How to issue ESOPs in India: scheme, approvals, filings

Indian ESOPs are governed by Section 62(1)(b) of the Companies Act 2013, read with Rule 12 of the Companies (Share Capital and Debentures) Rules 2014. The mechanics involve drafting an ESOP scheme, getting shareholder approval through a special resolution, granting options to eligible employees, recording vesting and exercise events, allotting shares on exercise, and handling perquisite tax withholding under Section 192(1C). Listed companies also follow SEBI (Share Based Employee Benefits and Sweat Equity) Regulations 2021.

Prepare an ESOP Scheme document covering: eligible employees (typically all permanent employees, sometimes directors), total options available, vesting period (commonly 4 years with 1-year cliff), exercise price (often face value or a discount to FMV), exercise period (commonly 3-5 years after vesting), treatment on resignation/termination/death, change of control, anti-dilution, and the constitution of the Compensation Committee. Many founders copy a US-style scheme; this fails on the perquisite-tax mechanics. Use an India-drafted scheme aligned with Companies Act and Income Tax provisions.

Section 62(1)(b) requires a special resolution (75% majority of voting members present and voting at a general meeting) approving the ESOP scheme. File Form MGT-14 with the Registrar of Companies within 30 days of passing the special resolution. The Board (or Compensation Committee if constituted) approves individual grants under the scheme. Maintain a grant register with employee name, grant date, options granted, exercise price, vesting schedule and exercise period. Annual return filings (Form MGT-7 and AOC-4) must disclose ESOPs outstanding and exercised.

Exercise price is typically set at face value (cheapest for the employee) or at a discount to FMV. The FMV at the time of grant determines the perquisite-tax base at exercise; even if the exercise price is below FMV, perquisite tax applies on (FMV at exercise - exercise price). For unlisted companies, FMV at exercise is determined by a Category I Merchant Banker registered with SEBI, using DCF or other approved methods (Rule 3 of Income Tax Rules). Listed shares use stock-exchange-quoted FMV on the date of exercise.

On exercise, the employee pays the exercise price and the company allots equity shares. File Form PAS-3 (Return of Allotment) within 30 days, attach the list of allottees and the merchant-banker valuation. Update the Register of Members (Form MGT-1) and issue share certificates within two months. Perquisite tax under Section 17(2)(vi) is computed on (FMV at exercise - exercise price); TDS must be deducted under Section 192. DPIIT-recognised eligible startups can defer perquisite TDS for up to 5 years from exercise or until sale/cessation, under Section 192(1C). Report ESOPs in annual Form SH-6 (Register of ESOP) and in Form MGT-7.

What is the maximum pool size for ESOPs in India?
There is no statutory cap, but most VC-backed Indian startups operate with an ESOP pool of 10-15% of fully-diluted equity. The pool is created and expanded through Board and shareholder approvals; lead investors at each priced round often require pool top-ups.

Can I issue ESOPs at zero exercise price?
Technically yes for face-value allotment, but the perquisite-tax mechanics get expensive for the employee. Most schemes use a face-value or near-FMV exercise price to balance employee value (low exercise cost) with perquisite-tax efficiency.

Is the Section 192(1C) deferral available to all startups?
Only to DPIIT-recognised startups that qualify under Section 80-IAC (eligible business with deduction). The deferral allows TDS deferral up to 5 years from the financial year of exercise, or sale of shares, or cessation of employment, whichever is earliest.

What FMV methodology is used for unlisted shares?
Rule 11UA of Income Tax Rules and Rule 3 prescribe DCF or NAV-based methods, certified by a SEBI-registered Category I Merchant Banker. The Merchant Banker Certificate is dated within 6 months of the relevant valuation date.

Do I file Form SH-6 every time options are granted?
No. SH-6 is the Register of ESOP, maintained internally. File MGT-14 within 30 days of the special resolution approving the scheme. File PAS-3 within 30 days of each allotment of shares on exercise. Report ESOP movements in the annual MGT-7.

Can I grant ESOPs to consultants and advisors?
Section 62(1)(b) covers employees and directors. Consultants and advisors typically receive sweat equity under Section 54 or are granted through a separate non-statutory scheme. Tax treatment differs - consultants are taxed on FMV at the time of grant or exercise as business income.