Employee Stock Option Plans (ESOPs) are powerful tools to attract, motivate and retain talent by giving employees the right to buy company shares at a preset price after a vesting period. ESOPs also align employee incentives with long-term company growth, but they carry specific legal, tax and disclosure obligations in India. This guide walks you through an end-to-end, compliance-first ESOP rollout process: from policy drafting to exercise, allotment and statutory filings.
1) Decide objectives & ESOP design (policy fundamentals)
Start with clear objectives: retention, reward, leadership pipeline, or founder dilution management. Key design parameters to define:
- Pool size (e.g., 5–15% of equity)
- Grantees (employees, directors, consultants — who qualifies)
- Vesting schedule (cliff + monthly/quarterly vesting)
- Exercise price (fixed / FMV / formula)
- Exercise window and post-termination treatment (accelerated vesting, buyback, forfeiture)
- Type of instrument (option leading to equity on exercise; RSU/ESPP differences)
- Performance vs time-based vesting
Document these in an ESOP Policy / Scheme Document (operational rules and definitions). This acts as the single source of truth for grants and disputes.
2) Check corporate powers & Articles of Association (AoA)
Confirm the company’s AoA allows issuance of shares / options. If not, amend AoA before approving the ESOP. ESOP issuance is governed under Section 62(1)(b) of the Companies Act, 2013 and related Rules — the scheme must be authorized by the company’s constitutional documents. ICSI
3) Board approval and draft scheme
- Convene a Board meeting to approve: draft ESOP scheme, pool size, grant policy, key dates (grant/vesting/exercise) and to call an EGM (if shareholder approval is required).
- Approve the grant letter template, employee communications, and appoint an ESOP administrator (company secretary/HR/legal).
Keep minutes and a certified copy of the Board resolution on the record.
4) Shareholder approval (special resolution) & MGT-14 filing
- Private companies: In practice, ESOP schemes require shareholders’ approval by special resolution (check Rule 12 and any relevant MCA notifications); hold an EGM and pass the special resolution with an explanatory statement setting out scheme details (number of options, class of employees, pricing, vesting, etc.). ICSI
- File Form MGT-14 with the RoC within 30 days of passing the special resolution (attach the scheme, certified copy of resolution and explanatory statement). cleartax
Practical tip: loop in investors early — ESOP pool size is often negotiated in funding rounds.
5) Register setup & internal records
Maintain statutory and internal registers required for ESOPs:
- Register of Employee Stock Options (Form SH-6 style tracking — maintain details of grants, vesting, exercises, cancellations)
- Cap table updates (grant pool should be visible as reserved equity)
- Individual grant letters and signed employee consent forms.
Many companies also use a digital equity management platform to track vesting schedules, exercises and generate tax reports.
6) Granting options (Grant Letter & communication)
Issue Grant Letters to grantees containing:
- Number of options granted
- Grant date & vesting commencement date
- Vesting schedule & cliff, exercise price, exercise period
- Termination / resignation / misconduct clauses
- Lock-in, transfer restrictions and right of first refusal (if applicable)
Obtain signed acceptance from each grantee and keep copies in employee files.
7) Vesting & exercise process
- Vesting: Options vest as per schedule; employees do not have shareholder rights until they exercise and shares are allotted.
- Exercise: Employee submits an exercise notice and pays the exercise price. The Board passes a resolution approving allotment of shares on exercise.
8) Allotment & RoC filing — PAS-3 (Return of Allotment)
After allotment on exercise, the company must file Form PAS-3 (Return of Allotment) with RoC within the statutory time (private placement/allotment timelines differ; often within 15–30 days depending on nature of allotment). Accurate list of allottees and certified board resolution must be attached. Timely PAS-3 filing preserves legal validity and avoids late fees. Fiscal Flow Website+1
9) Taxation & TDS considerations
ESOPs generally create two tax events for employees:
- Perquisite tax at exercise (or allotment) — the difference between fair market value (FMV) and exercise price is treated as a perquisite and is taxable as salary in the hands of the employee (employer must compute value and withhold TDS where applicable). For eligible start-ups, specific reliefs and deferments may apply under notified rules — confirm current Income-tax guidance and eligibility rules. Income Tax India+1
- Capital gains on sale — when employee sells shares, capital gains tax applies (short-term/long-term rules depend on holding period and whether shares are listed or unlisted).
