If shares have been given in lieu of salary, there is no reason why it should be disallowed.
When a company issues shares to its employees in lieu of salary, it has to debit the salary account. The US GAAP indeed mandates such expensing of ESOP and rightly so given the fact that had cash been paid for the services instead of shares, the salary account would have been debited in any case.
There are reports emanating from the corporate world in India that shares issued to employees are falling by the wayside in the income-tax assessments of the employers the assessing officers (AOs) are disallowing them as expenses presumably on the ground that they do not make the grade under the omnibus residuary Section 37 to which capital expenditures are an anathema.
The I-T department's contention could be that when technically competent people are paid for in the form shares, the company is obtaining an enduring benefit lasting several years. And expenditures giving rise to such benefits must fall by the wayside as ordained by the section, rightly or wrongly.
The AO ought not disallow recompense in the form of shares in the manner of knee-jerk reaction. Instead he ought to go into the substance of the transaction.
If shares have been given in lieu of salary, there is no reason why it should be disallowed merely because:
Salary has been paid in kind and not in cash; and
Shares evoke visions of long-term benefits.
For the recipient of salary in shares, what he has received may give a lasting benefit, but for the company itself the issue of shares is in lieu of the services rendered during the year, benefits from which have already accrued to the company.
If, however, shares are issued in lieu of technical knowhow brought to the table by the promoter, it could be disallowed under the law as it stands, which frowns on capital expenditure given the fact that technical knowhow does give a lasting benefit.
But then the company need not lose sleep over it because under Section 32 technical knowhow is one of the intangible assets eligible for depreciation on the written-down value at the rate of 25 per cent. In other words, the value of shares allotted in lieu of knowhow would be amortised over a period of time in the form of depreciation.
The bottomline is: What is disallowed under Section 37 would make the grade under Section 32 in instalments over a period of years.
S. Murlidharan (The author is a Delhi-based chartered accountant.)