ESOP Eligibility Under Companies Act 2013: Who Can and Cannot Get ESOPs

An ESOP (Employee Stock Option Plan) is one of the most effective tools for startups and private limited companies in India to attract and retain talent. It allows employees to become partial owners of the company, aligning their goals with business growth. However, not everyone is eligible for ESOPs. The Companies Act, 2013 clearly defines who can and cannot receive stock options for employees. For founders, CFOs, and HR teams, understanding these eligibility rules is critical to avoid legal issues and ensure compliance.

This blog explains ESOP eligibility under Indian law along with compliance, taxation, and practical insights for ESOP in India.

What is ESOP in India?

An Employee Stock Option Plan (ESOP) is a scheme under which employees are given the right to purchase shares of the company at a fixed price after a specific period.

It is governed by:

• Companies Act, 2013

• Rule 12 of Companies (Share Capital and Debentures) Rules, 2014

Key Features:

• Applicable to private limited companies in India

• Promotes employee ownership and long-term retention

• Widely used by startups and growing esop companies

An ESOP plan is also known as:

• Employee stock ownership plan

• Employee share option plan

• Stock option plan

• Employee share ownership plan

Who is Eligible for ESOPs?

Under Indian law, the following individuals are eligible for an employee stock option scheme:

Eligible Persons:

• Permanent employees of the company

• Directors (including whole-time directors)

• Employees or directors of holding or subsidiary companies

This allows startups to create a strong employee ownership plan across group companies.

Who Cannot Get ESOPs?

As per Rule 12, the following are generally not eligible:

• Promoters of the company

• Persons belonging to the promoter group

• Directors holding more than 10% equity (directly or indirectly)

Exception:

Startups (recognized by DPIIT) may allow ESOPs to promoters under certain conditions for a limited period.

Step-by-Step ESOP Issuance Process

To issue share options for employees, companies must follow a proper legal process:

1. Draft ESOP Scheme

Define:

• Eligible employees

• Vesting period

• Exercise price

• Number of ESOP stock options

2. Board Resolution

The Board approves the ESOP plan and calls for a shareholders’ meeting.

3. Shareholder Approval (Special Resolution)

• Mandatory under Companies Act

• Required for implementing the employee stock option plan

4. Filing of MGT-14

• File with ROC within 30 days of passing the special resolution

5. Grant of ESOPs

• Offer stock options for employees as per the scheme

6. Vesting & Exercise

• Employees complete vesting period

• Exercise their share options for employees

7. Filing of PAS-3

• Filed after allotment of shares

8. Maintain Statutory Registers

• Record ESOP grants and allotments properly

ESOP Valuation in India

ESOP valuation is essential for compliance and taxation.

Key Points:

• Fair Market Value (FMV) must be determined

• Valuation is done by a registered valuer or merchant banker

• Required for accurate ESOP taxation in India

Taxation of ESOPs in India

Understanding ESOP taxation in India is crucial for employees and employers.

1. Tax at Exercise Stage (Perquisite Tax)

When ESOPs are exercised:

• Difference between FMV and exercise price is taxed as salary

Example:

• Exercise Price: ₹100

• FMV: ₹300

• Taxable Income: ₹200 per share

Employer must deduct TDS on this amount.

2. Tax at Sale Stage (Capital Gains Tax)

When shares are sold:

• Profit is taxed as capital gains

Types:

• Short-Term Capital Gains (STCG)

• Long-Term Capital Gains (LTCG)

Holding period determines tax rate.

3. Income Tax Implications

• Employees must report gains in ITR

• ESOP benefits increase taxable income

This makes employee stock ownership both a wealth-building and tax-relevant instrument.

Key Compliance Requirements

For a compliant ESOP for private limited company in India, follow these requirements:

Legal Compliance

• Follow Companies Act, 2013

• Adhere to Rule 12 provisions

Mandatory Filings

• MGT-14 (special resolution)

• PAS-3 (allotment of shares)

Documentation

Maintain:

• ESOP scheme document

• Grant letters

• Vesting schedule

Accounting Compliance

• Record ESOP cost in financial statements

• Follow accounting standards

Important Restrictions

• Promoters generally cannot receive ESOPs

• Ensure eligibility criteria is clearly defined

Conclusion

Understanding ESOP eligibility under the Companies Act, 2013 is essential for designing a compliant and effective employee stock option plan. While ESOPs are a powerful way to build employee ownership, not everyone qualifies under Indian law.Startups and private limited companies must carefully identify eligible employees, follow proper compliance steps, and ensure correct ESOP valuation and taxation.A well-structured ESOP scheme not only rewards employees but also strengthens long-term business growth. When implemented correctly, it becomes a strategic advantage for modern esop companies in India.




Need help defining ESOP eligibility and structure? Accorp Partners can help you design a fully compliant ESOP plan as per Companies Act guidelines.