1. Meaning

ESOPs refer to various schemes by a company, offering an equity stake or ownership linked incentives to its employees. The stake may be in various forms such as allotment of shares, grant of stock options, etc. that entitle an employee to acquire shares in the future, or simply by way of rewarding him based on the appreciation in the value of the shares.

2. Objectives and benefits

The objectives may vary from the circumstances and requirements of each case and may include any of the following:

• To attract talent for the business of the Company;

• To retain and motivate the employees;

• To provide wealth creation opportunities

• Reward for past performance;

• Partial avoidance of immediate cash outflow for the company on account of salary;

• To align the interest of the employees with the shareholders and the Company

3. Explanation of some types of ESOPs

3.1 Under Stock Option Schemes, the company grants an option to employees, subject to fulfilment of certain conditions linked to continued employment or fulfilment of performance conditions, to apply for the shares of the company during a specified period of time at a price that is either pre-determined or is to be determined at an agreed formula.

3.2 Under Share Purchase Schemes (ESPS), the company offers shares to employees which are allotted against payment of offer price and are subject to certain lock in conditions.

3.3 Under a scheme of Stock Appreciation Rights or Phantom Equity Plan, employees are paid the appreciation in the price or value of the shares / notional units from the point of grant to the exercise date.

3.4 There can be numerous other types of scheme and variants.

4. Aspects to be considered in the process of setting up and implementing an ESOPs scheme

• Ensuring adequate reward linked with performance

• Compliance with provisions of Companies Act, 2013

• Compliance with Rules made under the Companies Act, 2013, in case of unlisted companies

• Compliance with SEBI guidelines, in case of listed companies

• Ensuring optimal tax treatment for employer and the employee

• Compliance of exchange control regulations in case of cross border ESOPs

• Proper accounting and disclosure

5. Companies Act

5.1 Sections 54 and 62(1)(b) of the Companies Act, 2013 (Act) enable the companies to issue sweat equity shares and ESOPs. Rule 8 and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 specify rules in respect of issue of sweat equity shares and ESOPs respectively for companies other than listed companies.

5.2 Section 149(9) and section 197(7) of the Companies Act, 2013 state that an independent director is not entitled to any stock option.

5.3 Sweat Equity Shares:

1. Definitions

1. Sweat equity shares are defined to 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 addition, by whatever name called.

2. Employees are defined to mean:

• A permanent employee of the company, working in India or outside India for at least 1 year; or

• A director of the company, whether whole-time director or not; or

• An employee or a director as defined in sub-clause (a) or (b) above of a subsidiary, in India or outside India, or of a holding company of the company

3. The clause 8(10) of the Companies (Share Capital and Debentures) Rules, 2014 specifies that the amount of sweat equity shares issued shall be treated as part of managerial remuneration for the purposes of the Act, if the following conditions are fulfilled:

• The sweat equity shares are issued to any director or manager; and

• They are issued for consideration other than cash, which does not take the form of an asset which can be carried to the balance sheet of the company in accordance with the applicable accounting standards.

2. Conditions precedent

The following conditions required to be fulfilled before issuing Sweat Equity Shares:

1. Companies are entitled to issue sweat equity shares after expiry of 1 year from the date of the commencement of the business.

2. Issue of sweat equity shares is authorised by a special resolution containing the prescribed particulars passed by the company at the general meeting.

3. The special resolution authorising the issue of sweat equity shares is valid for a period of 12 months. Allotment of shares pursuant to scheme authorised by special resolution has to be completed within 12 months of passing the special resolution.

4. Notice for the Resolution has to be accompanied by an explanatory statement containing the prescribed particulars.

5. Pricing of sweat equity shares to be issued to employees and directors is to be at a fair price calculated by an independent valuer.

6. Limit:

• The issue of equity shares by way of sweat equity cannot exceed 15% of the paid-up equity capital in a year or shares of an issue value of ₹ 5 crores, whichever is higher.

• Issuance of sweat equity shares in the company cannot exceed 25% of the paid-up equity share capital of a company at any time.

3. Conditions subsequent

The following conditions are required to be fulfilled subsequent to the issue of sweat equity shares:

1. Lock-in

• The sweat equity shares issued to directors or employees have to be locked in/non-transferable for a period of 3 years from the date of allotment.

• The share certificate should carry the fact that such share certificate is under lock-in and the period of expiry of lock-in shall be stamped in bold or mentioned in any other prominent manner on the share certificate.

2. Maintenance of Records

• A register has to be maintained in Form No. SH.3 and details to be updated in the register therein from time-to-time.

• The register of sweat equity shares shall be maintained at the registered office of the company or such other place as the board of directors may decide.

• The entries in the register shall be authenticated by the company secretary of the company or by any other person authorised by the board of directors for the purpose.

3. The board of directors shall disclose the prescribed details in the directors’ report.

4. Issue of Shares for consideration other than cash

The following conditions are applicable where a company proposes to issue sweat equity shares for consideration other than cash:

1. Valuation of the intellectual property or of the know-how provided or other value addition in respect of which sweat equity capital is issued, has to be carried out by a valuer.

2. The valuer is required to consult such experts, as he may deem fit, having regard to the nature of the industry and the nature of the property or the value addition.