Also check recent clarifications on cross-border ESOPs (GST/GST Council clarifications), and TDS reporting rules where ESOPs are provided through overseas holding companies. Goods and Services Tax Council
Practical: Maintain perquisite calculation worksheets and issue Form 16/TDS statements correctly; consult tax advisors for any start-up deferment schemes.
10) Listed companies & SEBI disclosure rules
Listed companies face additional disclosure and procedural requirements under SEBI regulations for share-based benefits — including detailed disclosures in board/ESOP committee reports and limits on grants to promoters/major shareholders. Ensure compliance with SEBI guidelines for listed entities. SEBI Investor
11) Ongoing compliance & governance
- Update statutory registers and minute books.
- Disclose aggregate ESOP movements in board reports and director’s report (per accounting and regulatory requirements).
- Monitor insider trading blackout periods and share transfer restrictions for employees.
- Re-approve or top-up ESOP pools when required and file MGT-14 each time a new special resolution is passed. Ebizfiling
12) Common pitfalls & compliance risks
- Not obtaining/filing shareholder approval where required (or failing to attach explanatory statement). ICSI
- Missing PAS-3 filing after allotment (late fees / legal risk). Fiscal Flow Website
- Incorrect perquisite calculations, incorrect TDS or late TDS deposit. Income Tax India
- Granting options to disallowed persons (e.g., some restrictions on promoters / large shareholders for listed companies). Reuters
ESOP implementation checklist (copy-paste)
- Draft ESOP Policy & Scheme (include pool size, vesting & exercise rules).
- Verify AoA; prepare AoA amendment if required.
- Board resolution to approve ESOP draft and call EGM (if needed).
- Prepare explanatory statement and hold EGM — pass special resolution.
- File MGT-14 within 30 days. cleartax
- Issue Grant Letters; collect signed acceptance.
- Maintain ESOP register and update cap table.
- Track vesting; accept exercise notices and pass allotment resolution.
- File PAS-3 within prescribed period after allotment. Fiscal Flow Website
- Compute perquisite value; deduct and deposit TDS as required. Income Tax India
- Disclose ESOP movements in statutory reports; maintain records for audits.
Quick timelines (typical)
- Board approval → within days (depending on calendar)
- Shareholder approval (EGM) → allow 21 days notice + meeting scheduling
- MGT-14 filing → within 30 days of passing resolution. cleartax
- PAS-3 allotment filing → within 15–30 days of allotment (depending on private placement/public allotment rules). Fiscal Flow Website
Conclusion
An ESOP is a strategic instrument — when designed and executed properly it drives ownership culture and retention. But ESOPs also bring a web of corporate, tax and securities rules that must be respected. Follow a structured process: design the policy, secure board and shareholder approvals, maintain statutory registers, handle vesting/exercise formalities carefully, file required RoC forms on time and treat tax/TDS obligations as a first-class part of the process.
Saving Mantra can help you with ESOP policy drafting, board/EGM pack preparation, MGT-14 & PAS-3 filings, tax computation templates, and continuous compliance dashboards to automate reminders and reports.
The information provided in this blog is for general informational and educational purposes only and should not be construed as legal, tax, or professional advice. While every effort has been made to ensure accuracy and compliance with the applicable provisions of the Companies Act, 2013 and related rules, laws and regulations may change over time and interpretations may vary based on specific facts and circumstances.
All services are subject to applicable laws, rules, and government approvals prevailing at the time of execution.