Employees Stock Options and Ownership Plans (ESOPs)
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 commonly preferred ESOPs
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.
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.
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.
4. Aspects to be considered in the process of setting up and
implementing an ESOPs scheme
4.1. Ensuring adequate reward linked with performance
4.2. Compliance with provisions of Companies Act, 2013
4.3. Compliance with Rules made under the Companies Act, 2013, in case of
unlisted companies
4.4. Compliance with SEBI guidelines, in case of listed companies
4.5. Ensuring optimal tax treatment for employer and the employee
4.6. Compliance of exchange control regulations in case of cross border
ESOPs
4.7. Proper accounting and disclosure
5. Companies Act
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.
Section 149(9) and section 197(7) of the Companies Act, 2013
state that an independent director is not entitled to any stock option.
6. Sweat Equity Shares
Definitions: 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.
Employee is 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
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.
Conditions precedent |
Conditions subsequent |
Companies are entitled to issue sweat equity shares
after expiry of 1 year from the date of the commencement of the
business. |
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. |
Issue of sweat equity shares is authorised by a special
resolution containing the prescribed particulars passed by the company
at the general meeting. |
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 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. |
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Notice for the Resolution has to be accompanied by an
explanatory statement containing the prescribed particulars. |
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Pricing of sweat equity shares to be issued to
employees and directors is to be at a fair price calculated by an
independent valuer. |
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Limit
- cannot exceed 15% of the paid-up equity
capital in a year or shares of an issue value of ₹ 5 crore, 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
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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:
- 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.
- 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.
- The valuer is required to submit a valuation report to the company
giving justification for the valuation.
- 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.
- 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.
7. Employee Stock Options
Definitions: 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.
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.
Conditions precedent |
Conditions subsequent |
A company is entitled to issue ESOs after expiry of one
year from the date it is entitled to commence the business. |
Minimum period of 1 year between grant of options and
vesting of options. |
Special Resolution:
- 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.
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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 |
Pricing of ESOs exercise price is to be determined in
conformity with the applicable accounting policies |
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. 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. |
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No person other than the employees to whom the option
is granted shall be entitled to exercise the option, except – in the
event of death while in employment Maintenance of records as specified |
Disclosure in Director's Report
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.
8. Provisions of SBEB Regulations will be applicable to:
- Employee Stock Option Schemes ["ESOS"]
- Employee Stock Purchase Schemes ["ESPS"]
- SBEB Regulations are now also applicable to Stock Appreciation Rights
Schemes ["SARS"]
- General Employee Benefits Schemes ["GEBS"]
- Retirement Benefit Schemes ["RBS"]
Provisions of SBEB Regulations will be applicable to any company whose
shares are listed on any recognised stock exchange in India and has a scheme:
- For direct or indirect benefit of employees, and
Involving dealing in or subscribing to or purchasing securities of the
company, directly or indirectly; and
- Satisfying, directly or indirectly, any one of the following conditions:
- The scheme is set up by the company or any other company in its group;
- The scheme is funded or guaranteed by the company or any other company
in its group;
- The scheme is controlled or managed by the company or any other company
in its group.
SBEB Regulations will not be applicable to shares issued to employees on
preferential allotment basis in compliance with SEBI (ICDR) Regulations 2009.
8.1 Implementation through Trusts
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
shareholders for setting up the schemes.
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.
- Trustees: 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.
- Minimum number of trustees: 2, if individuals or OPCs are
trustees. Sole trustee is required, if corporate entity is trustee.
- Voting rights: Trustees not entitled to vote on the shares held
by such trusts, to avoid any misuse.
- 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:
For |
Limits - % of the paid-up equity capital as at the end of
the financial year immediately prior to the year in which the
shareholder approval is obtained for such secondary acquisition (please
refer the notes below) |
ESOS, ESPS, SARS |
5% |
GEBS, RBS |
2% |
All schemes in aggregate |
5% |
- Sale/appropriation of secondary market acquisition
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
- 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
- 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 shareholders.
- The trust cannot become a mechanism for trading in shares and can sell
the shares in secondary market under the following circumstances only:
- Cashless exercise of options under ESOS;
- On vesting or exercise, as the case may be, of SAR under SARS;
- 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;
- 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;
- For repaying the loan, if the unappropriated inventory of shares
held by the trust is not appropriated within the specified timeline;
- Winding up of the scheme(s); and
- Based on approval (relaxation) granted by SEBI to ESOS, ESPS, SARS
for the reasons recorded in writing.
- 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.
- 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%.
- Eligibility of employees
An employee shall be eligible to participate in the schemes of the
company as determined by the Compensation Committee.
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.
- Compensation Committee
- 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).
- 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.
- 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.
- Shareholders' approval - No scheme can be offered to employees of a
company unless the shareholders 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 shareholders for the
schemes shall include the specified information.
- Variation of terms of the schemes
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.
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 shareholders in general meeting has been
obtained for such repricing.
- 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.
- Non-transferability
- Option, SAR or any other benefit granted to an employee under the
regulations shall not be transferable to any person.
- 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 stockbrokers 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.
- The option, SAR, or any other benefit granted to the employee cannot
be pledged, hypothecated, mortgaged or otherwise alienated in any other
manner.
- 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.
- 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.
- 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.
- 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.
8.2 Schemes implemented by unlisted companies
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 below.
Compliances and conditions
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 shareholders subsequent to the IPO – any time prior
to grant of new options or shares or SAR under such pre-IPO scheme.
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.
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 8.1.10 above.
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.
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.
9. Tax aspects
From A.Y. 2010-11 onwards, the ESOPs are again subject to tax in the hands of
the employee as perquisite
- 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.
- 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.
- 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.
- Rule 3(8) prescribes the following to determine fair market value of
specified security or sweat equity share:
Listed & trading |
Listed & not trading |
Not listed |
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. |
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 fair market value shall be such value of the share
in the company as determined by a merchant banker on the specified date. |
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. |
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. |
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10. 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 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.
For accounting purposes, employee share-based payment plans are classified
into the following categories:
Equity Settled |
Cash Settled |
Employee share-based payment plans with cash alternatives |
Under these plans, the employees receive shares |
Under these plans, the employees receive cash based on
the price (or value) of the enterprise's shares |
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 |
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.
Equity Settled |
Cash Settled |
Employee share based payment |
Recognise as expenses services received
from employee and credit Equity account - ' Stock option outstanding
account' |
Measure services received and liability incurred at
fair value |
Enterprise gives option to employee to settle
transaction either in cash or by issuing shares |
Option granted / vested immediately |
Option to be vested after completion of specific period |
Remeasure fair value of liability at each reporting
date - till the time liability is settled |
Accounting as per – Cash Settled method – if
enterprise has inccured liability to settle in cash
– Equity settled – to the extent no such liability is incurred |
On grant date, enterprise recognise services received
in full with corresponding credit to equity account |
Presume that services to be rendered by employee as
consideration for those instruments will be received in future |
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Valuation of Shares – measure the fair
value of shares or stock options granted on grant date – If market
prices are available - Based on market price
– If market prices are not available - Based on arm's length
transaction prices between knowledgeable willing parties
On exercise of right, the enterprise issues equity shares |
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Employee share based payment plans are valued as per Intrinisic Value method
or fair value method
- For Listed Companies - Intrinisic Value method - amount by which quoted
market price exceeds the exercise price of the option
- For Unlisted Companies - based on valuation report by independent valuer
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