3. The valuer is required to submit a valuation report to the company giving justification for the valuation.

4. The copy of gist along with critical elements of the valuation report of the valuer is required to be sent to the share holders with the notice of the general meeting.

5. The company is required to give justification for issue of sweat equity shares, which shall form part of the notice sent for the general meeting.

5.4 Employee Stock Options:

1. Definitions

1. ESOs 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 predetermined price / pricing formula.

2. Employees are defined to mean:

• Permanent employees of the company who have been working in India or outside India; or

• A director of the company, whether a whole-time director or not but excluding an independent director; or

• An employee as defined above, of a subsidiary, in India or outside India, or of a holding company of the company but does not include:

• An employee who is a promoter or a person belonging to the promoter group; or

• A director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than 10% outstanding equity shares of the company.

2. Conditions precedent

The following conditions are required to be fulfilled before issuing ESOs:

1. A company is entitled to issues ESOs after expiry of one year from the date it is entitled to commence the business.

2. Issue of ESOs is required to be authorised by a special resolution containing the prescribed particulars passed by the company at the general meeting.

3. Separate resolution is to be obtained in case of:

• Grant of option to employees of subsidiary or holding company; or

• Grant of option to identified employees, during any 1 year, equal to or exceeding 1% of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of option.

4. Pricing of ESOs exercise price is to be determined in conformity with the applicable accounting policies.

3. Conditions subsequent:

The following conditions are required to be fulfilled subsequent to issue of ESOs:

1. Certain basic conditions:

• Minimum period of 1 year between grant of options and vesting of options.

• Company has the freedom to specify the lock-in-period for shares issued pursuant to exercise of option.

• No right to dividend or to vote till shares are issued on exercise of option.

• The amount, if any, payable by the employees, at the time of grant of option may be –

• Forfeited by the company if the option is not exercised by the employees within the exercise period; or

• Refunded to the employees if the options are not vested due to non-fulfilment of conditions relating to vesting of option as per the Employees Stock Option Scheme.

2. Restrictions on Transfer/Transmission of ESOs

• Not transferable to any other person.

• Cannot be pledged, hypothecated, mortgaged or otherwise encumbered or alienated in any other manner.

• No person other than the employees to whom the option is granted shall be entitled to exercise the option, except -

• In the event of the death of employee while in employment, all the options granted to employee till such date shall vest in the legal heirs or nominees of the deceased employee.

• In case the employee suffers a permanent incapacity while in employment, all the options granted to him as on the date of permanent incapacitation, shall vest in him on that day.

• In the event of resignation or termination of employment, all options not vested in the employee as on that day shall expire. However, the employee can exercise the options granted to him which are vested within the period specified in this behalf, subject to the terms and conditions under the scheme granting such options as approved by the board of directors.

3. Variation

• A special resolution is required for variation in terms of ESOS not yet exercised by employees provided such variation is not prejudicial to the interests of the option holders and the notice for such special resolution to disclose, inter alia, the full details with rationale for variation.

• Notice for the resolution has to be accompanied by an explanatory statement containing the prescribed particulars.

4. Maintenance of Records

• A register has to be maintained in Form No. SH.6 and details have to be updated in the register therein from time-to-time.

• The Register of ESOPs shall be maintained at the registered office of the company or such other place as the Board may decide.

• The entries in the register shall be authenticated by the Company Secretary of the company or by any other person authorised by the board of directors for the purpose.

5. The board of directors shall disclose the prescribed details in the directors’ report.

6. Securities and Exchange Board of India (Share Based Employee Benefits) Regulations, 2014

Vide Notification No. LAD-NRO/GN/2014-15/16/1729 dated 28th October, 2014, the SEBI has notified (Share Based Employee Benefits) Regulations, 2014 (“SBEB Regulations”) to provide for regulation of all schemes by companies for the benefit of their employees involving dealing in shares, directly or indirectly, with a view to facilitate smooth operation of such schemes while preventing any possible manipulation and matters connected therewith or incidental thereto. SBEB Regulations are effective from the date of their publication in the Official Gazette. It replaces SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999.

6.1 Applicability

6.1.1 Provisions of SBEB Regulations will be applicable to:

1. Employee Stock Option Schemes [“ESOS”]

2. Employee Stock Purchase Schemes [“ESPS”]

SBEB Regulations are now also applicable to:

3. Stock Appreciation Rights Schemes [“SARS”]

4. General Employee Benefits Schemes [“GEBS”]

5. Retirement Benefit Schemes [“RBS”]

6.1.2 Provisions of SBEB Regulations will be applicable to any company whose shares are listed on any recognised stock exchange in Indian and has a scheme:

1. For direct or indirect benefit of employees; and

2. Involving dealing in or subscribing to or purchasing securities of the company, directly or indirectly; and

3. Satisfying, directly or indirectly, any one of the following conditions:

1. The scheme is set up by the company or any other company in its group;

2. The scheme is funded or guaranteed by the company or any other company in its group;

3. The scheme is controlled or managed by the company or any other company in its group.

6.1.3 SBEB Regulations will not be applicable to shares issued to employees on preferential allotment basis in compliance with SEBI (ICDR) Regulations 2009.

