ESOP Compliance in India: Secretarial, Regulatory, and Reporting Requirements Every Company Must Know
ESOPs in India are a regulated equity structure, with board approvals, filings, registers and annual disclosures to maintain for the life of the scheme.
Most founders treat ESOPs as an HR decision. Draft a scheme, get a lawyer to look at it, issue grant letters, done.
What they do not realise until a funding round, a secretarial audit, or an IPO preparation process is that ESOPs in India are a legally regulated equity structure with specific secretarial filings, board approvals, shareholder resolutions, annual disclosures, and statutory registers that must be maintained throughout the life of the scheme, not just at the time of launch.
Miss any of these and you are not simply non-compliant. You are creating a cap table problem that investors will flag, a documentation gap that delays due diligence, and in some cases an invalid grant structure that may not hold up when an employee tries to exercise.
This guide covers the complete ESOP compliance picture in India: from the statutory foundation to the step-by-step approval process, ongoing filings, annual disclosures, SEBI requirements for listed companies, accounting treatment, tax obligations, and the eight compliance mistakes that most commonly cause problems.
The statutory foundation
The authority to issue ESOPs in India comes from Section 62(1)(b) of the Companies Act, 2013. This section permits a company to issue shares to employees under a scheme of employee stock options, subject to specific approvals and conditions.
The procedural requirements covering how the scheme must be designed, who is eligible, what must be disclosed, and what records must be maintained are set out in Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014.
For listed companies, the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021, commonly referred to as the SEBI SBEB Regulations, add an additional and more demanding layer of compliance requirements on top of the Companies Act framework.
One terminology note worth knowing: the Companies Act uses the term Employee Stock Option Scheme (ESOS) while the industry universally uses Employee Stock Option Plan (ESOP). Both refer to the same instrument. This guide uses ESOP throughout, consistent with standard industry usage.
Which framework applies to your company?
Company type | Governing law | Key procedural point |
|---|---|---|
Private limited (unlisted) | Section 62(1)(b), Companies Act 2013 + Rule 12, Companies (Share Capital and Debentures) Rules, 2014 | MCA exemption allows an Ordinary Resolution rather than a Special Resolution. Significantly simpler approval process. |
Public limited (unlisted) | Section 62(1)(b), Companies Act 2013 + Rule 12 | Special Resolution (75% majority) required. More stringent disclosure requirements in the explanatory statement. |
Listed company | Companies Act 2013 + Rule 12 + SEBI (SBEB & SE) Regulations, 2021 | Compensation Committee mandatory. Stock exchange disclosures. SEBI June 2025 amendment applies (source needed). |
DPIIT-recognised startup | Companies Act 2013 + Rule 12 with startup relaxations | Promoters and directors holding more than 10% are eligible for ESOPs. Startups certified under Section 80-IAC can offer employees the tax deferral (source needed). |
Who is eligible and who is not
Understanding who can and cannot receive ESOPs is fundamental to scheme design. Granting options to ineligible employees creates a structural defect that cannot easily be corrected after the fact.
Category | Eligible? | Details |
|---|---|---|
Permanent employees (working in India or abroad) | Yes | All permanent employees on payroll, working in India or abroad |
Directors (excluding independent directors) | Yes | Part-time directors also eligible. Independent directors explicitly excluded. |
Employees of subsidiaries or holding companies | Yes | Must be explicitly included in the scheme document |
Promoters or promoter group members | No (standard companies) | Standard restriction. DPIIT-recognised startups have an exemption. |
Directors holding more than 10% equity | No (standard companies) | Direct, through relatives, or through corporate entities. Startups exempted. |
Independent directors | No | Explicitly excluded under Rule 12 and SEBI regulations |
Contract or temporary employees | No | Must be permanent employees to be eligible |
The DPIIT startup exception
For DPIIT-recognised startups, the 10% shareholder restriction and the promoter group restriction both do not apply for a period of ten years from the date of incorporation. This means a founder who holds a significant stake and is classified as a promoter can still receive ESOPs under a DPIIT-recognised startup, which is a material advantage that many early-stage companies overlook when structuring their ESOP schemes.
