Treatment of SWEAT Equity Shares under Income Tax Act, 1961

Sweat Equity Shares are  Shares  or Specified Securities issued at discount or for consideration other than cash to employees or directors  of the company as reward their hard work or for their value addition in the progress of the company . These are generally issue in lieu of value additions and against providing Intellectual Property Rights by the employees or directors to the Company.

Some Important Definitions:

Employees means;

1. A permanent employee or the company ,who is working in or outside Indian for at least one year in the Company ;or

2. A director of the company , whether whole time or not; or

3. An employee of director as defined above of a subsidiary or holding company of the company.

Value Addition; means actual or anticipated economic benefits derived or to be derived by the company from an expert/or a professional for providing know-how or making available rights in the nature of intellectual property rights , by such person to whom Sweat equity shares is being issued for which is not paid.

Section 2(h) of Securities Contract Regulation Act, 1956 defined “Securities “, which includes following;

1. Shares, scrips, stocks, bonds, debentures stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;

2. Derivatives;

3. Units or any other instruments by any collective investment scheme to the investors in such scheme;

4. Security receipt as defined in section 2(zg) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;

5. Government securities;

6. Such other instruments as may be declared by the Central Government to be securities and

7. Rights or interest in securities.

Section 54 of the Companies Act, 2013 provides conditions and procedure for issue of Sweat Equity Shares by companies.

Now Let Us Consider,

Rules of Valuation of Sweat Equity Shares Under Income Tax Act, 1961:

The following conditions to be satisfied to tax allotment of Sweat Equity Shares in the hand of the employees or directors of company;

1. The Securities of Shares involved are of Specified Securities or Shares as defined in Section 2(h) of the Securities Contract ( Regulation) Act, 1956;

2. The Specified Securities or Sweat Equity Shares are allotted or transferred on or after April 1, 2009. (Before April 1, 2009 Fringe Benefit Tax is applicable).

3. Specified Securities or Sweat Equity Shares are allotted by the employer or former employer to the employee.

4. Specified Securities or Sweat Equity Shares may be transferred to the employee or former employee, directly or indirectly.

If above conditions are satisfied ,perquisite will be taxable in the hands of employees in the assessment year relevant to previous year in which shares or securities are allotted or transferred to the employee.

The valuation for Securities will be done on Fair Market Value of securities at the date of exercise of option by the employee.

Valuation of Specified Securities or Sweat Equity Shares:

Quoted Shares; If the shares of the company is listed on any Stock Exchange, then the Fair Market Value will be average of opening price and closing price of the share on that date. If shares of the company is listed on more than one Stock Exchanges , then the Fair Market Value will be average of Opening Price and Closing Price of shares on that Stock Exchange on which records highest volume of trading of shares of the Company. Where at the date of exercise of option , there is no trading of shares on any Sock Exchange, then the Fair Market Value will be the closing price of the shares on any Stock Exchange on a date closest to the date of exercise of option and immediately preceding such date.

Unquoted Shares; if the shares of Company is not listed on any Stock Exchange then the Fair Market Value of Shares will be as determined by the Merchant Bankers on the Specified Date.

“Specified Date”; means the date of exercise of the option, or any date earlier the date of exercise of the option, not being a date, which is more than 180 days earlier than the date of excursive of the option.

Now Let Us Consider,

An Example:

Mr. A is a Scientist have patent in the field of Information Technology and based in UK. He has joined an Indian company on January 1, 2007 on Salary or Rs. 3, 00,000/- pm in X Limited. X Limited has provided him an option to allot 1,000 Equity Shares in lieu of utilising his patent work for the purpose of the company;

Date of granting the option	January 2, 2007
Date of vesting of the option	December 31, 2007
Nature is the option	To purchase, 1000 shares in X Limited at pre-determined price of Rs. 1/ Share at any time during 31st December, 2007 to 31st December, 2020
Date of exercise of option (allotment of one lot of 600 Shares)	January 1, 2009
Date of allotment of 600 Shares		January 1, 2009
Fair Market Value on December 31, 2007		Rs. 7,000/ Share
Fair Market Value on January 1, 2009		Rs. 7,500/ Share
Date of Exercise of option ( lot of 400 shares)		March 25, 2020
Date of allotment ( lot of 400 Shares)		April 1 , 2020
Fair Market Value on March 25, 2020		Rs. 7,500/ Share
Market value of patent rights provided by Mr. A to X Limited		Rs. 60,00,000

Let Us Analyse Above Conditions;

1. in case of allotment of first lot of 600 Shares of X Limited to Mr. A, X Limited has to pay Fringe Benefit Tax, since it has been allotted before April 1, 2009. The FBT of Rs. 41, 99,400[600*(Rs. 7000-Rs. 1)] will be paid by X Limited. Since cost of Acquisition of Shares in hand of Mr. A is Rs. 7000/- share.

2. In case of allotment of second lot of 400 shares, the transaction will be taxable as perquisite according to provisions Section 17(2) (VI) of the Income Tax Act, 1961 in the hand of Mr. A, since shares are allotted after April 1, 2009. The value of perquisite chargeable to tax for AY 2020-21 is Rs. 29,99,600[ 400*(Rs.7500-Rs.1)], since cost of acquisition of shares in the hand of Mr. A will be Rs. 7500/- share.