You need top talent to grow your business. Employee Stock Ownership Plans (ESOPs) are powerful tools for attracting and retaining high-calibre employees in Indian startups and established companies.
Until recently, the legal framework was limited. Only ESOPs were formally recognised under Indian law, while globally popular instruments like RSUs (Restricted Stock Units) and SARs (Stock Appreciation Rights) operated without clear legal backing.
The Corporate Laws Amendment Bill 2026 changes this. The bill formally recognises RSUs and SARs, giving Indian companies unprecedented flexibility in structuring equity compensation.
What Is the Startup India Initiative?
An Employee Stock Option Plan (ESOP) gives employees the right to purchase company shares at a predetermined price, called the exercise price. Employees are not required to buy the shares they have the option to do so.
This right becomes available only after a specific period of employment or achievement of performance milestones. This period is called the vesting period.
ESOPs align employee performance with company growth. When your company succeeds and its valuation increases, the gap between the exercise price and actual market value widens, creating wealth for the employee.
ESOP vs RSU vs SAR - Key Differences
Feature | ESOP | RSU | SAR |
What is granted | Option to buy shares | Shares (no purchase needed) | Cash/share value appreciation |
Exercise needed | Yes – pay exercise price | No – shares vest automatically | No – receive appreciation value |
Employee investment | Yes (pays exercise price) | No | No |
Best for | Startups (high growth potential) | Established companies | Cash-preferred employees |
Indian law status | Recognised under Companies Act | Now formally recognised (2026 Bill) | Now formally recognised (2026 Bill) |
Tax trigger | On exercise (perquisite tax) | On vesting (perquisite tax) | On receipt of value |
An ESOP requires the employee to pay the exercise price once options vest. This model suits startups with high growth potential, as the initial share price is often low.
An RSU (Restricted Stock Unit) grants actual shares to the employee upon vesting. The employee pays nothing. RSUs work well for late-stage or public companies where share value is substantial.
A SAR (Stock Appreciation Right) provides the employee with cash payment or shares equal to the appreciation in stock value over a set period. Employees get the financial upside without holding physical shares or paying an exercise price.
Corporate Laws Amendment Bill 2026 - RSUs and SARs Now Recognised
The Corporate Laws Amendment Bill 2026 represents a major development in Indian corporate law. Before this bill, only ESOPs were explicitly governed by the Companies Act 2013.
Companies offering RSUs and SARs relied on contractual arrangements without clear statutory backing. This often created compliance issues for legal and finance teams.
The 2026 Bill formally recognises both RSUs and SARs. This provides companies with a clear legal framework to grant these instruments.
This brings India in line with US and global equity compensation practices. The change is particularly significant for Indian subsidiaries of multinational corporations, late-stage startups, and pre-IPO companies.
Legal Framework for ESOPs in India
The Corporate Laws Amendment Bill 2026 represents a major development in Indian corporate law. Before this bill, only ESOPs were explicitly governed by the Companies Act 2013.
Companies offering RSUs and SARs relied on contractual arrangements without clear statutory backing. This often created compliance issues for legal and finance teams.
The 2026 Bill formally recognises both RSUs and SARs. This provides companies with a clear legal framework to grant these instruments.
This brings India in line with US and global equity compensation practices. The change is particularly significant for Indian subsidiaries of multinational corporations, late-stage startups, and pre-IPO companies.
Legal Framework for ESOPs in India
You must adhere to specific legal requirements depending on your company’s structure and status.
Companies Act 2013 - Section 62(1)(b)
Section 62(1)(b) of the Companies Act 2013 authorises companies to issue shares to employees under an ESOP scheme. Private or unlisted public companies must obtain prior shareholder approval through a special resolution before granting options.
This ensures existing shareholders consent to potential equity dilution before you promise options to employees.
SEBI SBEB Regulations 2021 (for listed companies)
Listed companies must comply with the Securities and Exchange Board of India (Share Based Employee Benefits and Sweat Equity) Regulations 2021. This framework governs ESOPs, RSUs, SARs, and phantom stock.
The regulations include specific rules for ESOPs granted to subsidiary company employees, ensuring transparency and fair valuation across corporate groups.
Startup India ESOP Benefits
DPIIT-recognised startups receive an attractive benefit: tax on ESOPs is deferred. Employees pay tax at the earliest of three events: sale of shares, an IPO, or five years from grant.
This provides significant cash-flow benefits for early employees who might struggle to pay tax on illiquid shares.
For a complete overview, read our guide, Startup India Registration : Legal Benefits, Process & Eligibility (2026), covering eligibility criteria, the registration process, key benefits, and compliance requirements for startups in India.
How to Set Up an ESOP Plan in India - Step by Step
Follow this structured approach to establish your ESOP plan properly:
Step 1: Board approval and ESOP policy drafting
Your Board of Directors must first approve the scheme concept. Draft a detailed ESOP policy outlining total pool size, eligibility criteria, vesting schedules, and exercise periods.
