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Capital Markets & Investment Banking

ESOP for Unlisted Companies

ESOP for Unlisted Companies

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SCOPEConfirmed in writing

Regulatory Framework

Companies Act, 2013, Section 62(1)(b): an unlisted company may issue shares under an Employee Stock Option Scheme only pursuant to a special resolution passed by shareholders. Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 prescribes the scheme mechanics for unlisted companies specifically: a minimum vesting period of one year between the date of grant and the date of vesting; disclosure of scheme particulars (total options, exercise price, vesting schedule) in the explanatory statement to the special resolution; and board/compensation-committee administration of the scheme.

Because the company is unlisted, the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 — which govern ESOPs at listed companies — do NOT apply; unlisted-company ESOPs are governed solely by the Companies Act and rules above, giving materially more flexibility on pricing and structuring than a listed-company scheme.

Valuation of the underlying shares for pricing the options follows Rule 11UA of the Income-tax Rules, 1962 (DCF or NAV method, typically via a merchant banker), and the resulting perquisite on exercise is taxed to the employee under Section 17(2)(vi) of the Income Tax Act, 1961.

Overview

ESOPs for unlisted companies are the standard equity tool for startups and private companies to attract and retain talent when cash compensation is limited. The grant is made under Section 62(1)(b) of the Companies Act 2013 with the shareholders' approval and the scheme's terms, and because the company's shares are unquoted, the exercise price and the perquisite value depend on the fair market value of the shares — determined under the valuation framework of Rule 11UA of the Income-tax Rules 1962(viib) for the valuation of unquoted shares at grant and exercise).

The tax position of the employee is the crux. At exercise, the difference between the fair market value and the exercise price is a perquisite, taxable in the year of exercise under Section 17(2)(vi) of the Income Tax Act, and the employee's eventual sale produces capital gains computed on that value. For a startup, the valuation at exercise can create a tax bill the employee never budgeted for — the reason the tax deferral and planning around ESOP exercise matters.

The corporate side is equally precise: the scheme, the resolutions and the filings under the Companies Act 2013, the allotment on exercise, and the cap-table and register updates. An unlisted company's ESOP that skips the statutory mechanics leaves its employees holding options that do not stand up at the next round.

This service is for unlisted companies — startups and private companies — designing, granting and managing ESOPs. We structure the plan under Section 62(1)(b), obtain the share valuation for grant and exercise, manage the perquisite and capital gains positions for the employees, complete the allotment and filings, and keep the plan aligned with the cap table through rounds and exits.

Valuation follows Rule 11UA/11UA(2) of the Income-tax Rules 1962 (rule amended 25-Sep-2023, Notification 81/2023). Post-FA-2024, s.56(2)(viib) angel-tax applies only to legacy periods; current-grant valuation follows Rule 11UA without the s.56(2)(viib) interplay.

How It Works

  1. 1

    Plan Design & Valuation

    We design the plan and determine the fair market value under Rule 11UA for the grant price.

    Harun Raaj & Associates does this1 week
  2. 2

    Scheme & Resolutions

    We draft the scheme under Section 62(1)(b) and the board and shareholder approvals.

    Harun Raaj & Associates does this1 week
  3. 3

    Grant & Vesting Administration

    We process grants and track vesting in the option ledger.

    Harun Raaj & Associates does thisOngoing
  4. 4

    Exercise & Employee Tax

    We manage exercises, the allotment and the employee perquisite positions under Section 17(2)(vi).

    Harun Raaj & Associates does thisAs exercised
  5. 5

    Cap Table & Filing Maintenance

    We keep the allotment filings, cap table and registers aligned through rounds.

    Harun Raaj & Associates does thisOngoing

Frequently Asked Questions

When is perquisite tax triggered on exercise of ESOPs in an unlisted company?
Tax is deducted by the employer at exercise under Section 192 of ITA 1961 (Section 392 under ITA 2025 for TY 2026-27 onwards). The perquisite value is the fair market value (FMV) on the date of exercise minus the exercise price paid. For unlisted companies, FMV is determined by a merchant banker valuation under Rule 3(8)(c) of the Income-tax Rules, 1962. Employees of eligible start-ups can defer TDS on ESOPs for up to 48 months from exercise, or until a liquidity event, whichever is earlier, under the proviso to Section 192(1C).
How are ESOP shares of an unlisted company taxed on sale?
On sale, capital gains are computed under Section 45 of ITA 1961 (Section 67 under ITA 2025). Cost of acquisition is the FMV used for perquisite valuation at exercise. Holding period starts from the date of allotment: less than 24 months = short-term capital gains taxed at slab rates; 24 months or more = long-term capital gains taxed at 20% with indexation under Section 112. Unlisted shares do not qualify for the concessional 10% LTCG rate under Section 112A, which requires STT payment on a recognised exchange.
What Companies Act compliance is required before ESOPs can be issued in an unlisted private company?
ESOPs in private companies are governed by Section 62(1)(b) of the Companies Act 2013 read with Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. A special resolution of shareholders is mandatory before any grant. The scheme must specify grant price, vesting schedule, exercise period, and lock-in. On each allotment, Form PAS-3 (return of allotment) must be filed with the Registrar of Companies within 30 days under Rule 12(10). One-person companies and Section 8 companies cannot issue ESOPs.
What merchant banker valuation is required, and at which stage?
FMV must be certified by a SEBI-registered Category I Merchant Banker at two stages: (1) at grant, to fix the exercise price and document the discount, if any; and (2) at the date of exercise, for computing the perquisite under Rule 3(8)(c) of the Income-tax Rules, 1962. The valuation report must be dated not more than 180 days before the exercise date. No prescribed form exists for the report, but it must document the methodology used (DCF or NAV).
Is there FEMA compliance when ESOPs are issued to a non-resident employee or when a resident later becomes NRI?
Yes. Issue of ESOPs to non-resident employees (NRIs, OCIs, foreign nationals) by an Indian unlisted company constitutes FDI and must comply with pricing guidelines under Schedule I of the FEMA (Non-debt Instruments) Rules, 2019. The company must file Form FC-GPR with its AD Bank within 30 days of allotment. If a resident employee becomes NRI after allotment, the shares are treated as acquired as a resident and may be held on a non-repatriation basis under Schedule B of the NDI Rules, with no fresh FEMA reporting required.

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