The Kerala High Court has held that the discount arising from the allotment of shares to employees under an Employee Stock Option Plan (ESOP) constitutes expenditure eligible for deduction under Section 37(1) of the Income-tax Act, 1961. Following the decisions of the Delhi and Karnataka High Courts, the Court dismissed the Revenue’s appeal and answered the questions of law in favour of the assessee.
Introduction
Employee Stock Option Plans (ESOPs) are widely used by companies to attract, retain and incentivise employees by providing them an opportunity to acquire shares at a price that may be lower than their market value.
An important tax question arises when a company allots shares to its employees at a discounted price: Can the discount on such shares be claimed as a deduction in computing the company’s taxable business income?
The Kerala High Court considered this issue in ITA No. 21 of 2025, reported as 2026:KER:71035, in the case concerning Geojit Financial Services Ltd. The judgment was delivered on 16 September 2026 by a Division Bench comprising Justice Devan Ramachandran and Justice Basant Balaji.
The Court affirmed the view that the discount on shares allotted under an ESOP can constitute revenue expenditure deductible under Section 37(1) of the Income-tax Act, 1961.
Background of the Case
Geojit Financial Services Ltd. had allotted shares to its employees under an Employee Stock Option Plan. The company claimed a deduction for the discount allowed on the shares under Section 37(1) of the Income-tax Act, 1961.
The Assessing Officer disallowed the claim. On appeal, the First Appellate Authority decided the issue in favour of the company.
The Revenue challenged that decision before the Income Tax Appellate Tribunal (ITAT), Cochin Bench. The Tribunal dismissed the Revenue’s appeal and upheld the deduction claimed by the company.
The Revenue thereafter approached the Kerala High Court.
The appeal was admitted on two substantial questions of law concerning the deductibility of the ESOP discount as revenue expenditure under Section 37(1).
Questions of Law Before the High Court
The High Court considered the following questions:
- Whether the discount allowed on shares allotted under an Employee Stock Option Plan constitutes revenue expenditure allowable under Section 37(1) of the Income-tax Act, 1961.
- Whether, on the facts and circumstances of the case, the ITAT was correct in affirming the order of the Commissioner of Income Tax (Appeals) allowing the deduction claimed by the assessee.
The central issue was whether the economic cost borne by an employer when issuing shares to employees at a discount could be recognised as business expenditure for income-tax purposes.
Revenue’s Argument Against the Deduction
The Revenue contended that the view adopted by the Delhi and Karnataka High Courts was contrary to law.
It argued that the deduction claimed in respect of the ESOP could be allowed only within the framework of Section 37(1), and questioned the Tribunal’s reliance on the earlier decision of the Bangalore Bench of the ITAT in Biocon Ltd. v. Deputy Commissioner of Income Tax, (2013) 25 ITR (T) 602 (Bang-Trib) (SB).
The Revenue also sought to distinguish the facts of the present case from the earlier decisions, pointing out that the assessee had not adopted the straight-line method of recognising ESOP expenses.
On this basis, the Revenue requested the High Court to take a different view and allow its appeal.
Assessee’s Reliance on Earlier High Court Decisions
The assessee relied principally on two decisions:
- Commissioner of Income Tax v. Lemon Tree Hotels (P) Ltd., 2018 SCC OnLine Del 13684, decided by the Delhi High Court.
- Commissioner of Income Tax (LTU) v. Biocon Ltd., (2021) 430 ITR 151, decided by the Karnataka High Court.
The assessee submitted that both High Courts had accepted the principle that the discount arising from the issue of shares under an ESOP could qualify as deductible revenue expenditure.
The assessee also acknowledged that the issue was pending before the Supreme Court for final resolution.
After considering the competing submissions, the Kerala High Court expressed its full agreement with the views taken by the Delhi and Karnataka High Courts.
Why Did the Court Treat ESOP Discount as Expenditure?
1. Section 37(1) and the Meaning of Expenditure
Section 37(1) of the Income-tax Act, 1961, provides for the deduction of qualifying business expenditure that is not covered by Sections 30 to 36 and is not capital expenditure or personal expenditure of the assessee, subject to the statutory conditions.
The Kerala High Court affirmed the principle that the expression “expenditure” under Section 37(1) includes a loss.
When a company allots shares to employees at a price below their market value, the company effectively absorbs the difference between the market value and the issue price.
The Court accepted that this difference can constitute expenditure for the purposes of Section 37(1).
In other words, the absence of a conventional cash payment does not, by itself, prevent the economic cost associated with the discounted issue of shares from qualifying as expenditure.
2. The Discount Represents a Business Cost
The Court relied on the reasoning adopted by the Karnataka High Court in Biocon Ltd.
Under an ESOP, employees may earn the right to exercise their options over a specified vesting period. The employer’s obligation develops in accordance with the terms of the scheme.
The Karnataka High Court had reasoned that where a business liability arises during an accounting year, it may qualify for deduction even if the precise amount is quantified or discharged at a later date.
The eventual exercise of the option and determination of the actual benefit may involve quantification of the liability, rather than making the underlying business obligation merely contingent.
The decision in Biocon Ltd. also treated the discount on shares issued to employees as a real economic cost incurred for business purposes, rather than a notional loss.
The Kerala High Court adopted this reasoning in deciding the appeal before it.
