ESOP Discount Is Revenue Expenditure Under Section 37(1) | ITAT Delhi Affirms Binding Precedent of Delhi HC in Lemon Tree & NDTV Cases

The Income Tax Appellate Tribunal, Delhi, has affirmed that the discount offered on employee stock option plans (ESOPs) constitutes allowable revenue expenditure under Section 37(1) of the Income Tax Act, 1961, rejecting the Revenue’s contention that such outlays are capital in nature. This ruling reinforces the jurisprudential clarity established by the Delhi High Court and provides critical guidance to companies across sectors that grant ESOPs as part of employee compensation.

Background & Facts

The Dispute

The assessee, Global Health Limited, operates Medanta Hospital and granted ESOPs to its employees during the assessment years 2017-18, 2018-19, and 2020-21. The Assessing Officer (AO) disallowed the claimed ESOP expenses in each year on the ground that the discount on share issuance represented a capital transaction, not a revenue expenditure. The Revenue contended that no actual monetary outflow occurred, and the expense was merely a notional book entry, ineligible under Section 37(1).

Key Facts

• The assessee debited the following amounts as ESOP expenses in respective assessment years:
  • Rs. 30,22,26,918 for A.Y. 2017-18
  • Rs. 31,96,43,000 for A.Y. 2018-19
  • Rs. 9,56,97,125 for A.Y. 2020-21
• The shares were issued directly by the company to employees at a discounted price, not purchased from the open market
• The company followed the ESOP scheme as per its approved plan and disclosed the expense in its financial statements
• No separate acquisition of shares from third parties occurred; the expense arose from the difference between fair market value and issue price
• The accounting treatment followed the principles of AS-15 (Employee Benefits), though not formally notified under Section 145(2)
• The ESOPs were granted as part of employee remuneration to retain talent and align interests with company performance

Procedural History

• 28.12.2019: AO passed assessment order for A.Y. 2017-18, disallowing ESOP expense of Rs. 30,22,26,918
• 27.09.2022: AO passed assessment order for A.Y. 2020-21, disallowing ESOP expense of Rs. 9,56,97,125
• A.Y. 2018-19 assessment was similarly processed under Section 144B
• 2020-2021: Assessee filed appeals before the Commissioner of Income Tax (Appeals) [CIT(A)]
• 30.09.2025: National Faceless Appeal Centre (NFAC), acting as CIT(A), deleted the disallowances in all three assessment years, relying on Delhi High Court precedents
• 25.05.2026: Hearing before ITAT Delhi
• 27.05.2026: Judgment pronounced

The Parties' Positions

For the Revenue

• Argued that ESOP discount is a capital transaction because it affects share capital structure
• Contended that no actual cash outflow occurred, making the expense notional and non-deductible
• Relied on Circular No. 9 of 2007 to assert that only expenditure on acquisition of shares from third parties qualifies
• Asserted that the matter is sub judice before the Supreme Court in Lemon Tree Hotels (P.) Ltd. and therefore should be stayed
• Claimed the CIT(A) erred by ignoring settled principles of capital vs. revenue expenditure

For the Assessee

• Maintained that ESOP discount is a form of employee compensation, akin to salary or bonus
• Cited binding decisions of the Delhi High Court in PCIT v. New Delhi Television Ltd. and Pr. CIT v. Lemon Tree Hotels (P.) Ltd.
• Argued that the expense is incurred wholly and exclusively for business purposes
• Highlighted that AS-15, though not notified, is judicially recognized for accounting ESOPs
• Emphasized that the Supreme Court case cited by Revenue was not on point and did not involve identical facts

Relief Sought

The Revenue sought to restore the disallowances of:

• Rs. 30,22,26,918 for A.Y. 2017-18
• Rs. 31,96,43,000 for A.Y. 2018-19
• Rs. 9,56,97,125 for A.Y. 2020-21

The assessee sought confirmation of the CIT(A)’s order allowing the deductions.

The Legal Issue

The central question was whether the discount on issuance of shares under an Employee Stock Option Plan constitutes allowable revenue expenditure under Section 37(1) of the Income Tax Act, 1961, or whether it is a capital expenditure ineligible for deduction.

Arguments Presented

For the Appellant (Revenue)

The Revenue contended that ESOP expenses are not deductible under Section 37(1) because:

• The issuance of shares at a discount does not involve any outflow of cash or equivalent economic resource
• The transaction alters the company’s capital structure, making it inherently capital in nature
• Circular No. 9 of 2007 restricts deduction to cases where shares are acquired from the open market
• The Supreme Court’s pending adjudication in Lemon Tree Hotels (P.) Ltd. warrants deference and stay of adjudication
• The CIT(A) erred in relying on High Court judgments that were not binding on the Tribunal

The Revenue further argued that allowing such deductions would create a loophole for companies to inflate expenses without actual cash outlay.

