Can ESOP expenditure be disallowed under Section 37(1) merely because the issue is pending before the Supreme Court?

No. If a jurisdictional High Court has already decided the issue in favor of the assessee and the Revenue’s SLP against that decision has been dismissed, the matter is settled and cannot be reopened by the Assessing Officer on grounds of pending Supreme Court litigation.

Is the accounting treatment of ESOP discounts determinative of their tax treatment under Section 37(1)?

No. While accounting standards may record ESOP discounts as expenses, the tax treatment depends on the nature of the transaction. If the discount is part of employee remuneration and incurred wholly and exclusively for business purposes, it qualifies as a revenue expenditure under Section 37(1), regardless of accounting classification.

Does a High Court judgment bind the ITAT even if the Supreme Court has admitted an SLP on the same issue?

Yes. The ITAT is bound by the decisions of the jurisdictional High Court. The admission of an SLP by the Supreme Court does not suspend or nullify the binding effect of a High Court judgment until the Supreme Court delivers a contrary ruling.

ESOP tax deduction Section 37 IT Act Bangalore ITAT

The ITAT Bangalore has affirmed that Employee Stock Option Plan (ESOP) expenditures, though notional in nature, qualify as allowable business expenses under Section 37(1) of the Income Tax Act when judicial precedent from a higher forum has settled the issue. This ruling reinforces the binding effect of High Court decisions on subordinate tribunals, even when the matter remains pending before the Supreme Court.

Background & Facts

The Dispute

The dispute centers on the allowability of ESOP-related expenditure of ₹903,035,787 incurred by IBM India Private Limited for Assessment Year 2022-23. The Assessing Officer (AO) disallowed this amount, arguing that ESOP discounts represent a capital transaction - foregoing of share premium - and not a revenue expenditure. The AO further contended that since the legal position on ESOP deductibility was pending adjudication before the Supreme Court in CIT v. Biocon Ltd., the issue could not be considered settled and thus required disallowance to preserve the revenue’s position.

Key Facts

The assessee, IBM India Private Limited, is engaged in software development, IT services, and hardware leasing.
The Return of Income for AY 2022-23 was filed on 25.11.2022, declaring total income of ₹40,77,72,04,140.
The AO issued notice under Section 143(2) on 02.06.2023 and passed the assessment order under Section 143(3) on 26.03.2025.
The disallowance of ₹903,035,787 was made solely on the ground that the issue was pending before the Supreme Court.
The assessee had previously claimed and been granted relief for ESOP expenditure in earlier assessment years (2015-16 to 2018-19) by the ITAT, consistent with the Karnataka High Court’s decision in CIT v. Biocon Ltd. (2020) 121 Taxmann.com 351.
The Karnataka High Court, in CIT v. IBM India Pvt. Ltd. (ITA No. 451 of 2023, decided on 15.12.2024), upheld the ITAT’s order allowing ESOP expenditure, and the Special Leave Petition filed by the Revenue was dismissed.

Procedural History

25.11.2022: Assessee filed Return of Income for AY 2022-23.
02.06.2023: Notice under Section 143(2) issued by AO.
26.03.2025: Assessment order passed by AO disallowing ESOP expenditure of ₹903,035,787.
24.04.2025: Assessee filed appeal before National Faceless Appeal Centre (NFAC), Delhi.
30.10.2025: CIT(A) deleted the disallowance, relying on precedent from ITAT’s own order in AY 2015-16 and Karnataka High Court’s decision.
18.03.2026: Hearing before ITAT Bangalore.
30.03.2026: ITAT pronounced order dismissing the Revenue’s appeal.

The Parties' Positions

For the Revenue (AO):

ESOP discount is a capital transaction, not revenue expenditure.
No actual cash outflow occurs; hence, it cannot be allowed under Section 37(1).
Accounting standards cannot override statutory provisions.
The Supreme Court’s pending adjudication in CIT v. Biocon Ltd. necessitates disallowance to preserve the revenue’s right to challenge.

For the Assessee (IBM):

The issue has been finally decided in its favor by the Karnataka High Court in CIT v. IBM India Pvt. Ltd. (ITA No. 451 of 2023).
The High Court’s decision, which affirmed the ITAT’s earlier rulings, is binding on the AO and CIT(A).
The dismissal of the Revenue’s SLP against the High Court’s order confirms finality.
Precedent from AY 2015-16 to 2018-19 was consistently in favor of the assessee.

Relief Sought

The Revenue sought to restore the disallowance of ₹903,035,787 and set aside the CIT(A)’s order. The assessee sought confirmation of the deletion of disallowance and affirmation of the binding nature of the Karnataka High Court’s judgment.

