Employee Stock Option Plan for an Unlisted Company

Employee Stock Option Plans (ESOPs) are a well-recognized method of compensating employees and attracting and retaining the best talent. Compensation in the form of equity shares helps in creating a sense of ownership in the mind of employees. Benefit schemes for employees, including ESOPs, have gained popularity, especially in start-ups that have limited financial resources in the initial years, but want to attract the best talent. ESOPs are the option or a right, but not an obligation, which is offered by a company to its employees to purchase its shares at a pre-determined price in the future. ESOPs align the interest of the employees with long term interest of the companies and play a vital role in retaining employees at the growing stage of the company.

A company may implement ESOP program, either directly or by setting up an irrevocable trust. In a nutshell, there are three stages in the life cycle of an ESOP i.e. grant, vesting and exercise. In the first stage, the company grants the options to its employees. In the second stage, there is an unconditional vesting period during which an employee cannot exercise the option. This vesting period cannot be less than one year from the date of grant of the option. In the last stage, the employee gets the right to exercise the option by making an application for the issue of shares against the vested options. Once the option is exercised within the time limit, the vested option is converted into shares by payment of the exercise price. The exercise price is normally determined in advance at the stage of grant.

Applicable Rules and Regulations:

Sec 2(37) of Companies Act, 2013 defines “employees stock option” read with Sec 62(1)(b) of Companies Act, 2013 and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. This Rule specifies that on complying certain terms and conditions only the unlisted company can offer shares to its employee’s under ESOP.

In accordance with the provisions of Section 2(37) of Companies Act, 2013, 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”.


1. Unlisted Company- Private Companies by way of Ordinary Resolution (Notification dated 05.06.15)

2. Unlisted Public Companies by way of Special Resolution.

3. Listed Company- In case Shares are listed, Company has to follow SEBI ESOP guidelines as well along with the provisions of the Companies Act, 2013.


1. A permanent employee of the company who has been working in India or outside India or of a holding company of the company;

2. A director of the company, excluding an independent director; who has been working in India or outside India or of a holding company of the company.

Provided, the following are excluded:

1. an employee who is a promoter or a person belonging to the promoter group;

2. a director who either himself or through his relative or through any Body Corporate, directly or indirectly, holds more than ten percent of the outstanding equity shares of the company.

Further, in order to promote startups, the Ministry of Corporate Affairs vide Notification dated 19.07.2016 issued the Companies (Share Capital and Debentures) Third Amendment Rules, 2016 wherein it was provided that Startups may issue the shares under ESOP to their promoters and directors who hold more than 10% for the first 5 years from the date of their incorporation. The restriction on issuing shares under ESOP to promoters and such directors continues for companies which does not fall under the category of startups.


S.No. Particulars
1.Give notice to Directors along with the agenda and notes on agenda to convene the Board Meeting at least seven days before the date of the meeting in compliance with the Secretarial Standards I to consider the issuance of ESOP.
2.Convene the Board Meeting to decide upon the matter for issuance of ESOP and accordingly, vesting the authority for its execution. In this Board meeting, the Company shall also decide upon the specified employees, in case the ESOP is being offered to specified employees only. Preparation of ESOP scheme is of primary important at this stage.
3.Send notice to members to convene EOGM of least 21 clear days in compliance with the Secretarial Standards II. The explanatory statement to the notice shall contain the disclosures and information as required under Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014.
4.Convene EOGM to pass special/ordinary (as discussed above) resolution to take shareholders’ approval w.r.t. issuance of ESOP.

Taxation Implications of ESOP

A) For the Employee

There are no cash outflows or taxation implications when the options are granted or as and when the options are vested in the employee.

The Income Tax Act, 1961 has laid down the following two stages of taxation for employees in respect of shares allotted to them under an ESOP. Stage 1 (Perquisites) – Upon allotment of shares after the employee exercises his option on the completion of the vesting period. Upon allotment of shares, 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 ESOP. The perquisite value and the tax deducted thereon by the company would be reflected in Form 16 and Form 12BA of the employee and treated as income from salary in the tax return.

Stage 2 (Capital Gains)– When the shares allotted to the employee are sold by him. If the company is listed on an Indian stock exchange and shares are held for more than 12 months, it will be considered as long-term capital gain and as per Finance Act 2018, it will be taxed u/s 112A at 10% exceeding Rs. 1 lakh of CG. If shares are held for less than 12 months, it will be considered as short-term capital gain and profit will be taxed at 15% u/s 111A.

Today, employees in start-ups and unlisted companies are also allotted ESOPs. These shares will be considered short-term assets if held for less than 24 months from the exercise date and taxed according to the respective tax slab. If the shares are held for more than 24 months, and sold after this period, these are considered as long-term gains and taxed at 20% after indexation of cost.

In case the employee chooses to not exercise his option, there shall be no tax implication for the employee.

B) For the Company

The Issuing Company can claim ESOP cost as deduction. The discounts under the ESOP are an employee cost and should be allowed as a deduction over the vesting period, in the hands of the issuing company.

When a Non-Executive Director is exercising ESOPs, the company is required to pay GST @18% on the perquisite value of ESOPs as it would work on a reverse charge basis. The circular issued by the GST Authority puts this matter beyond doubt. This will be in addition to 10% withholding tax under Section 194J of the Income Tax Act.

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