What the explanatory statement must include
When the general meeting notice is sent out for ESOP approval, it must be accompanied by an explanatory statement containing specific mandatory disclosures under Rule 12. The following must all be present:
- The total number of options to be granted.
- The class of employees eligible to participate.
- The appraisal process for determining eligibility of each employee.
- The requirements of vesting, including the minimum vesting period of one year from grant date.
- The maximum period within which options must be exercised after vesting.
- The exercise price or the formula for determining it.
- The exercise period.
- The lock-in period on shares issued after exercise, if any.
- The maximum number of options that may be granted to any single employee and in aggregate.
- The method of valuation of options.
- A statement that the company will comply with applicable accounting standards.
- The impact on diluted EPS if all outstanding options are exercised.
Documentation gap risk. If your existing scheme's explanatory statement is missing any of these items, that is a documentation gap that needs to be addressed before your next investor interaction or regulatory filing. It is not something that can be quietly corrected later; it must be addressed formally.
The approval process, step by step
This is where most companies cut corners, and where the problems surface during due diligence, secretarial audits, and IPO preparation.
Step | Action required | Deadline or timeline | Document generated |
|---|---|---|---|
1 | Check the Articles of Association. Confirm ESOP issuance is authorised. If not, amend the AoA first via EGM. | Before any ESOP action | Amended AoA (if required) |
2 | Draft the ESOP scheme document covering eligibility, number of options, vesting, exercise price, exercise period, lapse conditions, and accounting standards compliance statement. | Before board meeting | ESOP scheme document |
3 | Issue board meeting notice to all directors. | Minimum 7 days before meeting | Board meeting notice |
4 | Hold the board meeting. Approve the scheme, determine exercise price, fix EGM/AGM date. Cannot be done by circular resolution. | Board meeting date | Board resolution |
5 | File MGT-14 with the ROC for the board resolution. | Within 30 days of board meeting | Form MGT-14 |
6 | Issue EGM/AGM notice with explanatory statement to all directors, auditors, shareholders, and secretarial auditors. | Minimum 21 days before meeting | EGM notice + explanatory statement |
7 | Hold the general meeting. Pass an Ordinary Resolution (private company) or Special Resolution (public company). | General meeting date | Ordinary or Special Resolution |
8 | File MGT-14 with the ROC for the shareholder resolution. | Within 30 days of general meeting | Form MGT-14 |
9 | Issue signed grant letters to all eligible employees stating options granted, exercise price, vesting schedule, and exercise period. | After scheme approval | Grant letters (signed by company and employee) |
10 | Maintain the SH-6 register (Register of Employee Stock Options). Update after every grant, exercise, vesting, forfeiture, and lapse event. | Ongoing from first grant |
Ongoing filings and registers
Approval of the scheme is the beginning, not the end. Here is what ongoing compliance requires.
Form or obligation | Purpose | Deadline | Penalty for non-filing |
|---|---|---|---|
Form PAS-3 (Return of Allotment) | Notifies the ROC of shares allotted to employees on exercise. Required every time shares are issued after option exercise. | Within 30 days of allotment | Daily penalty for the company plus officer liability (source needed) |
Form MGT-14 (resolution filing) | Filed for board and shareholder resolutions at scheme setup and for each scheme modification. | Within 30 days of resolution | Daily penalty for the company (source needed) |
SH-6 register update | Updated after every grant, vesting, exercise, forfeiture, and lapse event. Primary evidence of ESOP administration. | Ongoing after each event | No specific penalty, but creates evidence issues in disputes and due diligence |
Annual return (MGT-7) | Must disclose ESOP details as part of the company's annual return to the ROC. | Within 60 days of AGM | Penalty depends on the default (source needed) |
Annual disclosures in the Board's Report
Every year, the company's Board's Report must include specific ESOP disclosures under Rule 12. These are mandatory; their absence is flagged by secretarial auditors and creates director liability.