6.2 Definitions

6.2.1 Some of the key definitions under SBEB Regulations are as under:

1. i‘Appreciation’ means the difference between the market price of the share of a company on the date of exercise of stock appreciation right (SAR) or vesting of SAR, as the case may be, and the SAR price;

2. ‘Emergency’ means the need of funds by the trust to meet the commitment arising out of the objective of the scheme;

3. ‘Employee stock option scheme or ESOS’ means a scheme under which a company grants employee stock option directly or through a trust;

4. ‘Employee stock purchase scheme or ESPS’ means a scheme under which a company offers shares to employees, as part of public issue or otherwise, or through a trust where the trust may undertake secondary acquisition for the purposes of the scheme;

5. ‘General employee benefits scheme or GEBS’ means any scheme of a company framed in accordance with SEEB Regulations, dealing in shares of the company or the shares of its listed holding company, for the purpose of employee welfare including healthcare benefits, hospital care or benefits, or benefits in the event of sickness, accident, disability, death or scholarship funds, or such other benefit as specified by such company;

6. ‘Grant date’ means the date on which the compensation committee approves the grant;

7. ‘Group’ means two or more companies which, directly or indirectly, are in a position to, —

• Exercise 26% or more of the voting rights in the other company; or

• Appoint> 50% of the members of the board of directors in the other company; or

• Control the management or affairs of the other company;

8. ‘Option’ means the option given to an employee which gives him a right to purchase or subscribe at a future date, the shares offered by the company, directly or indirectly, at a pre-determined price;

9. ‘Option grantee’ means an employee having a right but not an obligation to exercise an option in pursuance of ESOS;

10. ‘Relevant date’ means,-

• In the case of grant, the date of the meeting of the compensation committee on which the grant is made; or

• In the case of exercise, the date on which the notice of exercise is given to the company or to the trust by the employee;

21. ‘Retirement benefit scheme or RBS’ means a scheme of a company, framed in accordance with SBEB regulations, dealing in shares of the company or the shares of its listed holding company, for providing retirement benefits to the employees subject to compliance with existing rules and regulations as applicable under laws relevant to retirement benefits in India;

22. ‘SAR grantee’ means an employee to whom SAR is granted;

23. ‘SAR price’ means the base price defined on the grant date of SAR for the purpose of computing appreciation;

24. ‘Secondary acquisition’ means acquisition of existing shares of the company by the trust on the platform of a recognised stock exchange for cash consideration;

25. ‘Stock appreciation right or SAR’ means a right given to a SAR grantee entitling him to receive appreciation for a specified number of shares of the company where the settlement of such appreciation may be made by way of cash payment or shares of the company.

• An SAR settled by way of shares of the company shall be referred to as equity settled SAR;

26. ‘Stock appreciation right scheme or SAR scheme’ means a scheme under which a company grants SAR to employees;

6.2.2 Further:

1. The definition / meaning of ‘employee’ is almost same as that under the Company Law;

2. The meaning of ‘independent director’ is same as per clause 49 of listing agreement;

3. The meaning of ‘key managerial personnel’ and ‘relative’ are same as per the Companies Act, 2013;

4. The meaning of ‘promoter’ and ‘promoter group’ are same as assigned in SEBI (ICDR) Regulations.

6.3 Implementation through Trusts

6.3.1 A company may implement the scheme either directly or through irrevocable trust(s). Scheme(s) involving secondary acquisition or gift or both have to be mandatorily implemented through trust(s). Implementation schemes through setting up irrevocable trust(s) has to decide upfront while taking approval of share holders for setting up the schemes.

6.3.2 Several schemes permitted under SBEB Regulations can be implemented by a company through a single trust, subject to trust maintaining proper books of account, records documents for each such scheme so as to explain its transactions and to disclose at any point of time the financial position of each scheme and in particular give a true and fair view of the state of affairs of each scheme.

6.3.3 Trust deed and any modifications thereto are mandatorily required to be filed with the stock exchange in India where the shares of the company are listed.

6.3.4 Trustees:

6.3.4.1 Ineligibility: A person cannot be appointed as a trustee, if he –

• Is a director, KMP or promoter of the company or its holding, subsidiary or associate company or any relative of such director, KMP or promoter

• Beneficially holds 10% or more of the paid-up share capital of the company

6.3.4.2 Minimum number of trustees:

• 2, if individuals or OPCs are trustees

• Sole trustee, if corporate entity is trustee

6.3.4.3 Voting rights: Trustees not entitled to vote on the shares held by such trusts, to avoid any misuse

6.3.4.4 Trustees would have to ensure that appropriate approvals from share holders is obtained to implement schemes through trusts and secondary acquisitions.

6.3.5 The company is permitted to lend monies to the trust, subject to requirements of the Companies Act, 2013 and Companies (Share Capital and Debentures) Rules, 2014, on appropriate terms and conditions to acquire shares for the purpose of implementation of schemes

6.3.6 Restrictions on secondary acquisitions:

• Not to deal in derivatives – undertake only delivery based transactions for the purpose of secondary acquisitions

• Secondary acquisition in a financial year by the trust not to exceed 2% of the paid-up equity capital as at the end of the previous financial year

• Total number of shares under secondary acquisition held by the trust not to exceed the following limits any time:

Notes:

• Limits to automatically include the expanded capital of the company where such expansion has taken place on account of corporate action including issue of bonus shares, split or rights issue

• Above limits applicable for all trusts and schemes taken together at the company level and not at the level of individual trust or scheme

• Above limit not applicable for fresh issue of shares to the trust or gift from promoter or promoter group or other share holders

• If the options, shares or SAR granted under any of the schemes exceeds the number of shares that could be acquired by the trust through secondary acquisition, then such shortfall of shares has to be made up by the company through new issue of shares to the trust in accordance with the applicable provisions

6.3.7 Sale / appropriation of secondary market acquisition:

6.3.7.1 The unappropriated inventory of shares not backed by grants, acquired through secondary acquisition by the trust under ESOS, ESPS or SARS is required to be appropriated within a reasonable period – not beyond the end of the subsequent financial year.

