ESOP Companies Act 2013

Explore the provisions of the Companies Act 2013 regarding ESOPs, covering legal compliance, disclosures, and governance practices for companies offering stock options to employees.
Leverage your ESOPs for funds!
3 mins read
05-May-2025

Employee Stock Option Plans (ESOPs) allow employees to purchase company shares at a pre-determined price after completing a specific period of service. More than just a compensation benefit, ESOPs provide employees with a real ownership interest in the company. This not only boosts motivation and performance but also aligns individual contributions with the company’s long-term growth. By linking reward with results and loyalty with equity participation, ESOPs create a sense of shared success and commitment among employees.

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Legal framework for ESOPs

In India, the legal foundation of ESOPs rests on three pillars: the Companies Act, 2013, SEBI regulations, and the Income Tax Act, 1961. These ensure fair practices, clear disclosures, and tax efficiency for both employees and employers.

The ESOP Companies Act 2013 lays out how companies must issue and administer these plans from seeking shareholder approval to ensuring transparency and governance. If the company is listed, SEBI’s guidelines further ensure investor protection.

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Step-by-step ESOP implementation guidelines

Implementing an ESOP is more than drafting a plan it’s about making equity ownership real and accessible for your team. Here's how companies typically roll it out:

Step 1: Drafting the ESOP plan document

This plan outlines everything who is eligible, how many shares are on offer, vesting schedules, exercise price, and what happens in case of resignation or retirement.

Step 2: Determining the exercise price

For listed companies, SEBI rules determine valuation. For unlisted ones, fair market valuation methods apply.

Step 3: Obtaining shareholder approval

A special resolution under the Companies Act, 2013 is mandatory to formally adopt the ESOP scheme.

Step 4: Establishing an ESOP Trust (Optional)

While optional, many companies create a trust to handle administration. It holds and distributes shares on behalf of employees, making the ESOP run more smoothly.

Step 5: Granting options to employees

Once approved, options are granted through a formal letter that outlines the number of shares, price, and vesting timeline.

Step 6: Vesting of options

Options vest over a fixed period. Once vested, they’re ready for exercise.

Step 7: Exercise of options

Employees pay the exercise price to convert vested options into actual shares. This is where ESOP financing can ease the process.

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Step 8: Compliance and disclosure

Companies must regularly disclose the number of options granted, vested, or exercised in financial statements and regulatory filings.

Disclosure requirements

Transparency is fundamental to building and maintaining stakeholder trust when it comes to ESOPs. Companies are required to make detailed disclosures about their ESOP schemes including the number of options granted, the vesting schedule, the method of valuation, and how these options may impact the company’s capital structure. These disclosures must be included in the company’s financial statements, board reports, and annual filings. Listed companies are also required to submit periodic ESOP-related information to regulatory authorities like SEBI. Such transparency ensures that shareholders, regulators, and employees are fully informed about how ESOPs influence shareholding patterns, equity dilution, and long-term value creation. It also helps employees understand the potential worth of their stock options and how they tie into the company’s broader financial strategy.

Administration and governance

Administering an ESOP in India involves more than just legal compliance it demands sustained governance and operational efficiency. Most companies establish a formal ESOP committee or appoint trustees to oversee the plan’s implementation and ensure alignment with regulations and employee interests.

These entities handle tasks such as maintaining records, monitoring vesting, facilitating option exercises, and overseeing the transfer of shares. Where a trust is set up, it often acts as the custodian of shares, easing administrative burdens and enhancing transparency.

Governance also involves resolving employee queries, ensuring compliance with SEBI or Companies Act norms, and adapting the ESOP structure when needed. A strong governance framework builds trust among employees and contributes to the long-term success of the plan.

Taxation of ESOPs

Taxation on ESOPs is twofold. At the time of exercise, employees are taxed on the difference between the fair market value and the exercise price (as a perquisite). Later, when shares are sold, capital gains tax applies depending on how long the shares were held.

Companies, on the other hand, may claim a deduction under Section 37 of the Income Tax Act. So, while ESOPs can lead to significant employee gains, understanding tax impact is crucial to maximize benefits and avoid surprises.

ESOP financing solutions

A major challenge employees face while exercising ESOPs is the need for upfront capital. The exercise price can be significant, and without adequate liquidity, many may delay or miss the opportunity altogether.

To address this, institutions like Bajaj Finance offer ESOP financing loans designed to cover the exercise cost. These loans are structured with competitive rates and flexible terms, enabling employees to convert vested options into share ownership without depleting savings or liquidating assets.

This financing bridges the gap between option vesting and shareholding, empowering employees to realize the true value of their ESOPs. It enhances wealth creation and strengthens alignment with the company’s growth.

Compliance with other laws and regulations

ESOPs don’t operate in a vacuum. Companies must also follow broader corporate, securities, and labour laws. This includes staying compliant with SEBI’s regulations, maintaining proper disclosures, and adhering to governance standards.

Additionally, care must be taken to avoid any bias or unfair treatment in ESOP eligibility or distribution in line with employment and anti-discrimination laws.

Proper legal oversight helps avoid litigation, boosts employee confidence, and protects the company’s reputation.

Conclusion

A well-structured ESOP is a powerful tool for companies to retain top talent and for employees to build real wealth. But successful implementation means much more than issuing options. It requires clarity on the ESOP Companies Act 2013, solid governance, accurate disclosures, tax awareness, and above all employee-friendly support mechanisms like ESOP financing.

Do not let financial constraints delay your equity journey. With Bajaj Finance’s ESOP financing, you can exercise your options smoothly and confidently Apply today and take ownership of your future.

Frequently asked questions

What is ESOP under the Companies Act, 2013?
Under the Companies Act, 2013, an Employee Stock Ownership Plan (ESOP) is a scheme that allows employees to acquire shares of the company, providing them with an ownership interest. ESOPs are governed by Section 62 and relevant SEBI regulations.

What is section 62 of the Companies Act, 2013?
Section 62 of the Companies Act, 2013, deals with the issuance of further shares by a company. It includes provisions for rights issues, employee stock option plans (ESOPs), and the issuance of shares to specific individuals or groups through a special resolution.

Who are eligible for ESOP?
Eligibility for ESOPs typically includes full-time employees, directors (excluding independent directors), and officers of the company. Companies may also extend eligibility to employees of subsidiary, holding, or associate companies, as defined in their ESOP policy.

Can ESOPs be issued by private limited companies?

Yes, private limited companies can issue ESOPs under the Companies Act, 2013, provided they meet compliance requirements such as shareholder approval and adherence to specific rules under Section 62(1)(b) and related rules.

How are ESOPs taxed in India?

ESOPs are taxed twice: first as a perquisite when shares are allotted (taxed as salary), and again as capital gains when the employee sells those shares. Tax rates vary based on holding period and sale value.

What is the process to issue ESOPs under the Companies Act, 2013?

The company must prepare an ESOP scheme, get board and shareholder approval via a special resolution, and comply with Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014, ensuring proper disclosures and documentation.

Can foreign employees receive ESOPs from an Indian company?

Yes, Indian companies can grant ESOPs to foreign employees, but such issuances must comply with FEMA regulations, RBI guidelines, and applicable laws of the employee’s home country, including any foreign exchange reporting obligations.

What happens to ESOPs if an employee resigns or is terminated?

Unvested ESOPs typically lapse. Vested ESOPs may be exercised within a defined period, as per the company’s ESOP policy. Terms vary based on whether the exit is voluntary, due to misconduct, or other circumstances.

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