Allowability of Recharged ESOP Costs and Extension of BAPA Margins to Non-BAPA Transactions

Facts

Business Expenditure (ESOP Recharges):

The Assessee, a captive service provider for the Morgan Stanley group, rendered IT and ITeS services to overseas group entities.
Under a global group arrangement, employees of the Assessee were granted stock units/options of the parent company (listed on NYSE).
The overseas group entity recharged the cost of these shares to the Indian Assessee on a cost-to-cost basis once the shares were allotted to employees.
The Assessee claimed a deduction of ₹3.33 crores on a payment basis (actual allotment), while the same was taxed as a perquisite in the hands of the employees (with TDS).
The Assessing Officer (AO) disallowed this deduction, questioning its nature as a revenue expenditure under Section 37(1).

Transfer Pricing (BAPA Applicability):

The Assessee entered into international transactions with both US-based Associated Enterprises (AEs) and a UK-based AE.
The Assessee had a Bilateral Advance Pricing Agreement (BAPA) with the CBDT for the US transactions, fixing an arm’s length operating margin at 15.70%.
The Assessee applied this same 15.70% margin to its transactions with the UK AE, arguing that the functions, assets, and risks (FAR) were identical.
The Department challenged the application of BAPA-determined rates to non-BAPA (UK) transactions.

Decision

On ESOP Costs:

Final Verdict: In favour of the Assessee.
Ratio Decidendi: The Tribunal followed established precedents holding that ESOP costs (including recharges from parent companies) represent a form of staff remuneration. Since the cost is incurred to compensate employees for services rendered to the Assessee’s business, it is a valid revenue expenditure deductible under Section 37(1). The fact that the shares are of a group company does not change the nature of the expense for the Indian subsidiary.

On Transfer Pricing:

Final Verdict: Partly in favour of the Assessee.
Ratio Decidendi: The Tribunal held that if the nature of services provided to a non-BAPA AE (UK) is identical to those covered under a BAPA (US), the margin agreed upon by the CBDT in the BAPA serves as a valid benchmark for the “Arm’s Length Price” (ALP) for the other transactions. Applying a different benchmark for identical services solely based on geography was deemed unjustified.

Key Takeaways

ESOP Deductibility: This ruling reinforces that “ESOP Recharges” are deductible business expenses. To ensure allowability, companies must ensure:
- A formal inter-company agreement for recharges exists.
- The cost is claimed on a payment/allotment basis (matching perquisite taxation).
- TDS is diligently deposited on the perquisite value in the employees’ hands.
BAPA as a Benchmark: For multinationals, a BAPA is not just a safe harbor for the specific country involved; it is strong evidentiary material for other regions. If your FAR (Functions, Assets, Risks) analysis for a non-BAPA country is identical to a BAPA country, you can argue for the same margin to avoid complex benchmarking and TP adjustments.
IT Act 2025 Transition: While the sections are renumbered (Section 34 for business expenditure and Section 165 for Transfer Pricing), the core principle of “identical transaction treatment” remains the bedrock of tax certainty.

IN THE ITAT MUMBAI BENCH ‘J’

Morgan Stanley Advantage Services (P.) Ltd.

National Faceless Assessment Centre (NFAC) , Delhi^*

Smt. Beena Pillai, Judicial Member
and Girish Agrawal, Accountant Member

IT Appeal No. 6713 (MUM) of 2024
[Assessment year 2021-22]

APRIL 15, 2026

Madhur Agrawal, Adv. for the Appellant. Pankaj Kumar, CIT DR for the Respondent.

ORDER

Girish Agrawal, Accountant Member.- This appeal filed by the assessee is against the final assessment order passed pursuant to the directions of ld. Dispute Resolution Panel-3, Mumbai, (DRP) vide order No. ITBA/DRP/F/144C(5)/2024-25/1069078079(1), dated 25.09.2024, u/s. 144C(5) of the Income-tax Act, 1961 (hereinafter referred to as the “Act”), for Assessment Year 2021-22.

2. Grounds taken by the assessee are reproduced as under:

Ground 1:

Assessment proceeding is without jurisdiction and is liable to be quashed On the facts and in circumstances of the case and in law, the notice issued under section 143(2) of the Act is without jurisdiction and thus, the initiation of assessment proceedings is invalid as the said notice was issued by Assessment Unit instead of National Faceless Assessment Centre (NFAC) in accordance with section 143(2) and section 144B of the Act read with CBDT Notifications¹.