The Legal Issue

Whether the allowability of ESOP expenditure under Section 37(1) of the Income Tax Act, 1961, can be denied merely because the issue is pending before the Supreme Court, when a binding precedent from the jurisdictional High Court has already settled the matter in favor of the assessee.

Arguments Presented

For the Appellant (Revenue)

The Revenue contended that the disallowance was justified on the ground of uncertainty in law. It argued that since the Supreme Court had admitted a Special Leave Petition in CIT v. Biocon Ltd., the legal position on ESOP deductibility remained unsettled. The AO relied on the principle that tax authorities are not bound by lower court decisions when higher forums are yet to rule. It further asserted that ESOP discounts are not actual expenditures but accounting entries reflecting capital adjustments, and thus do not meet the test of "wholly and exclusively for business purposes" under Section 37(1).

For the Respondent (Assessee)

The assessee countered that the Karnataka High Court had conclusively decided the issue in its favor in CIT v. IBM India Pvt. Ltd. (ITA No. 451 of 2023), and the Revenue’s SLP against that judgment had been dismissed. It emphasized that the High Court’s decision was binding on the ITAT under Article 226 and the doctrine of stare decisis. The assessee also cited the consistent treatment of ESOP expenditure in prior years, which had been upheld by the ITAT and affirmed by the High Court, establishing a settled position.

The Court's Analysis

The ITAT emphasized that the jurisdictional High Court’s decision in CIT v. IBM India Pvt. Ltd. (ITA No. 451 of 2023) had already affirmed the allowability of ESOP expenditure under Section 37(1). The Tribunal noted that the Revenue had challenged this decision before the Supreme Court, but the SLP had been dismissed, thereby rendering the High Court’s order final and binding.

"Though the revenue might have challenged the deductibility of ESOP expenditure before the Honourable Supreme Court however, as in the case of the assessee the issue is settled by the Honourable Karnataka High Court against which the special limitation filed by the assessee is also dismissed, we do not find any merit in the appeal of the learned assessing officer."

The Tribunal rejected the Revenue’s argument that pending litigation before the Supreme Court justified disallowance. It held that the existence of a pending appeal before a higher forum does not negate the binding effect of a decision rendered by a coordinate High Court on the same issue. The ITAT reiterated that the AO’s role is to apply the law as settled by higher authorities, not to anticipate potential reversal.

The Tribunal also dismissed the Revenue’s contention that accounting standards or notional entries could override statutory provisions. It held that the nature of the expenditure - whether capital or revenue - must be determined by the substance of the transaction and judicial precedent, not merely by accounting treatment. The consistent allowance of ESOP expenditure in prior years, upheld by the High Court, further reinforced the conclusion that the expenditure was revenue in nature and allowable.

The Verdict

The appeal of the Revenue was dismissed. The ITAT upheld the order of the CIT(A) dated 30.10.2025, confirming the deletion of the disallowance of ₹903,035,787 relating to ESOP expenditure for AY 2022-23. The Tribunal held that the issue was squarely covered by the binding precedent of the Karnataka High Court, and no further disallowance could be made. The order of the AO dated 26.03.2025 was set aside insofar as it related to this disallowance.

What This Means For Similar Cases

Binding Precedent Overrides Pending Supreme Court Litigation

Practitioners must argue that if a jurisdictional High Court has decided an issue in favor of the assessee, and the Revenue’s SLP against that decision has been dismissed, the matter is final for all practical purposes.
Tax authorities cannot disallow expenditures merely because a similar issue is pending before the Supreme Court.
The doctrine of stare decisis requires lower forums to follow binding High Court rulings, even if the Supreme Court has not yet ruled.

ESOP Expenditure Is Revenue in Nature When Structured as Compensation

ESOP discounts treated as part of employee remuneration are revenue expenditures under Section 37(1), provided they are incurred wholly and exclusively for business purposes.
Accounting entries reflecting ESOP costs are not disqualifying; the substance of the transaction governs tax treatment.
Consistent past practice, especially when upheld by higher forums, strengthens the claim for allowance.

Procedural Compliance Requires Application of Existing Law

Assessing Officers must apply settled law, not delay assessments pending higher court decisions.
Disallowances based on "pending litigation" without legal basis are arbitrary and contrary to the principle of certainty in taxation.
Taxpayers should cite jurisdictional High Court judgments and SLP dismissal records to resist unwarranted disallowances.

Section 37(1) IT Act | ESOP Expenditure Allowable as Revenue Expense : ITAT Bangalore Binds Lower Authorities to Karnataka HC Precedent