ITAT: Expenditure Incurred by Flipkart Towards ESOP Eligible for Deduction Under Section 37 of Income Tax Act

ITAT: Expenditure Incurred by Flipkart Towards ESOP Eligible for Deduction Under Section 37 of Income Tax Act

The Income Tax Appellate Tribunal (ITAT), Bangalore in a cross appeal observed, that Expenditure Incurred of over Rs. 15.5 crore by Flipkart towards Employee Stock Ownership Plan (ESOP) was eligible for deduction under Section 37 of the Income Tax Act, 1961 (the Act).

The cross appeals by the assessee and revenue were against the order of the Commissioner of Income Tax (Appeals) [CIT(A)] Bangalore dated 19 October, 2022 for the assessment year 2017-18 was heard by the division bench of Shri George George K (Judicial Member) and Ms. Padmavathy S (Accountant Member).

The assessee- Flipkart India is engaged in the business of wholesale distribution of books, mobile, media, computers, gaming console and other related accessories, apart from developing technology solutions, website solutions, supply chain management, financial solutions, logistic solutions, engineering and outsourcing solutions for e-commerce business.

The assessee filed the return of income for AY 2017-18 on 30 November, 2017 declaring a loss of Rs.139,61,48,741. The case was selected for scrutiny and statutory notices were duly served on the assessee.

The Assessing Officer (AO) completed the assessment by making certain additions to Flipkart’s income, where it did not accept the loss declared by Flipkart in its books of account and treated the discounts offered by Flipkart on the goods sold by it, as capital expenses.

According to AO the profits foregone by Flipkart by offering discounts, created intangibles assets, such as goodwill and a brand value. It thus made additions on account of ‘valuation of marketing intangibles.’

Furthermore, the AO further disallowed the expenses claimed by Flipkart under Section 37 of the Income Tax Act towards ESOP.

Thereafter, Flipkart filed an appeal against the assessment order before the CIT(A) deleted the additions made by the AO towards valuation of Flipkart’s marketing intangible assets. However, the CIT(A) upheld the disallowance of the ESOP expenses.

Against the order of the CIT(A), both Flipkart and the revenue department filed an appeal before the ITAT.

Flipkart contended before the ITAT that the CIT(A) had erred in confirming the disallowance of the expenditure incurred on ESOP under Section 40(a)(i) of the Income Tax Act. The CIT(A) had observed that Flipkart was liable to deduct tax under Section 195 of the Income Tax Act on the reimbursements made to its Singapore based Holding Company towards ESOP expenditure.

Moreover, Flipkart vehemently argued that the ESOP cross charge payments made to its Holding Company were mere reimbursements, having no mark-up or profit element attached to it. Since it was a case of cost-to-cost reimbursement, there was no liability to withhold tax on the same under Section 195.

Thus, it argued that the ESOP expenses qualify the conditions prescribed under Section 37, and that they are in the nature of an unascertained liability and not a contingent liability.

The ITAT with respect to the issue of whether ESOP cross charge expenses are allowable under Section 37 of the Act said that the issue has been already decided by the ITAT in favor of the assessee in the case of Biocon Ltd. v. Dy. CIT [2013] which has also been affirmed by the Karnataka High Court in [2021] 430 ITR 151 (Karnataka) by categorically holding that “the expression ‘expenditure’ will also include a loss and therefore, issuance of shares at a discount where the assessee absorbs the difference between the price at which it is issued and the market value of the shares would also be expenditure incurred for the purposes of Section 37(1) of the Act.”

The ITAT thus held that the expenditure incurred by Flipkart towards ESOP was eligible for deduction under Section 37 of the Income Tax Act.

The Tribunal also upheld the order of the CIT(A) where it had deleted the additions made by the AO on account of valuation of Flipkart’s marketing intangibles. The CIT(A) had relied on the decision of ITAT Bangalore in assessee’s own case for the AY 2015-16, i.e., M/s Flipkart India Pvt Ltd vs. Assistant Commissioner of Income Tax (2018), to delete the additions.

The CIT(A) in its 2018 order had observed that the profit margin forgone by Flipkart cannot be held to be an expenditure incurred in creating an intangible asset or goodwill.

Accordingly, the ITAT allowed the appeal of Flipkart and dismissed the appeal of the revenue department.