Disclosure item | What to report |
|---|---|
Options granted | Total number of stock options granted during the financial year |
Options vested | Total number of options that vested during the year |
Options exercised | Total number of options exercised during the year |
Shares arising from exercise | Number of equity shares actually allotted on exercise |
Options lapsed | Options forfeited or cancelled during the year, with reason stated (resignation, performance, scheme terms) |
Exercise price | The exercise price at which options were granted |
Variation of terms | Any changes made to scheme terms during the year (requires fresh shareholder approval if adverse to employees) |
Money realised from exercise | Total cash received by the company on exercise of options |
Options in force at year-end | Outstanding options balance as at end of financial year |
Employee-wise details (senior employees) | Named disclosure for KMPs, senior management, and relatives of directors who received options |
Employees holding 1% or more of share capital | Identified employees granted options exceeding 1% of issued share capital in a year |
Diluted EPS | Earnings per share computed after considering effect of all outstanding options if exercised |
The Board's Report disclosure is not a summary. It is a prescribed statutory disclosure and every line item above must be addressed specifically. A generic statement that the company has an ESOP scheme does not satisfy the requirement.
Tallect insight: the filing most companies think they have already done. Most companies file MGT-14 at scheme setup and consider their ESOP compliance handled. The filing that accumulates into a multi-year gap is PAS-3, the Return of Allotment required within 30 days of every exercise event. A company running annual exercise windows without filing PAS-3 after each one can carry three or four years of non-compliance before it surfaces in investor due diligence. The 30-day deadline has no memory. Someone has to own it, calendar it, and treat every exercise event as a filing trigger. The companies that discover this problem late typically spend months in cleanup before their cap table is clean enough to present to investors.
Extra requirements for listed companies
Listed companies operate under a significantly more demanding compliance framework than unlisted companies. The SEBI SBEB Regulations, 2021 add requirements that go well beyond what the Companies Act mandates.
SEBI requirement | Applies to | Key document or filing |
|---|---|---|
Compensation Committee | All listed companies with ESOP schemes | Board resolution constituting the committee + committee charter |
Special resolution for scheme approval | All listed companies | Special resolution + explanatory statement with SEBI-prescribed disclosures |
Stock exchange periodic disclosures | All listed companies | Quarterly and annual disclosures per SEBI LODR and SBEB regulations |
Fair value accounting (Ind AS 102) | All listed companies and Ind AS preparers | Actuarial or Black-Scholes valuation report at each grant date |
Trust deed and trustee details | Companies using the trust route | Trust deed, trustee appointment, annual trust accounts |
Annual certificate of compliance | All listed companies | Signed certificate by Compliance Officer and Company Secretary |
SEBI June 2025 amendment. In its June 2025 board meeting, SEBI extended the ESOP benefit to employees of unlisted subsidiaries of listed companies, a significant expansion that allows groups with listed parent companies to offer equity to employees across their unlisted operating entities (source needed). Companies in this structure should review their ESOP scheme documents to ensure eligibility is correctly extended to subsidiary employees and that all SEBI disclosure requirements are met at the listed entity level.
Accounting: Ind AS 102 and IGAAP
ESOP expense must be recognised in the financial statements. This is not optional and getting it wrong creates a material financial statement error that auditors will flag.
Framework | Applicable to | Accounting requirement |
|---|---|---|
Ind AS 102 (Share-Based Payment) | All listed companies; large unlisted companies preparing Ind AS financials | Options measured at fair value at grant date using Black-Scholes or binomial model. Expense recognised over vesting period. |
ICAI Guidance Note on ESOP | Companies on IGAAP | Intrinsic value method permitted (FMV at grant date minus exercise price) (source needed). Expense spread over vesting period. |
Disclosure requirement (all companies) | All companies with ESOP schemes | Companies using the intrinsic value method must disclose what the expense would have been under the fair value method. |
The key practical requirement is that ESOP expense must be calculated at grant date using a recognised valuation model, typically Black-Scholes for most private company options. This requires an independent actuary or registered valuer to provide the fair value calculation. The expense is then spread over the vesting period and charged to the profit and loss account each financial year.