• If such trust(s) existing as on 28th October, 2014 are not able to appropriate the unappropriated inventory within 1 year,

• It has to be disclosed to the stock exchange(s) at the end of such period and then the same is required to be sold on the recognised stock exchange(s) where shares of the company are listed, within 5 years from the date of notification of SBEB Regulations

6.3.7.2 The trust is required to hold the shares acquired through secondary acquisition for a minimum period of 6 months except where they are required to be transferred for participating in open offer under the SEBI Takeovers Regulations, 2011, or participating in buy-back, delisting or any other exit offered by the company generally to its share holders

6.3.7.3 The trust is permitted to undertake off-market transfer of shares in the following circumstances only:

• Transfer to the employees pursuant to scheme(s);

• When participating in open offer under the SEBI Takeovers Regulations, 2011, or participating in buy-back, delisting or any other exit offered by the company generally to its share holders

6.3.7.4 The trust cannot become a mechanism for trading in shares and can sell the shares in secondary market under the following circumstances only:

1. Cashless exercise of options under ESOS;

2. On vesting or exercise, as the case may be, of SAR under SARS;

3. In case of emergency for implementing the GEBS, RBS, after recording the reasons for sale, subject to utilisation of money realised within definite period as per the scheme or trust deed;

4. Participation in buy-back or open offers or delisting offers or any other exit offered by the company generally to its share holders, if required;

5. For repaying the loan, if the unappropriated inventory of shares held by the trust is not appropriated within the specified timeline;

6. Winding up of the scheme(s); and

7. Based on approval (relaxation) granted by SEBI to ESOS, ESPS, SARS for the reasons recorded in writing.

6.3.8 The trust is subjected to the compliance and disclosures requirements as applicable to insiders or promoters under the SEBI (Prohibition of Insider Trading) Regulations, 1992.

6.3.9 Shareholding of the trust to be disclosed as ‘non-promoter and non-public’ to the stock exchanges

• It shall not form part of public shareholding which needs to be maintained at minimum 26%

6.4 Eligibility of employees:

6.4.1 An employee shall be eligible to participate in the schemes of the company as determined by the Compensation Committee.

6.4.2 If such an employee is a director nominated by an institution as its representative on the board of directors of the company, then specified compliances are required to be followed.

6.5 Compensation Committee

6.5.1 A company has to constitute a Compensation Committee for administration and superintendence of the schemes. Any other committee fulfilling the applicable requirements (e.g. Nomination and Remuneration Committee) can be designated as Compensation Committee. If the scheme is being implemented through a trust, the compensation committee has to delegate administration of such schemes to trust(s).

6.5.2 Composition: Compensation Committee be comprised of such board members as provide in section 178 of the Companies Act, 2013, that is, 3 or more non-executive directors out of which not less than half to be independent directors. While the Chairperson of the company (whether executive or non-executive) may be appointed as a member of the Nomination and Remuneration Committee but he cannot chair such Committee.

6.5.3 Role: The Compensation Committee has to, inter alia,

• Formulate the detailed terms and conditions of the schemes

• Frame suitable policies and procedures to ensure that there is no violation of securities laws by the trust, the company and its employees, as applicable.

6.6 Share holders’ approval

6.6.1 No scheme can be offered to employees of a company unless the share holders of the company approve it by passing a special resolution in the general meeting, and the explanatory statement to the notice and the resolution proposed to be passed by share holders for the schemes shall include the specified information.

6.6.2 Approval of share holders by way of separate resolution in the general meeting has to be obtained by the company in case of:

1. Secondary acquisition for implementation of the schemes – mentioning the percentage of secondary acquisition (subject to limits specified under SBEB Regulations) that could be undertaken;

2. Secondary acquisition by the trust in case the share capital expands due to capital expansion undertaken by the company including preferential allotment of shares or qualified institutions placement, to maintain the 5% cap;

3. Grant of option, SAR, shares or other benefits, as the case may be, to employees of subsidiary or holding or associate company;

4. Grant of option, SAR, shares or benefits, as the case may be, to identified employees, during any one year, more than or equal to 1% of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of option, SAR, shares or incentive, as the case may be.

6.7 Variation of terms of the schemes

6.7.1 The company may by special resolution in a general meeting vary the terms of the schemes offered pursuant to an earlier resolution of the general body but not yet exercised by the employee provided such variation is not prejudicial to the interests of the employees, unless variation is to meet the regulatory requirements.

6.7.2 Share holders’ approval have to be obtained to such variation of terms as required to be obtained for the original grant of option, SAR, shares or other benefits, as the case may be, mentioned in 6.6 above.

