ESOP discount allowable as deduction under Section 37(1) Income Tax Act | ESOP expense treatment : ITAT Delhi

The Income Tax Appellate Tribunal (ITAT) has affirmed that the discount arising from an employee stock option plan (ESOP) qualifies as a deductible business expense under Section 37(1) of the Income-Tax Act, and that composite expenses under Section 57 are allowable, thereby overturning the revenue’s contention that such amounts are non-deductible or contingent.

Background & Facts

The Dispute

The appellant, ACIT, Circle 10(1), challenged the order dated 23.12.2025 passed by the Commissioner of Income Tax (Appeals) which had deleted all additions made by the assessing officer against the respondent, Hero Fincorp Ltd, for Assessment Year 2021-22. The core contention revolved around two specific additions: (i) ESOP expenditure of Rs. 4.24 crores under Section 37(1) and (ii) a disallowance of Rs. 54,34,253 under Section 57.

Key Facts

• Assessment Year: 2021-22
• Return filing: Original return filed on 10.03.2022; revised return filed on 31.03.2022, showing total income of Rs. 4,50,01,86,740 and a refund claim of Rs. 10,15,97,310.
• Scrutiny: The case was selected for CASS scrutiny; statutory notices under s. 143(2) and s. 142(1) were issued.
• Alternative Investment Fund (AIF) investment:
  • 18/07/2018 - 515,000 units @ Rs. 1,000 each = Rs. 515,000,000
  • 13/08/2018 - 25,000 units @ Rs. 1,000 each = Rs. 25,000,000
  • 26/03/2019 - 290,000 units @ Rs. 1,000 each = Rs. 290,000,000
  • Total AIF investment: Rs. 830,000,000
• ESOP expense claimed: Rs. 4.24 crores debited under “employee benefit expense” and amortised over the vesting period.
• Assessing officer’s disallowances:
  • Rs. 54,34,253 under Section 57 (claimed as composite expense)
  • Rs. 4.24 crores under Section 37(1) (deemed notional)
  • Bad debt written-off: Rs. 5,32,08,837
  • Bogus purchases: Rs. 1,12,000
  • Unexplained expenditure: Rs. 1,62,000
• Assessment order: Dated 29.12.2022 under s. 143(3).
• First appeal: Before the Ld CIT(A) - order dated 23.12.2025 deleted all additions.
• Second appeal: Revenue appealed only against the deletion of the ESOP addition and the Section 57 disallowance.

Procedural History

• 10.03.2022: Original return filed.
• 31.03.2022: Revised return filed.
• 29.12.2022: Assessing officer’s assessment order under s. 143(3).
• 23.12.2025: Ld CIT(A) order deleting all additions.
• 01.07.2026: Hearing before the ITAT, Delhi Bench.
• 24.08.2026: Judgment pronounced.

The Parties' Positions

• Appellant (Revenue): Asserted that ESOP expense is notional, involves no cash outflow and is therefore a contingent liability; contended that the Section 57 expense is composite and not wholly and exclusively incurred for earning income.
• Respondent (Hero Fincorp Ltd): Submitted that ESOP discount is a genuine employee cost, an ascertained liability under the ESOP scheme, and thus deductible under Section 37(1); argued that the Section 57 expense was incurred wholly and exclusively for the purpose of earning interest income.

Relief Sought

The revenue sought restoration of the disallowances of Rs. 4.24 crores (ESOP) and Rs. 54,34,253 (Section 57). The assessee sought confirmation that both amounts remain deductible.

The Legal Issue

Whether the discount granted under an employee stock option plan constitutes a deductible business expense under Section 37(1) of the Income-Tax Act, and whether a composite expense under Section 57 can be allowed when it is incurred wholly and exclusively for the purpose of earning income.

Arguments Presented

For the Appellant

• ESOP discount is a notional loss; no actual cash outflow, therefore not “expenditure” within the meaning of Section 37(1).
• The liability is contingent on future vesting and exercise; contingent liabilities are non-deductible.
• The Section 57 expense is composite, part of it not directly linked to earning the interest income, and thus fails the “wholly and exclusively” test.
• Relied on Ranbaxy Laboratories Ltd. v. Addl. CIT and the revenue’s own submissions that the discount represents a short-term capital receipt rather than a revenue expense.