Companies that have never recognised ESOP expense in their P&L, particularly startups that have been treating options as off-balance-sheet, need to address this before any fundraise or IPO. It directly affects reported profitability and EBITDA figures that investors rely on.
Cross-border ESOPs and FEMA
For companies with employees in multiple countries, or for Indian employees receiving ESOPs from foreign parent companies, the Foreign Exchange Management Act adds a compliance layer that is frequently overlooked.
Indian employees who receive ESOPs from a foreign company, for example an Indian subsidiary whose parent is incorporated in Singapore, the Cayman Islands, or Delaware, are acquiring foreign securities. These acquisitions must be reported to the RBI under the applicable framework, typically under the Liberalised Remittance Scheme or the specific FEMA regulations governing foreign securities held by Indian residents (source needed). Indian employees must also report their foreign equity holdings in Schedule FA of their annual ITR.
For companies granting ESOPs to Indian employees from a foreign parent entity, the structure must be documented and reported under the applicable RBI framework. Non-compliance with FEMA reporting is a widespread problem in cross-border ESOP structures, and the consequences, ranging from significant penalties to compounding violations, are disproportionate to the effort required to comply. Neither obligation is typically flagged at the time of grant; it surfaces during Income Tax assessments or when employees sell and realise gains that cannot be explained in their tax history.
Tax treatment for employers and employees
ESOP taxation in India happens at two stages: exercise and sale. Both stages create obligations for both the employer and the employee.
Event | Tax treatment | Employer obligation | Employee obligation |
|---|---|---|---|
At grant | No tax event | None | None |
At vesting | No tax event | None | None |
At exercise (unlisted) | Spread (FMV minus exercise price) taxed as a perquisite, salary income at applicable slab rate | Deduct TDS on perquisite value. Include in Form 16. Report in 24Q. | Declare perquisite income in ITR. Pay tax on spread. |
At exercise (listed) | Spread taxed as a perquisite based on market price on exercise date | Deduct TDS. Include in Form 16. | Declare in ITR. Pay tax at slab rate. |
At sale (short term, under 24 months, unlisted) | Capital gains taxed at applicable slab rate | None | Declare in ITR Schedule CG |
At sale (long term, over 24 months, unlisted) | LTCG at 12.5% without indexation benefit | None | Declare in ITR Schedule CG |
Tax deferral (DPIIT startups) | Tax at exercise deferred to a later trigger event (source needed) | TDS at the trigger event rather than exercise | Tax payable only at the trigger event, removing the exercise tax trap |
Income Tax Act 2025. Effective from 1 April 2026, the Income Tax Act 2025 consolidated and modernised India's direct tax framework. For ESOPs, the Act clarified the treatment of perquisite income for employees who have worked in multiple jurisdictions during the vesting period, providing clearer guidance on how to apportion the spread between Indian and foreign tax jurisdictions (source needed). For companies with internationally mobile employees who received grants in one country and exercised in another, this clarification reduces the ambiguity that previously required case-by-case legal opinions.
The DPIIT startup tax deferral
The most significant ESOP tax benefit available in India applies to employees of DPIIT-recognised startups that have received Inter-Ministerial Board certification. Under this framework, the perquisite tax at exercise is deferred to the earliest of the date of sale of shares, the date of cessation of employment, or the end of a fixed period after the relevant assessment year (source needed).
This deferral is a real financial benefit because employees at pre-IPO startups do not need to find cash to pay a large tax bill at the moment of exercise when shares remain illiquid. Employers at DPIIT-recognised startups should ensure this benefit is clearly communicated to employees at the time of grant so they can make informed exercise decisions.