For the Respondent (Assessee)

The assessee countered that:

• ESOP discount is a direct cost of securing employee services, analogous to salary or bonus
• The Delhi High Court in Lemon Tree Hotels (P.) Ltd. and NDTV Ltd. had unequivocally held that such expenses are revenue in nature
• The absence of cash outflow is irrelevant under the mercantile system of accounting
• AS-15 provides a credible and widely accepted framework for recognizing ESOP expenses
• The Supreme Court case cited by Revenue was not on the same legal point and had not yet been decided
• The Tribunal is bound by the precedents of the jurisdictional High Court under Article 226 of the Constitution

The Court's Analysis

The Tribunal undertook a detailed review of the jurisprudence on ESOP deductibility, beginning with the binding precedents of the Delhi High Court. It emphasized that the High Court in Pr. CIT v. Lemon Tree Hotels (P.) Ltd. had squarely addressed the Revenue’s core contention - that only expenditure on acquisition of shares from third parties qualifies for deduction.

"What the Revenue urges essentially is that unless the employer/assessee acquires the shares from a third party, it cannot claim any deduction and that expenditure claimed for allotment or issue of ESOP is merely notional. This Court is of the opinion that such an argument ignores the realities of functioning of commercial entities who would then be asked to purchase shares from market place or third party at prevailing rates instead of allotting them."

The Tribunal noted that the High Court had rejected the notion that ESOPs are capital transactions, observing that no capital asset is acquired by the company through the issuance of shares to employees. Instead, the company incurs a cost to obtain services, which is the essence of revenue expenditure.

The Tribunal further held that the absence of actual cash outflow does not render the expense non-deductible. Under the mercantile system of accounting, which governs income tax computation, expenses are recognized when incurred, not when paid. The discount on shares represents a real economic cost to the company, reflected in the dilution of equity value.

The Tribunal dismissed the Revenue’s reliance on Circular No. 9 of 2007, noting that circulars are administrative guidelines and cannot override judicial interpretation of statutory provisions. It also rejected the argument that the matter was sub judice before the Supreme Court, observing that the pending SLP in Lemon Tree Hotels did not involve the same legal issue or facts, and that the Delhi High Court’s decision remained binding until overruled.

The Tribunal affirmed that AS-15, though not formally notified under Section 145(2), had been consistently accepted by courts and tribunals as a valid basis for accounting ESOP expenses. The fact that the expense was recorded in accordance with accepted accounting principles further supported its deductibility.

The Verdict

The Revenue’s appeals were dismissed in their entirety. The Tribunal upheld the order of the CIT(A) dated 30.09.2025, confirming the allowability of ESOP expenses of Rs. 30,22,26,918 for A.Y. 2017-18, Rs. 31,96,43,000 for A.Y. 2018-19, and Rs. 9,56,97,125 for A.Y. 2020-21 under Section 37(1) of the Income Tax Act. The Tribunal directed that the disallowances be deleted and the assessments be rectified accordingly.

What This Means For Similar Cases

ESOP Costs Are Revenue Expenditure, Not Capital

• Practitioners must now treat ESOP discounts as deductible business expenses under Section 37(1), regardless of whether shares are issued from treasury or newly allotted
• The distinction between capital and revenue expenditure must be based on the purpose of the outlay - compensation for services rendered - not on accounting mechanics
• Companies can confidently claim ESOP expenses in their tax returns without fear of disallowance, provided the scheme is bona fide and documented

Jurisdictional Precedents Bind the Tribunal

• The ITAT is bound by the decisions of the jurisdictional High Court under Article 226
• Arguments based on pending Supreme Court matters cannot override binding High Court rulings unless the Supreme Court has stayed the judgment
• Practitioners should cite Lemon Tree Hotels (P.) Ltd. and NDTV Ltd. as authoritative precedents in all ESOP-related disputes before the Tribunal

Accounting Standards Support Tax Deductibility

• Even unnotified accounting standards like AS-15 can be relied upon to substantiate the recognition of ESOP expenses
• The Tribunal’s endorsement of AS-15 reinforces the principle that tax computation must align with commercial reality and accepted accounting practices
• Companies should ensure their ESOP accounting policies are clearly documented and consistently applied