6.7.3 The notice for passing special resolution for variation of terms of the schemes is required to disclose full details of the variation, the rationale therefor, and the details of the employees who are beneficiaries of such variation.

6.7.4 Repricing: A company may reprice the options, SAR or shares, as the case may be which are not exercised, whether or not they have been vested if the schemes were rendered unattractive due to fall in the price of the shares in the stock market, if such repricing is not detrimental to the interest of the employees and approval of the share holders in general meeting has been obtained for such repricing.

6.8 Winding up of the schemes

In case of winding up of the schemes being implemented by a company through trust, the excess monies or shares remaining with the trust after meeting all the obligations, if any, has to be utilised for repayment of loan or by way of distribution to employees as recommended by the Compensation Committee.

6.9 Non-transferability

6.9.1 Option, SAR or any other benefit granted to an employee under the regulations shall not be transferable to any person.

6.9.2 No person other than the employee to whom the option, SAR or other benefit is granted, shall be entitled to the benefit arising out of such option, SAR, benefit etc. except for the following:

• In case of ESOS or SAR, under cashless exercise, the company may itself fund or permit the empanelled stock brokers to fund the payment of exercise price which shall be adjusted against the sale proceeds of some or all the shares, subject to the provisions of the applicable law or regulations

6.9.3 The option, SAR, or any other benefit granted to the employee cannot be pledged, hypothecated, mortgaged or otherwise alienated in any other manner.

6.9.4 While in employment,

• In the event of death of employee all the options, SAR or any other benefit granted to him under a scheme till such date to vest in the legal heirs or nominees of the deceased employee.

• If the employee suffers a permanent incapacity all the options, SAR or any other benefit granted to him under a scheme as on the date of permanent incapacitation, shall vest in him on that day.

6.9.5 In the event of resignation or termination of the employee,

• All the options, SAR, or any other benefit which are granted and yet not vested as on that day shall expire

• An employee shall be entitled to retain all the vested options, SAR, or any other benefit, subject to the terms and conditions formulated by the Compensation Committee.

6.9.6 If an employee who has been granted benefits under a scheme is transferred or deputed to an associate company prior to vesting or exercise, the vesting and exercise as per the terms of grant shall continue in case of such transferred or deputed employee even after the transfer or deputation.

6.10 Listing

In case new issue of shares is made under any scheme, shares so issued have to be listed immediately in any recognised stock exchange where the existing shares are listed, subject to the specified conditions

6.11 Schemes implemented by unlisted companies

6.11 The shares arising after the IPO of an unlisted company, out of options or SAR granted under any scheme prior to its IPO to the employees shall be listed immediately upon exercise in all the recognised stock exchanges where the shares of the company are listed subject to compliance with SEBI (ICDR) Regulations, 2009 and provisions mentioned at 6.12.1 below.

6.12 Compliances and conditions

6.12.1 A company cannot make any fresh grant involving allotment or transfer of shares to its employees under any schemes formulated prior to its IPO and prior to the listing of its equity shares ('pre-IPO scheme’) unless such pre-IPO scheme:

• Is in conformity with SBEB Regulations; and

• Is ratified by its share holders subsequent to the IPO – any time prior to grant of new options or shares or SAR under such pre-IPO scheme.

6.12.2 When holding company issues option, share, SAR or benefits to the employee of its subsidiary, the cost incurred by the holding company for issuing such option, share, SAR or benefits is required to disclose in the 'notes to accounts' of the financial statements of the subsidiary company. If the subsidiary reimburses the cost incurred by the holding company in granting option, share, SAR or benefits to the employees of the subsidiary, both the subsidiary as well as the holding company are required to disclose the payment or receipt, as the case may be, in the ‘notes to accounts’ to their financial statements.

6.12.3 The company has to appoint a registered merchant banker for the implementation of schemes covered by SBEB Regulations till the stage of obtaining in-principle approval from the stock exchanges for listing of shares referred to at 6.10 above.

6.13 Certificate from auditors

The board of directors of every company that has passed a resolution for the schemes under SBEB Regulations is required to place before the share holders a certificate from the auditors of the company at each annual general meeting stating that the scheme(s) has been implemented in accordance with SBEB Regulations and in accordance with the resolution of the company in the general meeting.

6.14 Accounting policies

Any company implementing any of the share based schemes has to follow the requirements of the 'Guidance Note on Accounting for employee share-based Payments' (Guidance Note) or Accounting Standards as may be prescribed by the Institute of Chartered Accountants of India (ICAI) from time to time, including the disclosure requirements prescribed therein.

6.15 Administration of schemes at a glance

6.16 Relaxation

SEBI may suo motu or on an application made by a company along with a non-refundable fee of ₹ 1 lakh, for reasons recorded in writing, grant relaxation from strict compliance with any of SBEB regulations subject to such conditions as it deems fit in the interests of investors in securities and the securities market.

Note: The stringent norms prescribed by SEBI (Prohibition of Insider Trading) Regulations, 2015 substantially restrict the opportunities for the employees and senior management in possession of unpublished price-sensitive information to reap the benefits of ESOPs.

7. Tax aspects

7.1 From A.Y. 2010-11 onwards, the ESOPs are again subject to tax in the hands of the employee as perquisite:

1. Section 17(2)(vi) provides that the value of any specified security including ESOP or sweat equity shares allotted or transferred, directly or indirectly, by the employer or former employer, free of cost or at concessional rate will be taxed as perquisites in the hands of the employee receiving such benefit.