IPO-stage considerations
The ESOP compliance requirements that seem manageable in isolation become critically important when a company begins preparing for an IPO. SEBI's ICDR Regulations require that ESOP schemes be compliant with the SEBI SBEB Regulations before the DRHP is filed.
In practice, IPO due diligence from investment banks and legal counsel involves a detailed review of the entire ESOP history: every grant, every exercise event, every SH-6 entry, every PAS-3 filing, and every Board's Report disclosure going back to the scheme's inception. Any gap in this record causes delays in the IPO timeline that cannot be fixed quickly.
For companies planning an IPO in the next two to three years, the right time to audit ESOP compliance is now, not six months before the DRHP filing.
Tallect insight: start the ESOP compliance audit 18 months before you think you need to. SEBI's ICDR Regulations require ESOP schemes to be in compliance with SEBI SBEB Regulations before the DRHP is filed. Any procedural defects, such as missing SH-6 entries, undisclosed grants, or incorrect share capital disclosures, need to be resolved before the DRHP review process begins. SEBI officers specifically examine ESOP documentation as part of IPO due diligence, and unresolved issues cause delays that cannot be fixed on a short timeline. Companies that begin this audit 18 to 24 months before a planned IPO filing have time to remediate. Companies that begin it six months before the DRHP deadline often do not.
The 8 most common compliance mistakes
Mistake | What actually happens | How to fix it |
|---|---|---|
1. Granting ESOPs before shareholder approval | All options issued without prior scheme approval are legally unenforceable. Discovered in investor due diligence, causing deal delays and restructuring costs. | Do not grant options until the scheme is approved. If already done, seek legal advice on regularisation, which may involve the NCLT, and fresh shareholder approval (source needed). |
2. Not maintaining the SH-6 register | During due diligence, investors ask for SH-6 as primary evidence of ESOP administration. A missing register creates an immediate red flag. | Reconstruct from grant letters and exercise records. Keep updated from every event going forward. |
3. Missing PAS-3 filing after allotment | Creates a compliance gap the ROC can impose penalties for. Triggers adverse observations in secretarial audit. | File delayed PAS-3 with applicable late fees. Establish a calendar trigger for every exercise event. |
4. Not updating the Board's Report | Secretarial auditors flag missing ESOP disclosures. Creates liability for directors who signed off the report. | Prepare a standard ESOP disclosure template. Include it in the Board's Report preparation checklist every year. |
5. Unsigned or incomplete grant letters | If an employee disputes their grant and the letter is unsigned or missing key terms, the company has no documented evidence of the agreed terms. | All grant letters must be signed by both an authorised signatory and the employee. Keep original physical and digital copies. |
6. FEMA non-compliance (cross-border) | Non-reporting of foreign ESOP acquisitions by Indian employees can result in FEMA violations with significant penalties. | Implement a FEMA compliance process for every cross-border ESOP grant. Brief employees on ITR reporting obligations at exercise. |
7. Not recognising ESOP expense in P&L | Under Ind AS 102, ESOP expense must be recognised over the vesting period. Missing this understates expenses and overstates profits, which is a material financial statement error. | Obtain a grant-date valuation from an actuary or registered valuer. Build expense recognition into the monthly accounting close. |
8. Circular resolution for scheme approval | ESOP scheme approval via circular resolution is invalid. A formal board meeting is mandatory. Options granted under a circular resolution approval carry a procedural defect. | Always convene a formal board meeting for ESOP-related resolutions. Document this clearly in board minutes. |
What good compliance looks like
Companies that manage ESOP compliance well share a few consistent characteristics.
They treat the SH-6 register as a live document updated within days of every grant, exercise, vesting, lapse, and forfeiture event, not a document reconstructed annually before the Board's Report is prepared.