3. ESOPs Serve a Commercial Purpose
An important aspect of the Court’s reasoning was the commercial purpose underlying an ESOP.
Companies use employee stock options to attract and retain employees, align employee interests with those of the business, and encourage continued service.
The Court accepted the view that issuing shares at a discount for this purpose does not amount to a waste of capital. Instead, the arrangement is intended to support the earning of profits by securing employee services and providing incentives.
Accordingly, the discount cannot simply be treated as a short receipt of capital. It may constitute a business expenditure incurred to achieve the company’s commercial objectives.
4. The Accounting Treatment and Vesting Period
The Karnataka High Court’s decision in Biocon Ltd., as reproduced and relied upon by the Kerala High Court, also considered the accounting treatment of ESOP expenses over the vesting period.
The reasoning recognised the relevance of accounting for the discount over the period in which the employee earns the right to exercise the options.
However, the Kerala High Court’s judgment should not be read as holding that every accounting treatment or every amount claimed under an ESOP is automatically deductible. The deduction remains subject to the applicable statutory conditions and the facts of the particular case.
The Revenue’s argument concerning the method of recognising ESOP expenses was considered in the appeal, but the High Court ultimately agreed with the principles stated in the Delhi and Karnataka decisions.
The Court’s Reliance on the Delhi High Court’s Decision in Lemon Tree Hotels
In Commissioner of Income Tax v. Lemon Tree Hotels (P) Ltd., the Delhi High Court had considered the Revenue’s contention that expenditure relating to an ESOP should not be allowed where the employer had not acquired shares from a third party.
The Revenue’s position was that the expenditure was merely notional where shares were allotted by the employer rather than purchased from the market.
The Delhi High Court rejected that reasoning, observing that it failed to account for the commercial realities of employee share-option arrangements. If employers were required to purchase shares from the market or third parties at prevailing prices instead of allotting them under an ESOP, the commercial consequences would be different.
The Delhi High Court consequently found no question of law warranting interference in the matter before it.
The Kerala High Court expressly affirmed its agreement with this approach.
The Court’s Final Decision
After considering the relevant authorities and the submissions made by both sides, the Kerala High Court held that the discount on shares allotted under the ESOP could be treated as expenditure for the purposes of Section 37(1).
The Court concluded that the arrangement was intended to support the company’s business by securing employee services and providing incentives, rather than to waste capital.
It answered both questions of law in favour of the assessee, dismissed the Revenue’s appeal and confirmed the order of the ITAT, Cochin Bench.
The decision therefore upheld the deduction claimed by Geojit Financial Services Ltd. in the case before the Court.
Practical Implications for Companies and Taxpayers
The judgment is relevant to companies that use employee stock options as part of their compensation and employee-retention strategies.
1. ESOP Discount May Qualify as Deductible Business Expenditure
The decision supports the position that the discount on shares allotted under an ESOP can constitute revenue expenditure under Section 37(1), rather than being automatically excluded as a notional loss.
2. Commercial Purpose Is Relevant
The business purpose of an ESOP is significant. Where the arrangement is designed to attract, incentivise and retain employees, the economic cost of providing the benefit may be relevant in determining the deductibility of the discount.
3. Proper Accounting and Documentation Matter
Companies should maintain appropriate documentation concerning the ESOP scheme, the option terms, the vesting schedule, the valuation and calculation of the discount, and the accounting treatment adopted.
These records may be important when substantiating the expenditure claimed and demonstrating compliance with the applicable statutory requirements.
4. Deductibility Must Be Examined on the Facts
The judgment does not establish that every expense described as an ESOP discount must necessarily be allowed. The terms of the scheme, the nature of the expenditure, the relevant accounting period and the statutory conditions remain important.
Companies should therefore assess their particular arrangements and the applicable legal position before claiming a deduction.
5. The Supreme Court Proceedings Must Be Kept in View
The judgment records that the issue was pending before the Supreme Court for final resolution. The Kerala High Court’s decision should therefore be understood in the context of the authorities and procedural position referred to in the judgment.
For transactions or tax positions requiring a current assessment, the subsequent status of the issue before the Supreme Court should be verified.
Conclusion
The Kerala High Court’s decision in ITA No. 21 of 2025 reinforces the principle that the discount arising from shares allotted under an Employee Stock Option Plan can constitute revenue expenditure deductible under Section 37(1) of the Income-tax Act, 1961.
By affirming the reasoning adopted by the Delhi and Karnataka High Courts, the Court recognised the commercial purpose of ESOPs and the economic cost borne by employers when providing share-based incentives to employees.
The decision is significant for companies using ESOPs as part of their employee compensation strategy and for taxpayers examining the treatment of ESOP expenses under the Income-tax Act.
Nevertheless, the deductibility of a particular claim must be assessed in accordance with the facts, the applicable statutory requirements and the prevailing judicial position.
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Case Reference: Principal Commissioner of Income Tax, Kochi-I v. Geojit Financial Services Ltd., ITA No. 21 of 2025, 2026:KER:71035, Kerala High Court, judgment dated 16 September 2026.
Disclaimer: This article is intended for general legal information and educational purposes. It is based on the judgment identified above and should not be treated as tax or legal advice on any particular matter. The applicable law and subsequent judicial developments should be verified before taking a position in a specific case.