ESOP Eligibility: Who Can and Cannot Receive ESOPs in India

An ESOP (Employee Stock Option Plan) is one of the most effective tools for startups and private limited companies to build long-term employee ownership. However, not everyone in a company is eligible to receive ESOPs under Indian law.

For founders, CFOs, and HR professionals, understanding who can and cannot receive ESOPs in India is critical for compliance and proper structuring of an employee stock option scheme.

This blog explains ESOP eligibility rules under Indian law, along with compliance requirements, taxation, and practical insights for Indian businesses.

What is ESOP in India?

An Employee Stock Option Plan (ESOP) allows employees to purchase company shares at a predetermined price after a vesting period. It promotes employee share ownership and aligns employee interests with company growth.

Legal Framework:

Governed by Companies Act, 2013

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

Applicability:

• ESOP for private limited company in India is widely used

• Common among startups and growing esop companies

Other commonly used terms include:

• Employee share option plan

• Employee stock ownership plan

• Stock option plan

• Employee ownership plan

Who Can Receive ESOPs in India?

Under Rule 12, ESOP eligibility is clearly defined.

Eligible Persons:

1. Permanent Employees

• Full-time employees working in India or outside India

• Includes employees of holding, subsidiary, or associate companies

2. Directors (Excluding Independent Directors)

• Whole-time directors are eligible

• Non-executive directors may also be included

3. Employees of Group Companies

• Employees of holding or subsidiary companies can receive stock options for employees

Practical Example

A Bengaluru-based startup can grant ESOP stock to:

• Its software developers

• Its CFO

• Employees working in its foreign subsidiary

This helps expand employee stock ownership across the group.

Who Cannot Receive ESOPs in India?

Certain individuals are specifically restricted under Indian law.

Not Eligible:

1. Promoters

• Promoters of the company cannot receive ESOPs

2. Promoter Group Members

• Any person belonging to the promoter group is excluded

3. Directors Holding More Than 10% Equity

• Directors with more than 10% shareholding are not eligible

Important Exception:

Startups recognized by DPIIT may have relaxations for promoter eligibility in certain cases.

Practical Insight

A founder holding 15% shares in a startup cannot receive ESOPs under normal rules. However, early-stage startups may structure equity differently to balance employee ownership plans.

Step-by-Step ESOP Issuance Process

To implement an ESOP for private limited company in India, companies must follow:

1. Draft ESOP Scheme

Define:

• Eligibility criteria

• Vesting schedule

• Exercise price

• Number of share options for employees

2. Board Resolution

• Approve the employee stock option plan

3. Shareholder Approval (Special Resolution)

• Mandatory under Companies Act

4. Filing of MGT-14

• File with ROC within 30 days

5. Grant of ESOPs

• Issue ESOPs only to eligible employees

6. Vesting & Exercise

• Employees earn and exercise options

7. Filing of PAS-3

• Required after allotment of shares

8. Maintain Statutory Registers

Maintain records of:

• ESOP grants

• Employee eligibility

• Share allotments

ESOP Valuation in India

ESOP valuation is essential before granting and exercising options.

Key Points:

• Fair Market Value (FMV) must be determined

• Conducted by a registered valuer or merchant banker

Why It Matters:

• Ensures fair allocation of ESOP stock

• Impacts ESOP taxation in India

• Builds transparency in employee ownership plans

Taxation of ESOPs in India

Understanding ESOP taxation in India is important for both companies and employees.

1. Tax at Exercise Stage (Perquisite Tax)

• FMV – Exercise Price = Taxable income

• Taxed as salary

2. Tax at Sale Stage (Capital Gains Tax)

• Applies when shares are sold

Types:

• Short-Term Capital Gains (STCG)

• Long-Term Capital Gains (LTCG)

3. Income Tax Implications

• No tax at grant stage

• Tax arises at exercise and sale stages

Key Compliance Requirements

To ensure a compliant employee stock option scheme, companies must follow:

Legal Compliance

• Follow Companies Act, 2013

• Adhere to Rule 12 provisions

Mandatory Filings

• MGT-14 (special resolution)

• PAS-3 (share allotment)

Documentation

Maintain:

• ESOP scheme

• Grant letters

• Eligibility records

Accounting Compliance

• Record ESOP costs properly

• Ensure transparency in financial statements

Common Mistakes to Avoid

• Granting ESOPs to promoters without checking eligibility

• Ignoring shareholding limits for directors

• Not updating ESOP scheme as per law

• Missing compliance filings

Conclusion

Understanding ESOP eligibility in India is essential for building a compliant and effective employee stock option plan. While ESOPs are a powerful tool for driving employee ownership, they must be structured carefully to comply with legal requirements.

Indian startups and private limited companies must ensure that only eligible employees, directors, and group company staff receive ESOPs, while avoiding restricted categories like promoters and major shareholders.

By following the correct process, ensuring proper ESOP valuation, and understanding ESOP taxation in India, companies can design a strong and compliant employee ownership plan.

A well-structured ESOP scheme not only rewards employees but also builds long-term trust, retention, and growth in India’s startup ecosystem.

Consult Accorp Partners to structure transparent, compliant, and high-impact ESOP plans that benefit both companies and employees.