ESOP Cross Charges Paid To Overseas Ultimate Holding Company Is Allowable Expenditure: ITAT Allows Deduction To HP

The Bangalore Bench of the Income Tax Appellate Tribunal (ITAT), while ruling in favour of the HP, held that employee stock option plan (ESOP) cross charges paid to overseas ultimate holding companies are an allowable expenditure.

The two-member bench headed by N.V. Vasudevan (Vice President) and Chandra Poojari (Accountant Member) has observed that the ESOP expenditure incurred is a compensation/incentive to the employee and has a direct nexus with his/her employment. The compensation to the employees in the form of ESOP is included in the salary of the employees under Section 17 of the Income Tax Act. Therefore, such expenses are incurred for the purposes of business and are hence allowable expenditure under section 37 of the Income Tax Act in the hands of the employer, i.e., the company.

The assessee/appellant company is engaged in providing application maintenance and development, enterprise resource planning, and specialised services like data warehousing and business intelligence, testing services, and infrastructure management services.

During the assessment proceedings for the subject AY 2016-17, the AO sought certain details in respect of Employee Stock Option Plan (ESOP) cross-charges incurred by the Company, based on the disclosures made in the financial statements.

The assessee company furnished its response explaining the reasons why Tax Deduction at Source (TDS) provisions are not applicable on the subject cross-charges, which are on a cost-to-cost basis.

The AO proceeded to make adjustments under section 37 of the Income-tax Act, 1961. The AO also noted his observation on the non-deduction of TDS under Section 195 of the Act.

Section 37 provides that any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession, not being in the nature of capital expenditure or personal expenses, shall be eligible for deduction in the computation of total income.

The assessee submitted that the employees of the company are eligible to participate in share-based compensation schemes of the Ultimate Holding Company, in which the shares of Ultimate Holding Company are granted to employees of the company on satisfying certain conditions. Under the ESOP schemes, employees are eligible to purchase or get shares of Ultimate Holding Company. The shares of Ultimate Holding Company are issued under ESPP/ESIP schemes as HPISO is not a listed entity and its shares are not traded in the open market.

The assessee submitted that the differential price or full price of the shares granted under schemes is considered as a part of the 'perquisite' taxable in the hands of employees under section 17(2). The company has deducted the appropriate TDS under section 192.

The assessee contended that the ESOP cross-charges incurred by the company represented the actual expenditure incurred by the company. The remittance made towards cross charges is in fact in the nature of incentives/compensation paid to the employees of HPISO, who form part of its business and are involved in carrying out day-to-day business operations/management.

The ITAT held that the ESOP charges incurred by the company represent actual expenditure and, therefore, the question of ESOP charges being notional in nature, as alleged by the learned AO, does not arise.

The ITAT determined that the expenditure of ESOP cross-charge by the Ultimate Holding Company to HPISO is an actual expense incurred and remitted by HPISO, rather than a hypothetical expense.

"AO failed to evaluate the facts of the case and made an unwarranted disallowance by wrongful application of section 37(1) of the Act. The AO had also erred in stating that the subject cross-charges were subject to withholding under Section 195 of the Act," the ITAT said.

Case Title: M/s. Hewlett Packard (India) Software Operation Pvt. Ltd. Versus Deputy Commissioner of Income-tax

Citation: IT(TP)A No.213/Bang/2021

Date: 03.10.2022

Counsel For Appellant: Padam Chand Khincha

Counsel For Respondent: Pradeep Arya

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