Ground 2:

Final assessment Order is time barred On the facts and in circumstances of the case and in law, the learned AO erred in not passing the final assessment order within the time limit prescribed under section 153 of the Act which is the outer time limit for passing the final assessment order and hence, the final assessment order dated 23 October 2024 which is passed after 31 December 2023 (being the time limit as per the provisions of Section 153 of the Act) is time barred and liable to be quashed.

Ground 3:

Disallowance of expenditure claimed towards Employee Incentive Compensation Plan (EICP) On the facts and in circumstances of the case and in law, the learned AO erred on the following:

3.1 In disallowing the deduction for expense amounting to INR 3,33,56,983 incurred towards EICP claimed as deductible under section 37(1) of the Act, by not appreciating that the EICP cost is incurred wholly and exclusively for the purpose of business and is in the nature of revenue expenditure and thereby, deductible under section 37(1) of the Act.

3.2 In not following the decision of the Hon’ble jurisdictional Income-Tax Appellate Tribunal (ITAT) passed in MSAS’ own case for AY 2016-17 wherein the ITAT on similar facts and circumstances has adjudicated the matter in favour of MSAS.

Ground 4:

Adjustment to the Arm’s Length Price (ALP)

On the facts and circumstances of the case and in law, the learned AO/ Transfer Pricing officer (TPO) has erred in making an upward transfer pricing adjustment of INR 97,52,60,637 in respect of the international transaction ofprovision of IT and IT enabled services, on the following grounds:

4.1 The learned DRP has erred in not considering Bilateral Advance Pricing Agreement (BAPA) entered into by the Appellant with the Central Board of Direct Taxes covering the year under consideration and the transaction with all Associated Enterprises (AEs) except Morgan Stanley & Co. International PLC (MSIP).

4.2 The learned TPO/DRP erred in classifying the ITes services provided by the Assessee as KPO in nature without considering the actual nature of the services involved and without appreciating that the Assessee classified its services as KPO solely for the purpose of safe harbour application on a conservative basis to avoid litigation.

4.3 The learned TPO/DRP erred in rejecting the economic analysis of the Assessee undertaken in accordance with the provisions of the Act read with the Rules and in conducting a fresh economic analysis for the determination of the ALP in connection with the impugned international transaction.

4.4 The learned TPO/DRP erred in considering certain companies as comparable to the Appellant despite not being comparable to the Appellant

4.5 The learned TPO/DRP erred in not providing the Appellant a working capital adjustment.

4.6 The learned TPO/DRP erred in not providing the Appellant a risk adjustment

4.7 Without prejudice to the aboveground, the learned AO/TPO has erred in not considering that the services provided by the Appellant to MSIP are identical to the services covered under the BAPA and accordingly, the arm’s length margin can be aligned to the margin agreed under the BAPA.

Ground 4:

Initiation of penalty proceedings under section 270A of the Act On the facts and circumstances of the case and in law, the learned AO erred in initiating penalty proceedings under section 270A of the Act for the additions/ disallowances made in the Final Assessment Order.

Each of the grounds of appeal referred above is separate and may kindly be considered independent of each other.

2.1. Ground no.1 raised is not pressed and therefore dismissed as not pressed. Ground no.2 raised by the assessee deals with jurisdictional issue on the aspect of limitation in terms of section 153 which is left open and not adjudicated upon, more particularly, in view of the amendment by Finance Act 2026, in this regard. Liberty is granted to the assessee to raise the same if circumstances so warrant, at appropriate forum.

2.2. The effective issues in the present appeal are vide ground nos. 3 and 4 in respect of disallowance of expenditure claimed towards Employee Incentive Compensation Plan (EICP) and transfer pricing adjustment in respect of international transaction of provision of IT and ITES services, respectively.