2. Explanation (c) to section 17(2)(vi) provides that the perquisite value of specified security including ESOP or sweat equity shares shall be the fair market value on the date on which the option is exercised by the employee as reduced by the amount actually paid by, or recovered from such employee.

3. Explanation (d) to section 17(2)(vi) provides that fair market value means the value to be determined in accordance the method as may be prescribed.

4. Rule 3(8) prescribes the following to determine fair market value of specified security or sweat equity share:

• In a case where, on the date of the exercising of the option, the shares of the company are listed on a recognised stock exchange, the fair market value shall be the average of the opening price and closing price of the shares on that date on the said stock exchange.

• Where, on the date of exercising of the option, the shares are listed on more than one recognised stock exchanges, the fair market value shall be the average of opening price and closing price of the shares on the recognised stock exchange which records the highest volume of trading in the shares.

• Where, on the date of exercising of the option, there is no trading in the shares on any recognised stock exchange, the fair market value shall be —

  • The closing price of the shares on any recognised stock exchange on a date closest to the date of exercising of the option and immediately preceding such date; or

  • The closing price of the shares on a recognised stock exchange, which records the highest volume of trading in such shares, if the closing price, as on the date closest to the date of exercising of the option and immediately preceding such date, is recorded on more than one recognised stock exchange.

• Where, on the date of exercising of the option, the shares in the company are not listed on a recognised stock exchange, the fair market value shall be such value of the share in the company as determined by a merchant banker on the specified date.

7.2 Provisions applicable in earlier years are summarised below:

1. From A.Y. 2001-02 up to A.Y. 2007-08 (see proviso to S. 17(2)(iii), S. 47 (iii) and fourth proviso to S. 48 of the Income-tax Act, 1961).

ESOPs are not taxed at the time of grant or exercise. As per proviso to S. 17(2)(iii), the value of benefit arising out of allotment of shares, warrants or debentures free of cost or at concessional rate under a scheme of stock options in accordance with guidelines issued by the Central Govt. is not treated as perquisite.

Transfer under a gift or irrevocable trust of shares, warrants or debentures allotted under a scheme of stock options would attract capital gains. The market value of such shares, etc. would be treated as full value of consideration of such transfer

2. From A.Y. 2008-09 up to A.Y. 2009-10, the ESOPs are subjected to FBT

ESOPs are subject to Fringe Benefit Tax (FBT) at the time of allotment or transfer of shares on the excess of fair value as on the date of vesting and the Exercise Price [S. 115WB(1)(d), S. 115WC(1)(ba)];

The value on which the employer pays FBT is treated as cost of acquisition in the hands of the employee [S. 49(2AB)]; and

The employer can recover FBT from the employee if the scheme is suitably modified and the recovery of fringe benefit tax is deemed to be the tax paid by such employee in relation to value of fringe benefits provided to him. However, the employee will not be entitled for any refund out of such deemed payment of tax and is also not be entitled to claim any credit of such deemed payment of tax against tax liability on other income or against any other tax liability [S. 115WKA, S. 115WKB].

3. Further, Rule 40C and Rule 40D have been prescribed for valuation of specified security being equity shares and specified security not being equity shares respectively.

• Valuation of shares of a listed company

• Where the shares of the company are listed on a recognised stock exchange on the date of vesting of the option, the fair market value will be the average of the opening price and closing price of the shares on that date on the said stock exchange.

• Where the shares are listed on more than one recognised stock exchange on the date of vesting of the option, the fair market value will be the average of opening price and closing price of the shares on the recognised stock exchange which records the highest volume of trading in the shares.

• In case, on the date of vesting of the option, there is no trading in the shares on any recognised stock exchange, the fair market value will be the closing price of the shares on any recognised stock exchange on a date closest to the date of vesting of the option and immediately preceding such date.

• Valuation of shares of an unlisted company or specified security not being an equity share

  • Where the shares in the company are not listed on a recognised stock exchange on the date of vesting of the option, the fair market value will be such value of the shares of the company as determined by a merchant banker on the specified date. Similarly, the fair market value of a specified security not being an equity share in a company will be such value of the share in the company as determined by a merchant banker on the specified date.

8. Important Case Laws

[2003] 86 ITD 342 (BANG.) - Infosys Technologies Ltd. v. DCIT

[2004] 2 SOT 611 (BANG.) - Wipro Ltd. v. DCIT

[2007] 13 SOT 706 (DELHI) - Alok Kumar v. JCIT

[2007] 15 SOT 555 (DELHI) - Ravi Kumar Sinha v. DCIT

[2007] 159 TAXMAN 440 (KAR.) Infosys Technologies Ltd.

[2008] 21 SOT 454 (HYD.) - Makarand Gadre v. ACIT

[2008] 166 TAXMAN 204 (SC) - CIT v. Infosys Technologies Ltd.

