ITAT Mumbai sets aside Section 263 order on ESOP cost and Facebook advertisement payments

1. Background of the dispute

Play Games 24X7 Pvt. Ltd. Vs PCIT-13 (ITAT Mumbai) concerns the exercise of revisionary powers under Section 263 of the Income Tax Act 1961 for Assessment Year 2013-14.

The assessee, M/s. Play Games 24X7 Pvt. Ltd., challenged the order dated 28.03.2018 passed by the Principal Commissioner of Income Tax-13, Mumbai (PCIT), whereby the PCIT invoked Section 263 and held that the original assessment order was:

  • Erroneous, and
  • Prejudicial to the interests of the Revenue

The PCIT’s objections related to two principal aspects:

  1. Deduction of Rs.1,53,88,418 claimed as Employee Welfare Cost under an Employee Stock Option (ESOP) scheme, and
  2. Non-deduction of tax at source on advertisement payments of Rs.1,76,29,464 made to Facebook Ireland Ltd. (FB Ireland), allegedly attracting disallowance under Section 40(a)(i).

The assessee argued that both issues had been fully examined by the Assessing Officer (AO) in the scrutiny proceedings and that a mere difference of opinion could not justify revision under Section 263.

The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT Mumbai) accepted the assessee’s contentions and quashed the Section 263 order.


2. Assessment history and initiation of Section 263 proceedings

2.1 Original return and assessment

  • The assessee filed its return of income declaring total income of Rs.1,63,72,570.
  • A revised return was also filed on 25.10.2013, reflecting the same total income of Rs.1,63,72,570.
  • The AO completed the assessment under Section 143(3).

In the assessment, the AO made only two disallowances:

  • Rs.10,46,126 (20% of Rs.52,30,632) out of travelling and conveyance expenses, and
  • Rs.5,15,532 (20% of Rs.25,77,660) out of miscellaneous expenses.

Thus, the assessed income was computed at Rs.1,89,30,410.

2.2 Issues flagged in Section 263 notice

The PCIT later initiated revisionary proceedings under Section 263. In the show cause notice, the PCIT alleged that the assessment order was erroneous and prejudicial to the interests of the Revenue because:

  1. ESOP discount claim

    • The assessee had claimed deduction of Rs.1,53,88,418 as Employee Welfare Cost under its ESOP scheme, computed as:
      • Total ESOP discount: Rs.7,25,18,244
      • Less: amount carried forward to subsequent years: Rs.5,71,29,826
      • Net amount claimed for the year: Rs.1,53,88,418
    • According to the PCIT, the AO had not properly examined the allowability or computation of this claim.
  2. Payments to Facebook Ireland

    • The assessee had made payments of Rs.1,76,29,463 to Facebook Ireland towards advertisement expenses.
    • The PCIT alleged that the AO failed to examine:
      • Whether tax was required to be deducted at source under Section 195, and
      • Whether disallowance under Section 40(a)(i) was warranted on account of non-deduction of TDS.

Relying on these two perceived omissions, the PCIT set aside the original assessment and directed the AO to reframe the assessment after fresh examination of these issues.

The assessee appealed to the ITAT Mumbai against this Section 263 order.


3. Grounds raised by the assessee before ITAT

The assessee’s appeal primarily challenged the validity of the Section 263 action on both legal and factual grounds. In substance, the assessee contended that:

  • On ESOP cost

    • The AO had issued queries and the assessee had filed detailed submissions on the ESOP accounting and the claim of Rs.1,53,88,418 as Employee Welfare Cost.
    • The method of amortisation of ESOP discount over the vesting period was fully aligned with the Special Bench ruling in Biocon Ltd. vs. DCIT, (2013) 35 taxmann.com 335 / (2014) 144 ITD 21 (Bangalore – Trib.) (SB) / (2013) 155 TTJ 649.
    • The AO had taken one of the legally permissible views; hence, the order could not be termed “erroneous” merely because the PCIT preferred another view.
  • On Facebook advertisement payments

    • Complete particulars of payments to Facebook Ireland had been placed before the AO during assessment proceedings.
    • The AO accepted the claim after due enquiry, and the issue was subsequently adjudicated in the assessee’s own case for AY 2015-16 (ITA No.1533/M/2019, order dated 23.03.2022), where the Tribunal held that such payments did not constitute royalty or fees for technical services and were not taxable in India, as Facebook Ireland did not have a Permanent Establishment in India.