pte. Ltd., to employees and consultants of the Assessee under a share option plan. Pursuant to a cost-reimbursement arrangement, the Assessee was required to reimburse the attributable ESOP cost to the parent company on a cost-to-cost basis.
• The Assessing Officer (‘AO’) disallowed the entire ESOP expenditure on the ground that the valuation report was dated after the relevant financial year, the options were subject to vesting conditions and possible forfeiture, and therefore no crystallised liability had arisen.
• The Commissioner of Income-tax (Appeals) ['CIT(A)'] upheld the AO's findings. Aggrieved by the order of the CIT(A), the Assessee preferred an appeal before the Bangalore bench of the ITAT.

ASSESSEE’S CONTENTIONS:

• The assessee contended that the ESOP scheme was introduced to hire, retain and incentivize employees and to recognise their contribution to the business. It was submitted that the expenditure was incurred wholly and exclusively for the purpose of the assessee's business.
• Therefore, the liability was not hypothetical or contingent. The assessee was obligated to reimburse the ESOP expenditure to its Singapore parent company for the cost incurred by the latter for the benefit of the assessee’s employees.
• It was further submitted that the ESOP expenditure was duly recognised in the audited financial statements for the year ended 2022. Merely because the valuation report was obtained subsequently, the expenditure could not be denied, and hence liability could not be deferred.
• The assessee contended that the cross-charge letter provided for recovery of ESOP cost from Zepto on a cost-to-cost basis, thereby crystallising the reimbursement liability upon introduction of the ESOP scheme.
• Reliance was placed on Karnataka High Court’s judgement in Biocon Ltd ².recognising that ESOP expenditure is revenue expenditure allowable under Section 37 and the liability arising during the vesting period is not contingent even though the payment obligation arise after such vesting period.

AO’S CONTENTIONS:

• The AO contended that the assessee and its holding company were newly incorporated and had no past business history, profits, reserves or surplus to support a reliable valuation. The valuation was also based on assumptions without supporting documentary evidence and without comparable listed companies.
• The shares had not been handed over to employees and the options were subject to vesting and possible forfeiture / termination. Accordingly, the liability was uncertain and contingent, and the expenditure was rightly treated as hypothetical and notional. Further, the ESOP liability had neither accrued nor crystallised as on 31.03.2022, as the valuation report was issued in the next year.

ITAT OBSERVATIONS:

• The ITAT observed that ESOPs are granted to attract, retain and motivate employeesand compensate them for their services. Accordingly, the related cost constitutes employee compensation incurred for business purposes.
• The Tribunal reiterated that ESOP expendituregives rise to an ascertained liability during the vesting period and is allowable as a deduction under section 37(1) of the Act. Actual exercise of options or allotment of shares merely represents discharge of an existing liability and does not create the liability.
• The ITAT further relied on the case of Bharat Earth Movers³ and observed that once a business liability has definitely arisen, deduction cannot be denied merely because discharge or quantification is to occur at a future date, the liability need only be capable of being estimated with reasonable certainty.
• Accordingly, the possibility of future lapse or forfeiture does not make the liability contingent from inception. ESOP expenditure is recognised over the vesting period and maybereversed or adjusted if options subsequently lapse or remain unvested.
• Importantly, the Tribunal observed that the reimbursement obligation arose pursuant to a contractual arrangement under which the Singapore holding company bore the ESOP cost for employees rendering services to the Assessee. Accordingly, the expenditure could not be regarded as a voluntary or notional book entry
• The ITAT further observed that the post year-end date of the valuation report was not determinative of the year in which the expenditure accrued. What is relevant is the valuation date and the period to which the expenditure relates
• Accordingly, the ITAT held that the ESOP expenditure cross-charged by the Singapore parent company represented employee compensation incurred wholly and exclusively for the purposes of the Assessee's business. The liability accrued during the vesting period as employees rendered services and could not be regarded as hypothetical or contingent merely because the options were subject to vesting, forfeiture or future exercise. Consequently, the expenditure attributable to the relevant vesting period was held to be allowable as a deduction under section 37(1) of the Act

AURTUS COMMENTS

• The present case reinforces the judicial position laid down in Biocon Ltd. that ESOP expenditure represents employee remuneration and gives rise to an ascertained liability during the vesting period. The decision is significant as it rejects Revenue's recurring argument that ESOP expenditure is contingent merely because options remain subject to vesting conditions or potential forfeiture.
• Thedecisionis particularly relevant for Indian subsidiaries participating in group-wide ESOP arrangements, as it supports the position that a genuine contractual cross-charge towards ESOP costs should constitute an allowable business expenditure, linked to the underlying employee services, under section 37(1) and subsequent adjustments can be carried out to give effect of forfeiture of options, lapse of options, etc.

Footnotes

1 Zepto Private Limited vs. DCIT [2025] TS-1484-ITAT-2026

2 Biocon Ltd. v. DCIT[2013]35taxmann.com335(Bang.Trib-SB.)

3 Bharat Earth Moversv. CIT[2000]245ITR428(SupremeCourt

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.