[2008] 112 ITD 1 (MUM.) (SB) - Sumit Bhattacharya v. ACIT

[2008] 23 SOT 565 (MUM.) - Kanu Kumar Mukerji v. ACIT

[2009] 118 ITD 177 (BANG.)- Giridhar Krishna M. v. ACIT

[2009] 120 ITD 444 (BANG.) - Muthuswamy Ravikumar v. ACIT

[2009]027 SOT 175(DELHI) Vijay Gopal Jindal

[2010] 1 ITR(TRIB.) 471 (MUMBAI) - ACIT v. Smt. Tripti Sharma

[2010] 39 SOT 17 (DELHI) (URO) - Ranbaxy Laboratories Ltd. v. ACIT

[2010] 35 SOT 18 (MUM.)(URO) - Bomi S. Billimoria v. ACIT

[2010] 127 TTJ 356 (HYD.) – ACIT v. Dr. Dhurjati Gupta

[2010] 191 TAXMAN 439 (MAD.) – CIT v. A. K. Khosla

[2010] 322 ITR 586 (MAD.) Mrs. Chitra Venkataraman

[2011] 47 SOT 363 (Mum.) - ACIT v. Pramod H. Lele

[2012] 150 TTJ 240 (Delhi - Trib.) – ACIT v. Ambrish Kumar Jhamb

[2012] 53 SOT 70 (Chandigarh)(URO) – ACIT v. Spray Engineering Devices Ltd.

[2012] 023 Taxmann.com 286 (MAD) PVP Ventures Ltd

[2013] 155 TTJ 649 (Bengaluru - Trib.) (SB) –Biocon Ltd. v. DCIT

[2013] 59 SOT 203 (Delhi - Trib.) - ACIT v. Robert Arthur Keltz

[2013] 33 taxmann.com 415 (Delhi - Trib.) Abhiram Seth

[2013] 40 taxmann.com 451 (Chennai - Trib.) Murugappa Management Services Ltd

[2013] 35 taxmann.com 454 (Delhi) Smt. Neenu Dutta

[2014] 50 taxmann.com 236 (Delhi - Trib.) Kamlesh Bahedia

[2014] 45 taxmann.com 338 (Bengaluru - Trib.) – ACIT v. Chittaranjan A. Dasannacharya

[2014] 63 SOT 242 (Bangalore - Trib.) - Novo Nordisk India Pvt. Ltd. vs. DCIT

[2014] 65 SOT 79 (Hyderabad - Trib.)(URO) - P. Sudhakar Prasad

[2014] 66 SOT 159 (Hyderabad - Trib.)(URO) - Dr. Reddy's Laboratories Ltd.

[2014] 362 ITR 38 (AAR – New Delhi) - Mrs. Smita Anand

[2014] 41 taxmann.com 16 (Madras) K Parthasarathy

[2014] 40 CCH 0824 (Del ITAT) Lemon Tree Hotel Ltd.

[2015] 229 Taxman 236 (Gujarat) - Bharat V. Patel

[2015] 61 taxmann.com 361 (Mumbai - Trib.) HDFC Bank Ltd

[2015] 62 taxmann.com 390 (Mumbai - Trib.) Mahindra & Mahindra Employees' Stock Option Trust

[2016] 68 taxmann.com 433 (Ahmedabad - Trib.) Cera Sanitaryware Ltd

[2016] 65 taxmann.com 304 (Mumbai - Trib.) Vernan Private Trust

9. Accounting treatment

The Ministry of Corporate Affairs has notified the Companies (Indian Accounting Standards) Rules, 2015 to be effective from 1st April, 2015 that has made the converged Indian Accounting Standards, i.e. Ind AS applicable in a phased manner. One of them, Ind AS 102 on “Share based Payment” specifies the financial reporting by an entity when it undertakes a share-based payment transaction including. Once applicable, the Ind AS 102 will replace the Guidance Note on Accounting for Employee share-based payments (“the GN”) issued by the ICAI in January 2005.

The following is the summary of key recommendations stated in the GN:

1. Recognising the need for establishing uniform sound accounting principles and practices for all types of share-based payments, the Accounting Standards Board of the Institute is developing an Accounting Standard covering various types of share-based payments including employee share-based payments. However, as the formulation of the Standard is likely to take some time, the Institute has decided to bring out this Guidance Note. Once the Accounting Standard dealing with share-based payments comes into force, this Guidance Note will automatically stand withdrawn.

2. The GN establishes financial accounting and reporting principles for employee share-based payment plans, viz., employee stock option plans, employee stock purchase plans and stock appreciation rights. For the purposes of the GN, the term 'employee' includes a director of the enterprise, whether whole time or not.

3. For accounting purposes, employee share-based payment plans are classified into the following categories:

1. Equity-settled: Under these plans, the employees receive shares.

2. Cash-settled: Under these plans, the employees receive cash based on the price (or value) of the enterprise's shares.

3. Employee share-based payment plans with cash alternatives: Under these plans, either the enterprise or the employee has a choice of whether the enterprise settles the payment in cash or by issue of shares.

4. An employee share-based payment plan falling in the above categories can be accounted for by adopting the fair value method or the intrinsic value method. The accounting treatment specified herein below is based on the fair value method. The application of the intrinsic value method is explained in paragraph 15.

Equity-Settled Employee Share-Based Payment Plans

Recognition

5. An enterprise should recognise as an expense (except where service received qualifies to be included as a part of the cost of an asset) the services received in an equity-settled employee share-based payment plan when it receives the services, with a corresponding credit to an appropriate equity account, say, 'Stock Options Outstanding Account'. This account is transitional in nature as it gets ultimately transferred to another equity account such as share capital, securities premium account and/or general reserve as recommended in the GN.

