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An employee is the key of the success of every organization and every employee deserves to be compensated for the efforts made by them to make the organization successful in the competitive market and the issue of Sweat Equity shares and ESOP is the best way to compensate them also in order to motivate the morale of the employees and also to retain them for long term, Companies opt following modes of issue:

Retention Mechanisms

Employee Stock Option’ (ESOP) has been defined under Sub-section (37) of Section 2 of the Companies Act, 2013, according to which “employees’ stock option” means the option given to the directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price.

Life cycle of ESOP

Life cycle of ESOP

Sweat equity shares (SWEAT) mean equity shares issued by a company to its directors or employees at a discount or for consideration, other than cash for providing know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called.

1. Meaning
ESOPs are given in the nature of Incentive and retention plan these can be issued to employees and officers.

ESOP is not an obligation rather it is a right of the employee to purchase certain amount of share of the company at a pre decided price.

Sweat Equity Shares are issued as consideration for creation or transfer of intellectual Property Rights to the company or as other value addition.
2. Eligibility
Employees of the Company:

1. Permanent employee of the Company who has been working in India or outside India.

2. A director of the Company whether whole time director or not.

3. An employee of director of subsidiary or holding in India or Outside India.

Startups may issue the shares under ESOP to their promoters and directors who hold more than 10% for the first 10 years from the date of their incorporation.

Who all are not Included: –

1. Independent director

2. Promoter or promoter group (Company which does not fall under the category of startups)

3. Director holding more than 10% equity in the Company

1. Permanent employee of the Company who has been working in India or outside India, for at least last 1 year

2. Director of Company-Whole time director or not.

3. An employee of director of subsidiary or holding in India or Outside India.

3. Consideration
The consideration has to be paid in cash. The consideration can be partly cash and partly IPRs/value addition or fully noncash consideration.
4. Lock in Period
Not Specified as such 3 years
5. Pricing Guidelines
There is no pricing guideline defined for issuance or grant of ESOPs. Pricing guidelines are defined for Sweat Equity shares which are required to be determined by a registered valuer.
6. Restrictions on Issue
Company has no such restrictions in issuance or grant of ESOPs Limits as Per Rule 8

However, a company registered under startup may issue sweat equity shares not exceeding 50% of its paid up capital up to 10 years from the date of its incorporation or registration.

7. Valuation
At the time of Grant of Option: FMV shall be calculated by registered valuer.

At the time of exercise of option: – valuation shall be done by Merchant banker

For Unlisted Company: –

Fair value of shares at the time of “grant of Option” and “exercise of option” shall be done by registered valuer as per “Guidance note on accounting for employee share-based payment” (issued 2005). Income Tax Act, 1961 does not specify any method for computation of FMV of shares but Section 17 and Rule3 (8) of the Act provides that for the purpose of perquisite valuation the FMV of ESOP shall be such value as determined by a merchant banker on the specified date (any date of exercising of the option; or any date earlier than the date of the exercising of the option, not being a date which is more than 180 days earlier than the date of the exercising).

For Listed Company: – Valuation of IPR/Know How (The Valuation of IPR and Know How or any other addition shall be done by merchant banker.

For Unlisted Company:- A registered Valuer or SEBI registered Merchant Banker or CA in practice having 10 years of experience.

8. Tax Implications (For Employees)
  • Upon allotment of shares (after the employee exercises his option, on the completion of the vesting period), the employer will have to compute the perquisite value of ESOP taxable in the hands of the employee under “income from salary” and deduct tax on such shares.
  • At the time of Sale
At the time of allotment: – sweat equity shares will be taxable in the hands of employee under head “Salary” in the year in which the shares are allotted or transferred to employees.

At the time of sale:- Capital gains are taxable in hands of employee in year in which shares/securities are transferred.

less than 12 months

it will be considered as short-term capital gain and profit will be taxed @ 15%

More than 12 months

it will be considered as long-term capital gain and it will be taxed @ 10% exceeding Rs. 1 lakh of CG

About the Author

Gourav Goyal

Author is Gourav Goyal, working as Director – Assurance with Neeraj Bhagat & Co. Chartered Accountants, a Chartered Accountancy firm helping foreign companies in setting up business in India and complying with various tax laws applicable to foreign companies while establishing their business in India. He is a member of the Institute of Chartered Accountants of India (ICAI) since 2012. He has been conducting Statutory & Tax audit, Internal audit of large & medium scale Limited Companies, carrying out Bank Audits and providing services in the field of accounts, Income Tax & Company Law matters.


Author Bio

Neeraj Bhagat & Co. is helping foreign companies in opening up of Liaison/ Branch Office in India and complying with various tax laws applicable to foreign companies while establishing a business in India. Neeraj Bhagat is the founder of Neeraj Bhagat & Co. Chartered Accountants, a Chartered View Full Profile

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June 2024