For the Respondent

• ESOP discount is an employee remuneration, a fringe benefit under Section 115WB, and therefore an allowable business expense.
• The liability is ascertained at the time the option is granted; the company incurs a legal obligation even if cash outflow occurs later, satisfying the “incurring” limb of Section 37(1).
• Cited Lemon Tree Hotels Ltd., Biocon Ltd., Bharat Earth Movers v. CIT, and Rotork Controls India Ltd. v. CIT to establish that ascertained liabilities, even if quantifiable later, are deductible.
• For Section 57, argued that the expense was wholly and exclusively incurred for earning the interest income, referencing CIT v. Infosys Technologies Ltd. and Bhavin A Shah v. ACIT.

The Court's Analysis

The Tribunal began by interpreting the term “expenditure” in Section 37(1). It noted that the statute does not restrict deduction to cash outflows; the expression includes any liability that has been incurred. The Court quoted the Supreme Court’s definition in Indian Molasses Co. (P.) Ltd. v. CIT that “expenditure” means “spending or paying out,” but emphasized that the Act also speaks of “incurring” a liability, which is sufficient for deduction.

"Thus, from perusal of section 37(1), it is evident that the aforesaid provision permits deduction for the expenditure laid out or expended and does not contain a requirement that there has to be a pay out."

The Tribunal examined the nature of ESOP discount. It held that the discount is a fringe benefit under Section 115WB, which the legislature expressly treats as a consideration for employment. Consequently, the discount is an employee cost and falls squarely within the ambit of Section 37(1). The Court rejected the revenue’s characterization of the expense as “notional” or “contingent,” observing that the liability becomes ascertained at the grant date and the company is bound to honour the discount when the options vest.

The Tribunal then applied the ratio from Bharat Earth Movers and Rotork Controls India, which allow deduction of liabilities that have definitely arisen in the accounting year, even if their exact quantum is determinable only later. The ESOP liability satisfies this test because the company’s obligation to issue shares at a discounted price is enforceable once the employee completes the vesting period.

Regarding the Section 57 disallowance, the Tribunal found that the expense was incurred wholly and exclusively for earning the interest income, as the assessee had clearly linked the expense to the interest receipts from the AIF investment. The revenue’s argument of “composite” nature was dismissed because the portion attributable to the interest income satisfied the statutory requirement.

The Tribunal also affirmed that the other disallowances (bad debt, bogus purchases, unexplained expenditure) were correctly made by the assessing officer, as they were not part of the present appeal.

In sum, the Tribunal concluded that the revenue’s appeal was untenable on both points and dismissed it, thereby upholding the Ld CIT(A)’s deletions.

The Verdict

The ITAT dismissed the revenue’s appeal. The Tribunal held that the ESOP discount of Rs. 4.24 crores is an allowable deduction under Section 37(1) of the Income-Tax Act, and that the Rs. 54,34,253 disallowed under Section 57 is also deductible. Consequently, the deletions made by the Ld CIT(A) stand, while the other disallowances (bad debt, bogus purchases, unexplained expenditure) remain in force.

What This Means For Similar Cases

ESOP Discounts Are Tax-Deductible

• Practitioners should treat ESOP-related discounts as fringe benefits and claim deduction under Section 37(1).
• The liability need not involve an immediate cash outflow; the mere incurrence of a legal obligation suffices.

Contingent vs. Ascertained Liability

• A liability that becomes enforceable upon vesting is ascribed and deductible, even if quantification occurs later.
• Revenue cannot rely on the “contingent” label to block deduction where the obligation is contractually binding.

Composite Expenses Under Section 57

• Ensure that the expense claimed is wholly and exclusively incurred for the specific head of income.
• Provide clear documentary linkage between the expense and the income-earning activity to defeat “composite” objections.

Practical Checklist for Counsel

• Identify the statutory provision (e.g., Section 37(1), Section 57) and map the factual matrix.
• Gather board resolutions, ESOP scheme documents, and valuation reports to demonstrate ascertained liability.
• Prepare a detailed cost-benefit analysis showing the expense’s exclusive nexus with the income source.
• Anticipate revenue’s contention of “notional” loss and be ready to cite Lemon Tree Hotels, Biocon, Bharat Earth Movers, and Rotork Controls.