Discount on shares allotted to employees under ESOP recognized as allowable revenue expenditure under Section 37(1), affirming precedents from Delhi and Karnataka High Courts.
In a significant ruling dated September 16, 2026, the Kerala High Court (Division Bench) in the case of Principal Commissioner of Income Tax, Kochi-I vs. M/s. Geojit Financial Services Ltd. has held that the discount allowed on shares allotted to employees under the Employees Stock Option Plan (ESOP) qualifies as a revenue expenditure deductible under Section 37(1) of the Income Tax Act, 1961.
The controversy arose when the respondent company, Geojit Financial Services Ltd., issued shares to its employees at a discount under its ESOP scheme. The Assessing Officer disallowed the company's claim to deduct the discount as business expenditure, contending that only the actual cost of acquiring shares could be allowed as an expenditure. The company challenged this disallowance, and the First Appellate Authority and subsequently the Income Tax Appellate Tribunal (ITAT), Cochin Bench, ruled in favour of the company allowing the deduction.
The Revenue appealed to the Kerala High Court, framing two key questions of law: whether the discount on ESOP shares is allowable as revenue expenditure under Section 37(1), and whether the ITAT was correct in affirming the deduction.
After hearing both sides, the Court affirmed the decisions of the Delhi High Court in Commissioner of Income Tax Delhi-2 v. Lemon Tree Hotels (P) Ltd. and the Karnataka High Court in Commissioner of Income Tax (LTU) v. Biocon Ltd., both of which had ruled that ESOP discounts are allowable as revenue expenditure. The Court observed that the term "expenditure" under Section 37(1) includes losses, and the discount absorbed by the company (the difference between the market price and issue price of shares) constitutes an ascertained liability and is incurred wholly and exclusively for the purpose of business.
The Court rejected the Revenue's contention that the discount is a contingent liability or a short receipt of capital, clarifying that the primary objective of issuing shares at a discount under ESOP is to secure and incentivize employees, thereby enhancing the company's profitability. The Court also noted that the accounting treatment of such expenses follows the Securities and Exchange Board of India (SEBI) guidelines and the mercantile system of accounting.
The judgment highlighted that even though the Supreme Court has the final say on the issue, the Kerala High Court respectfully aligns itself with the concurrent High Court rulings favouring the assessee. Consequently, the Court dismissed the Revenue's appeal and upheld the ITAT order allowing the deduction of ESOP discount under Section 37(1) of the Income Tax Act.
This ruling provides clarity and reassurance to companies implementing ESOP schemes, confirming that the discount provided to employees is a legitimate business expense deductible in computing taxable income.
Bottom Line:
Income Tax - Discount on shares allotted to employees under ESOP is allowable as revenue expenditure under Section 37(1) of the Income Tax Act - Such discount is not a contingent liability or short receipt of capital, but an ascertained expenditure incurred to secure and incentivise employees.
Statutory provision(s):
Income Tax Act, 1961 Section 37(1)
