Discount on shares offered under ESOP is construed, both by the employees and company, as nothing but a part of package of remuneration. It is deductible on straight line amortization basis over vesting period of the options.
In the instant case the moot question that arose before the ITAT was whether the Employee Stock Option compensation expense, was an allowable deduction in the computation of income under the head “Profits and gains of business or profession”?
The Tribunal allowed deduction on such discount and held as under:
1) When a company undertakes to issue shares to its employees at a discounted premium on a future date, the primary object of this exercise is not to raise share capital but to earn profit by securing the consistent and concentrated efforts of its dedicated employees during the vesting period;
2) Such discounted premium is construed, both by the employees and company, as nothing but a part of package of remuneration. In other words, such discounted premium on shares is a substitute of direct incentive in cash for availing of the services of the employees;
3) The discount on premium under ESOP was simply one of the modes of compensating the employees for their services and was a part of their remuneration. The sole object of issuing shares to employees at a discounted premium was to compensate them for the continuity of their services to the company;
4) Such discount couldn’t be described either as a short capital receipt or a capital expenditure. It was nothing but the employees cost incurred by the company. The substance of this transaction was to disburse compensation to the employees for their services, for which the form of issuing shares at a discounted premium was adopted;
5) By undertaking to issue shares at discounted premium, the company does not pay anything to its employees but incurs an obligation of issuing shares at a discounted rate on a future date in lieu of their services, which is nothing but an expenditure under section 37(1) of the Act;
6) A liability was definitely incurred by the assessee and was deductible, notwithstanding the fact that its quantification might take place in a later year. The discount in relation to options vesting during the year couldn’t be held as a contingent liability;
7) Liability to pay the discounted premium was incurred during the vesting period and the amount of such deduction was as per the terms of the ESOP scheme by considering the period and percentage of vesting during such period. Deduction of the discounted premium was to be allowed during the years of vesting on a straight line basis;
8) The amount of discount claimed as deduction during the vesting period is required to be reversed in relation to the unvested or lapsed options at the appropriate time. However, an adjustment to the income is called for at the time of exercise of option by the amount of difference in the amount of discount calculated with reference the market price at the time of grant of option and the market price at the time of exercise of option – BIOCON LTD. V. DY.CIT  35 taxmann.com 335 (Bangalore – Trib.) (SB)