ITAT Pune’s Ruling on ESOP Deduction and Transfer Pricing in Brainbees Solutions Limited Vs ACIT

1. Background and Procedural History

The Pune Bench “C” of the Income Tax Appellate Tribunal decided the appeal of Brainbees Solutions Limited Vs ACIT (ITAT Pune) concerning Assessment Year 2022-23. The assessee, popularly associated with the “FirstCry” brand, is engaged in trading in baby and kids’ products and FMCG goods through multiple channels, along with providing IT and digital marketing support services to its group entities abroad.

For AY 2022-23, the assessee filed a nil return of income. The assessment, however, culminated in a final order dated 30.01.2026 under Section 143(3) read with Section 144C(13) of the Income Tax Act 1961 determining total income at ₹93,57,99,520. This figure essentially arose from:

  • Disallowance of ESOP expenditure: ₹82,73,04,280
  • Transfer pricing (TP) adjustments aggregating to ₹10,84,95,240, comprising:
    • Trading / distribution segment: ₹3,07,17,757
    • Provision of IT/software support services: ₹44,03,532
    • Provision of digital marketing support services: ₹27,20,236
    • Royalty segment: ₹7,06,53,715

The assessee challenged:

  • The disallowance of ESOP expenses claimed under Section 37(1)
  • The TP methodology and selection/rejection of various comparables and royalty benchmarking
  • The initiation of penalty proceedings under Section 270A(9) and Section 271AAD(1)(i)
  • Certain jurisdictional and legal issues (limitation, validity of notice, etc.)

The Dispute Resolution Panel (DRP) had substantially affirmed the disallowance of ESOP and most TP adjustments. The Tribunal ultimately partly allowed the appeal, granting substantive relief on ESOP and remanding significant TP issues for fresh examination.

2. ESOP Expenditure: Allowability Under Section 37(1)

2.1 AO’s Stand and Disallowance

During assessment proceedings, the Assessing Officer noticed that the assessee had claimed ₹82,73,04,280 as ESOP-related expenditure (employee share-based payment). In the AO’s opinion:

  • ESOP charge represented a notional or contingent outgo, hinging on the gap between the fair market value of shares and the exercise price granted to employees.
  • There was no actual cash outflow; at most, the assessee received lower or no securities premium, which, being capital in nature, could not yield a revenue deduction.
  • The debit to the profit and loss account was, according to the AO, a capital adjustment rather than a revenue expenditure.

The AO therefore:

  • Treated ESOP cost as notional and capital in nature, not meeting the criteria of Section 37(1)
  • Relied on earlier Tribunal decisions such as ACIT v. Ranbaxy Laboratories, Medha Servo Drivers Limited, Mahindra & Mahindra Ltd. v. DCIT, VIP Industries Ltd. v. DCIT, and others that had disallowed ESOP-related claims.
  • Disallowed the entire amount of ₹82,73,04,280, and initiated penalty proceedings under Section 270A(9)(a) and Section 271AAD.

The assessee had pointed out that in its own case for AY 2015-16, the CIT(A) allowed ESOP deduction (subject to verification of amount) and that the Revenue did not pursue an appeal.

2.2 DRP’s Reasoning

The DRP upheld the disallowance mainly on the ground that the issue was “pending” at higher judicial forums and that Revenue had challenged favourable High Court and Tribunal decisions. It relied on references such as PCIT v. Lemon Tree Hotels (P.) Ltd. and observations about the role of the DRP as a continuation of the assessment process.

The DRP effectively kept the disallowance alive, despite acknowledging the existence of High Court and Special Bench decisions allowing ESOP deductions.

2.3 Tribunal’s Analysis and Directions

The Tribunal examined the jurisprudence on ESOP deduction, including:

  • Biocon Ltd. v. DCIT, [2013] 25 ITR (T) 602 (ITAT Bangalore, Special Bench)
  • CIT v. Biocon Ltd., [2021] 430 ITR 151 (Karnataka High Court), decision dated 11 November 2020
  • CIT v. PVP Ventures Ltd., [2012] 23 taxmann.com 286 (Madras High Court)
  • CIT v. Lemon Tree Hotels Ltd., [2019] 104 taxmann.com 26 (Delhi High Court)
  • PVR Ltd. v. CIT, [2022] 145 taxmann.com 331 (Delhi High Court)
  • Pune Bench decisions such as Capgemini Technology Services Limited v. DCIT, Sandvik Asia Private Limited v. ACIT, and others cited by the assessee such as iGate Computer Systems Ltd. v. DCIT, Bajaj Finance Ltd. v. DCIT, and PVR v. Addl. CIT.

It noted that:

  • The Special Bench in Biocon held that discount on issue of shares under ESOP is a deductible business expenditure under Section 37(1) spread over the vesting period.
  • The Karnataka High Court in CIT v. Biocon Ltd. approved the Special Bench view, characterising ESOP discount as a revenue outgo incurred wholly and exclusively for the purpose of business.
  • Similarly, the Madras High Court in CIT v. PVP Ventures Ltd. and the Delhi High Court in CIT v. Lemon Tree Hotels Ltd. upheld the allowability of ESOP discount as revenue expenditure.
  • The assessee also cited PCIT v. Page Industries Limited, [2021] 431 ITR 409 (Karnataka High Court), and submission that the SLP (PCIT v. Page Industries Ltd., SLP (C) No.11465/2021) had been dismissed.

The Tribunal underscored two critical points:

  1. Binding nature of High Court decisions / Special Bench: In absence of any contrary judgment of the Supreme Court or any stay on the above High Court decisions, the Tribunal is bound to follow them.
  2. Revenue appeal pending is not a ground: A mere fact that the Revenue has filed or intends to file SLP or appeal cannot by itself justify continuing a disallowance. Unless those decisions are stayed or reversed, they hold the field.

The Tribunal also took note that in the assessee’s earlier year, relief on ESOP issue had already been granted in appellate proceedings and not assailed by the Revenue, strengthening the position on consistency (Radhasoami Satsang v. CIT, [1992] 193 ITR 321).

2.4 Outcome on ESOP Issue

Applying the above precedents, the Tribunal:

  • Rejected the AO’s characterisation of ESOP cost as notional and capital in nature.
  • Held that the entire ESOP expenditure of ₹82,73,04,280 was allowable as a deduction under Section 37(1).
  • Directed the AO to delete the disallowance in full.