When a company offers Employee Stock Option Plans (ESOPs), it typically allows employees to buy shares at a “discount” (a price lower than the market value). A common question for business owners is: Can this discount be claimed as a business expense?

1. Is the ESOP “Discount” a Tax-Deductible Expense?

An expenditure is deductible if it is laid out wholly and exclusively for the purpose of business and is not of a capital nature. For years, tax authorities have been arguing that ESOP expenditures are “notional” because no cash flows out of the company. However, the judiciary has largely settled this in favour of taxpayers, viewing it as a part of employee compensation.

The ITAT Bangalore special bench ruling in Biocon Ltd.^[1] (also affirmed by Karnataka High Court^[2]) remains the “North Star,” establishing that ESOP discount is a deductible expenditure over the vesting period. Other courts too have decided the matter in favour of taxpayers at various instances for following reasons:

• ESOP discount is a real expenditure, reflecting employee remuneration paid in equity rather than cash.
• The liability arises on grant and accrues over the vesting period as employees render service exercise merely determines final settlement.
• Since the objective of ESOPs is employee retention and motivation, and not capital formation, the cost is revenue in nature.
• If a business liability has arisen in the accounting year, the same is permissible as deduction, even though, liability may have to quantify and discharged at a future date

2. TDS Obligation

When an employee exercises their options, it triggers a “Perquisite” which is treated as salary.

• When to Deduct: TDS must be deducted at the time of exercise (except for eligible startups).
• How much to Deduct: Calculate the tax based on the employee’s applicable slab rate (including surcharge and cess) on the perquisite value.