The government may appeal against a Madras high court judgement on employee stock options (Esops) that could have a bearing on how corporate tax is calculated. The appeal plan was disclosed by a senior income tax department official, who didn’t want to be identified.

In a 19 June judgement, the Madras high court had said that the price difference between when an Esop is awarded and when it’s exercised by an employee can be treated by the company as revenue expenditure. In effect, this will allow firms to seek an income tax rebate against such expenditure.

“The department (of income tax) may appeal against the order as it feels that expenditure on stock options allotted to employees is of the nature of capital expenditure and not revenue expenditure,” said the official cited above.

Companies typically incentivize their employees by giving them options to buy their shares in future, at a fixed “call price”, so that the latter can gain financially from an increase in the market price of the stock.

The Madras high court judgement could potentially benefit companies by “hundereds of crores”, said Rohit Garg, a senior associate at New Delhi-based Vaish Associates Ltd, who deals with tax issues.

Although a high court judgement typically applies to its jurisdiction, it will be taken as the precedent until another high court gives a conflicting verdict in a similar case, Garg said.

Vaish Associates is representing drug maker Ranbaxy Laboratories Ltd in a similar case in the Delhi high court.

A Mumbai-based tax expert with a consultancy shared this view.

“While passing its judgement, the high court should have considered that stock options cannot be treated as revenue expenditure. The court should have looked at all facets of the case,” said the expert who didn’t want to be named.

Vishal Shah, an executive director with PricewaterhouseCoopers, however, said that since stock options are aimed at incentivizing employees, they are a part of remuneration and should be considered as revenue expenditure.

The Madras high court gave its judgement on a case filed in 2005 by PVP Ventures Ltd, a Chennai-based company that operates in the real estate, energy and media sectors.

In the case of PVP Ventures, the income tax department had said that the difference between the call price and the prevailing market price was “notional” or “contingent” and, therefore, could not be allowed as a deduction on the revenue account.

The Income Tax Appellate Tribunal (ITAT) had ruled against this stand of the income tax department, following which it approached the Madras high court.

In its June order, the high court held that the loss occurring on account of the difference in the call price and the market price is an “ascertained liability”, thereby allowing the company to claim tax benefits under section 37(1) of the Income Tax Act.

To be sure, as per the Securities and Exchange Board of India (Sebi) guidelines, companies are already liable to debit such a difference in their profit and loss accounts.

Interestingly, in March, the Bangalore ITAT had formed a special bench to look into various conflicting judicial opinions in the matter by various tribunals in at least four cases of a similar nature.

Under the so-called “doctrine of judicial discipline”, the Madras high court order will take precedence over ITAT orders or those of special benches, until there is a conflicting order by another high court on a similar issue, or there is a Supreme Court ruling.

The Bangalore ITAT is currently considering a similar case related to pharma company Biocon Ltd. (LiveMinit)