3. Brief facts of the case are that assessee is set up by Morgan Stanley Group (MS group) to support its front office and back office units in their global operations. It is engaged in rendering IT and IT enabled services to various business units of overseas MS group entities. The support services rendered by the assessee to MS group entities broadly covers support functions. Assessee filed its return of income on 04.03.2022 reporting total income at Rs.514,56,16,180/-. Assessee had reported international transactions entered into by it with its AEs which amongst others, included provision of IT and ITES support services amounting to Rs.3095,74,21,049/- for which assessee adopted transactional net margin method (TNMM) as the most appropriate method (MAM) for determination of Arm’s Length Price (ALP). As per the transfer pricing study report (TPSR), assessee benchmarked this transaction to the operating of margin of 14.74%, with the updated margins of 20 comparable companies. According to the assessee, there has been no change in the functions, assets and risks assumed (FAR) profile of the assessee when compared with the preceding years. Ld. TPO, after taking into consideration the submissions made by the assessee, arrived at operating margin of 24.53% and thus, made an adjustment of Rs.90,57,05,436/- being the ALP of international transactions representing IT and ITES support services entered into by the assessee with its AEs.

4. In respect of disallowance made towards expenditure for EICP, fact of the matter is that assessee had entered into an agreement with an AE to award stock units/options in relation to shares in MS group entities to its employees. Shares of MS group entity are listed on New York Stock Exchange and are traded in open market. Units, i.e., underlying shares of MS group entity awarded to the employees of the assessee are either by way of a fresh issue of shares or by purchasing the shares from the market or existing shares held by the trust. MS Group entity awards stock units at the request of the assessee under EICP to its employees basis which and subject to the vesting period, the employees are entitled for allotment of MS shares.

4.1. Periodically settlement is made with MS entity in consideration of stock units and subsequently the cost incurred by it is recharged on a cost-to-cost basis. Assessee accounts for the expenses payable to the MS group entity from the stock units and appropriate them over the life of stock units, i.e., between grant and conversion based on the market price of the underlying shares on the date of grant of the stock units. This provision debited to the profit and loss account over the life of the stock units (net of foreign exchange fluctuation gain) is disallowed while computing the total income which is duly reported in the tax audit report. Assessee makes payment to the MS entity based on the market price of the shares as on the date of allotment of shares to its employees, for which it claims a deduction in the year when assessee makes payment, which is also reported in the tax audit report. The shares allotted to the employees are taxable as perquisites in the hands of the employees for which appropriate TDS is done. Based on the above methodology, assessee has made a provision in its book of accounts of Rs.7,51,85,000/- which it has added back and has claimed deduction of Rs.3,33,56,983/- for the payment made by it on conversion of stock units/exercise of option which has been disallowed by the ld. Assessing Officer u/s. 37(1).

4.2. The issue is a legacy issue which has already been dealt by the Coordinate Bench in assessee’s own case for Assessment Year 2016-17 in Morgan Stanley Advantage Services Pvt. Ltd. v. CIT (Appeals) [ITAppeal No. 1083(Mum) of 2021, dated 27-6-2022]. Relevant para in this respect is extracted below for ready reference:

“18. As discussed in the preceding paragraph, issue raised in this case by the assessee as to allowability of ESOP cost being in the nature of Revenue expenditure has already been decided by the Special Bench of Tribunal in case of Biocon Ltd. 144 ITD 21 (Bangalore). The Co-ordinate Bench of Tribunal also in case of Goldman Sachs (1) Securities Pvt. Ltd. (supra), decided the issue in favour of the assessee by holding that discount on issue of ESOP is allowable as deduction under the head “Profits & Gains of Business or Profession”. So the expenditure claimed by the assessee on account of ESOP under section 37(1) of the Act is allowable. So, the Impugned order passed by Id. CIT(A) directing the AO to delete the disallowance.

4.3. There being no material change in the factual position as discussed above, respectfully following the Coordinate Bench in assessee’s own case (supra), the addition made towards disallowance made by ld. Assessing Officer u/s. 37(1) is deleted. Ground no.3 raised by the assessee is allowed.

5. For the upward transfer pricing adjustment made by the ld. TPO, assessee strongly contended before the ld. DRP by submitting that the year under consideration is covered under the Bilateral Advance Pricing Agreement (BAPA), where the operation margin of 14.99% is agreed to be the ALP for the transaction under consideration. Ld. TPO had concluded the operating margin under the TNMM to be 28.57% instead of 14.99% as determined by the assessee. Assessee had withdrawn the relevant grounds before the ld. DRP and requested to consider the operating margin as agreed in the BAPA at 15.70%. However, in the final assessment order, the addition was still made amounting to Rs.89,82,48,295/-. Contention of the assessee is that it had applied for BAPA with the United States of America for five consecutive years, covering financial year 2018-19 to 2022-23 and roll back for financial year 2017-18. The said BAPA was signed between the Central Board of Direct Taxes (CBDT) and assessee on 15.03.2024, copy of which is placed in the paper book. Pursuant to this BAPA, assessee completed the post APA compliances including filing of modified return of income for the Assessment Year under consideration on 04.04.2024, copy of which is also placed in the paper book.