They have a calendar trigger for PAS-3 filing that fires automatically after every exercise event. The 30-day deadline is not something that should depend on someone remembering.
They prepare the Board's Report ESOP disclosure from a standard template that is updated throughout the year as events occur, not assembled from memory at the end of the financial year.
They engage a Company Secretary who specifically understands ESOP compliance rather than treating it as a general secretarial matter, particularly once the employee count and option pool reach a scale where errors have material consequences.
They brief employees on their tax obligations at the time of grant, particularly on the perquisite tax at exercise and the TDS implications, so exercise decisions are made with a clear understanding of the cash requirement rather than as a surprise at the point of exercise.
Tallect insight: what separates companies that sail through due diligence from those that spend months in remediation. It is not the quality of the lawyers they hired at scheme launch. It is whether they treated ESOP compliance as a live operational process or an annual paperwork exercise. The SH-6 register is either current or it is not. The PAS-3 filings either happened within 30 days of each allotment or they did not. The Board's Report disclosures either match the register or they require reconstruction. These are not sophisticated compliance challenges. They are calendar and ownership problems. The companies that sail through IPO diligence are not more compliant than others in some abstract sense. They just never let these things slide in the first place.
Frequently asked questions
What is the difference between an Ordinary Resolution and a Special Resolution for ESOP approval in India?
An Ordinary Resolution requires more than 50% of votes cast to be in favour. A Special Resolution requires 75% or more. Under the Companies Act, private limited companies were given an MCA exemption that allows ESOP scheme approval by Ordinary Resolution, making the process significantly simpler. Public limited companies and listed companies must pass a Special Resolution. The type of resolution required determines the vote threshold at your general meeting and must be correctly stated in the meeting notice and explanatory statement.
What must be included in the explanatory statement for ESOP approval?
Rule 12 specifies the mandatory disclosures that must appear in the explanatory statement attached to the general meeting notice. These include the total number of options to be granted, the class of employees eligible, the appraisal process for determining eligibility, the minimum vesting period of one year, the maximum exercise period, the exercise price or formula, the lock-in period on shares issued after exercise if any, the maximum options that can be granted to any single employee, the valuation methodology, a statement that accounting standards will be complied with, and the dilutive impact on earnings per share. Missing any of these creates a procedural defect in the scheme approval.
When must PAS-3 be filed and what happens if it is missed?
Form PAS-3 (the Return of Allotment) must be filed with the Registrar of Companies within 30 days of every allotment of shares to employees following exercise. This filing is required each time exercise events result in share allotment, not just at scheme setup. Missing the 30-day deadline attracts a daily penalty at the company level, plus officer liability under the Companies Act (source needed). Companies that run annual exercise windows without filing PAS-3 after each event accumulate multi-year compliance gaps that surface during investor due diligence.
What are the tax obligations for employers when employees exercise ESOPs?
At the time of exercise, the employer must calculate the perquisite value (the spread between FMV and exercise price) for each employee who exercises. The employer must deduct TDS on this perquisite value, include it in Form 16 as part of salary income, and report it in the quarterly TDS return Form 24Q. For listed company shares, FMV is the market price on the exercise date. For unlisted company shares, FMV is determined by a merchant banker valuation or registered valuer as per Rule 11UA of the Income Tax Rules. Failure to deduct TDS on the perquisite value makes the company liable for the TDS amount plus interest and penalties.
What is the DPIIT startup tax deferral benefit and how does it work?
DPIIT-recognised startups with Inter-Ministerial Board certification can offer employees a tax deferral on the perquisite arising at exercise. Instead of paying tax at the time of exercise, the employee pays tax at the earliest of the date of sale of shares, the date of cessation of employment, or the end of a fixed period after the relevant assessment year (source needed). This eliminates the cash tax burden at exercise, which is particularly valuable at pre-IPO startups where shares cannot be sold to fund the tax liability. The employer's TDS obligation is similarly deferred to the triggering event rather than the exercise date.