6. If the shares or stock options granted vest immediately, the employee is not required to complete a specified period of service before becoming unconditionally entitled to those instruments. In the absence of evidence to the contrary, the enterprise should presume that services rendered by the employee as consideration for the instruments have been received. In this case, on the grant date, the enterprise should recognise services received in full with a corresponding credit to the equity account.

7. If the shares or stock options granted do not vest until the employee completes a specified period of service, the enterprise should presume that the services to be rendered by the employee as consideration for those instruments will be received in the future, during the vesting period. The enterprise should account for those services as they are rendered by the employee during the vesting period, on a time proportion basis, with a corresponding credit to the equity account.

Measurement

8. An enterprise should measure the fair value of shares or stock options granted at the grant date, based on market prices if available, taking into account the terms and conditions upon which those shares or stock options were granted (subject to the requirements mentioned at paragraphs 9 to 11 below). If market prices are not available, the enterprise should estimate the fair value of the instruments granted using a valuation technique to estimate what the price of those instruments would have been on the grant date in an arm's length transaction between knowledgeable, willing parties. The valuation technique should be consistent with generally accepted valuation methodologies for pricing financial instruments (e.g., use of an option pricing model for valuing stock options) and should incorporate all factors and assumptions that knowledgeable, willing market participants would consider in setting the price (subject to the requirements mentioned at paragraphs 9 to 11 below).

9. Vesting conditions, other than market conditions, should not be taken into account when estimating the fair value of options at the grant date. Instead, vesting conditions should be taken into account by adjusting the number of shares included in the measurement of the transaction amount so that, ultimately, the amount recognised for employee consideration for the shares or stock options granted is based on the number of shares or stock options that eventually a cumulative basis, no amount is recognised for employee services received if the shares or stock options granted do not vest because of failure to satisfy a vesting condition (i.e., these are forfeited), e.g., the employee fails to complete a specified service period or performance condition.

10. To apply the requirements at paragraph 9 above, the enterprise should recognise an amount for the employee services received during the vesting period based on the best available estimate of the number of shares or stock options expected to vest and should revise that estimate, if necessary, if subsequent information indicates that the number of shares or stock options expected to vest differs from previous estimates. On vesting date, the enterprise should revise the estimate to equal the number of shares or stock options that ultimately vest.

11. Market conditions, such as a target share price upon which vesting (or exercisability) is conditioned, should be taken into account when estimating the fair value of the shares or stock options granted.

After vesting date

12. On exercise of the right to obtain shares or stock options, the enterprise issues shares on receipt of the exercise price. The shares so issued should be considered to have been issued at the consideration comprising the exercise price and the corresponding amount standing to the credit of the relevant equity account (e.g., Stock Options Outstanding Account). In a situation where the right to obtain shares or stock option expires unexercised, the balance standing to the credit of the relevant equity account should be transferred to general reserve.

Cash-Settled Employee Share-Based Payment Plans

13. For cash-settled employee share-based payment plans, the enterprise should measure the services received and the liability incurred at the fair value of the liability. Until the liability is settled, the enterprise is required to remeasure the fair value of the liability at each reporting date and at the date of settlement, with any changes in value recognised in profit or loss for the period.

Employee Share-Based Payment Plans With Cash Alternatives

14. For employee share-based payment plans in which the terms of the arrangement provide either the enterprise or the employee with a choice of whether the enterprise settles the transaction in cash or by issuing shares, the enterprise is required to account for that transaction, or the components of that transaction, as a cash-settled share-based payment plan if, and to the extent that, the enterprise has incurred a liability to settle in cash (or other assets), or as an equity-settled share-based payment plan if, and to the extent that, no such liability has been incurred.

Intrinsic Value Method

15. Accounting for employee share-based payment plans dealt with hereto before is based on the fair value method. There is another method known as the 'Intrinsic Value Method' for valuation of employee share-based payment plans. Intrinsic value, in the case of a listed company, is the amount by which the quoted market price of the underlying share exceeds the exercise price of an option. In the case of a non-listed company, since the shares are not quoted on a stock exchange, value of its shares is determined on the basis of a valuation report from an independent valuer. For accounting for employee share-based payment plans, the intrinsic value may be used, mutatis mutandis, in place of the fair value as described in paragraphs 5 to 14 above.

Recommendation

16. It is recommended that accounting for employee share-based payment plans should be based on the fair value approach as described in paragraphs 5 to 14 mentioned above. However, intrinsic value method as described in paragraph 15 is also permitted. An enterprise using intrinsic value method is required to make disclosures of impact of the net results and EPS – both basic and diluted – for the accounting period, had the fair value method been used.

Other Aspects

17. Apart from the above, the GN also deals with various other significant aspects of the employee share-based payment plans including those related to performance conditions, modifications to the terms and conditions of the grant of shares or stock options, reload feature, graded vesting, earnings-per-share implications, accounting for employee share-based payments administered through a trust, etc. The GN also recommends detailed disclosure requirements. The appendices to the GN provide detailed guidance on measurement of fair value of shares and stock options, including determination of various inputs to the option-pricing models and examples to illustrate application of various principles recommended in the GN.