5.1. Assessee has furnished the summary of transactions which are covered by the BAPA which amounts to 99.80% of the transaction for the AEs falling within the jurisdiction of USA. Only one entity which has the effect of balance of 0.20% is not covered under the said BAPA as its jurisdiction falls in United Kingdom. The details are tabulated below:

Sr. No.	Name of the Associated Enterprise	Jurisd iction	Amount(INR)	AEs covered under BAPA v. not covered	Reference to Paper book
1	Morgan Stanley & Co. LLC	USA	41,50,60,348	99.80%	AEs covered under BAPA
2	Morgan Stanley Fund Services Inc	USA	1,70,37,51,143
3	Morgan Stanley Investment Management Inc.	USA	17,19,10,530
4	Morgan Stanley Services Group Inc.	USA	28,60,39,02,838
5	Morgan Stanley & Co International PLC (MSIP)	UK	6,27,96,190	0.20%	AE not covered under BAPA
Total			30,95,74,21,049	100.00%

5.2. In respect of the UK entity not covered under the BAPA, it was submitted that the transaction entered with the said AE is identical to the transaction covered in the BAPA with other AEs. FAR analysis in respect of the same has already been examined during the BAPA proceedings and accordingly, ALP has been agreed for the same under the BAPA. Assessee thus, submitted that ALP agreed under the BAPA shall also apply to the transactions undertaken by the assessee with this UK entity. It was submitted that the ALP in respect of UK entity should be aligned to the ALP agreed under the BAPA for identical transaction with AEs covered under the said BAPA. Based on this submission, assessee furnished the computation of transfer pricing adjustment which shall be retained for the uncovered jurisdiction of UK, if aligned to BAPA for the said one entity. The same is tabulated below:

Particulars	Reference	Amount(INR) / Percentage	Reference to Paperbook
Value of International Transaction for MSIP	A	6,27,96,190	Page 148
Total Cost wrt MSIP	B	5,47,29,118
Operating Margin of MSAS as per TPSR	C= (A-B)/B	14.74%	Page 838
Operating Margin as per BAPA	D	15.70%	Page 171
TP Adjustment aligned to BAPA	E= “B*(D-C)	5,25,400

5.3. Reliance was placed on the decision of Coordinate Benches in the case of Texas Instruments (India)(P) Ltd. v. ACIT (Bangalore – Trib.) and in the case of JP Morgan Services (P) Ltd. v. DCIT (Mumbai), wherein it was held that margin accepted at ALP in respect of US AE transactions had to be regarded as arm’s length mark-up cost to non US transactions also.

5.4. On the above factual matrix, we referred to and perused the BAPA placed in the paper book at page – 165 onwards. It is noted that the same is entered in respect of IT and ITES services for AEs based in USA. In clause 2 of the said agreement, it is stated that it shall apply to consecutive five years commencing from previous year from 2018-19 to previous year 2022-23 relevant to Assessment Year 2019-20 to 202324 and roll back for Assessment Year 2018-19 which are termed as covered years. In clause 3, the covered transactions are listed, which includes provision of information technology, provision of information technology enabled services, employee stock option plans, amongst others. In clause 6, for ALP it is stated that the international transactions relating to the provision on IT and ITES support services shall be considered to be at arm’s length if the operating margin of the assessee is 15.70%. Appendix-1a contains the list of AEs which forms part of the table above, all falling within the US jurisdiction.

5.5. In the present case before us, it is undisputed that the transactions entered into by the assessee with US AEs and non US AEs are similar. Accordingly, in the given set of facts, the margin accepted in BAPA in respect of US AEs is to be regarded at arm’s length mark up for the non US AE transactions also. Accordingly, by drawing force from the decision of Coordinate Benches as noted above, the transfer pricing adjustment needs to be retained in respect of the uncovered jurisdiction of UK for one AE for aligning with BAPA @ 15.70% based on the computation furnished by the assessee as extracted above. Ground no.4 is partly allowed.

6. In the result, appeal of the assessee is partly allowed.