A well-drafted policy prevents disputes and aligns with your company’s corporate goals.
Step 2: Shareholder approval (special resolution at GM)
Once your Board approves the draft policy, convene a General Meeting. Shareholders must pass a special resolution (requiring 75% majority) approving the ESOP scheme.
If your plan includes employees of holding or subsidiary companies, you need a separate special resolution.
Step 3: ESOP trust creation (optional but recommended)
You can administer ESOPs directly or through an Employee Welfare Trust. Creating a trust is recommended for larger employee pools, as it simplifies administration of share transfers and provides smoother exit mechanisms.
Step 4: Grant letters to eligible employees
With the plan approved, identify eligible employees and issue formal Grant Letters. Each letter must specify the number of options granted, vesting schedule, exercise price, and any performance conditions.
Step 5: Vesting schedule commencement
After the grant date, the vesting period begins. Employees must fulfil time-based or performance-based conditions outlined in their grant letter.
Options that meet these conditions are “vested” and eligible for conversion into shares.
Step 6: Exercise window and share allotment<
Upon vesting, employees enter the exercise window. They submit an exercise application and pay the required exercise price. Your Board then passes a resolution to allot corresponding equity shares.
Step 7: ROC filings (Form PAS-3 for share allotment)
Following share allotment, file Form PAS-3 (Return of Allotment) with the Registrar of Companies within 30 days. Update your Register of Members to reflect the employee’s new shareholder status.
ESOP Vesting - How It Works
Vesting ensures employees remain with your company to earn their equity. A typical vesting schedule spans four years with a one-year “cliff” (a period before any vesting occurs).
For example, 25% of granted options might vest after exactly one year of service. The remaining 75% then vests monthly or quarterly over three years.
If an employee resigns before completing the first year, zero options vest. Well-structured plans include acceleration clauses in a merger or acquisition, unvested options may automatically vest. For a complete understanding, read our guide, Shareholders’ Agreements in India : A Comprehensive Guide for Founders, Investors, and Company Secretaries, covering key clauses, legal considerations, and practical strategies for effective governance and risk management.
ESOP Taxation in India - Employee Perspective
Taxation occurs in two phases for employees exercising ESOPs.
Tax on Exercise (Perquisite Tax)
When an employee exercises vested options, the difference between Fair Market Value (FMV) on exercise date and the exercise price is treated as a “perquisite” (a benefit in kind). This amount is added to salary income and taxed at the individual’s income tax slab rate.
Your company must deduct this as Tax Deducted at Source (TDS) before allotting shares.
Tax on Sale of Shares (Capital Gains)
When the employee sells shares, they pay Capital Gains tax on the difference between sale price and the FMV considered during exercise.
For listed company shares under the Finance Act 2024:
- Short-Term Capital Gains (shares held less than one year): 20%
- Long-Term Capital Gains (shares held over one year): 12.5% on gains exceeding ₹1.25 lakh
For unlisted shares:
- Short-Term Capital Gains: taxed at individual’s slab rate
- Long-Term Capital Gains (held over two years): 12.5%
Startup ESOP Tax Deferral
Employees of DPIIT-recognised startups don’t pay perquisite tax at exercise. Tax is deferred until shares are sold, the company goes public, or five years elapse from grant whichever occurs first.
ESOP for Employees of Subsidiaries - Cross-Border Plans
Indian subsidiaries of foreign companies often grant parent company ESOPs or RSUs to Indian employees. This creates complex cross-border compliance requirements.
Under the Foreign Exchange Management Act (FEMA), Indian employees acquiring foreign shares must comply with Liberalised Remittance Scheme (LRS) limits when remitting funds abroad for exercise prices.
They must report foreign assets in annual Indian income tax returns under the Foreign Asset schedule. Indian subsidiaries face compliance burdens including RBI reporting and FEMA adherence.
Common ESOP Mistakes Indian Companies Make
Avoid these frequent errors when implementing equity compensation:
- Granting ESOPs without shareholder approval: Issuing grant letters based only on Board approval invalidates options under the Companies Act.
- Not drafting proper ESOP policy: Vague policies lead to legal disputes regarding vesting schedules and leaver clauses.
- Incorrect FMV determination: For unlisted companies, a SEBI-registered Merchant Banker or Registered Valuer under the Companies Act must determine FMV. Internal valuations are illegal for tax purposes.
- Not establishing ESOP trust for larger pools: Direct administration becomes cumbersome as employee numbers scale.
- Ignoring FEMA implications for cross-border grants: Failing to report foreign equity grants results in penalties for employees and subsidiaries.
- Not planning M&A acceleration clauses: Ambiguous policies during acquisitions can stall deals or unfairly penalise employees.
Expert Assistance with Indian Equity Compensation
Altacit Global’s corporate team designs and implements ESOP, RSU, and SAR plans for startups and established companies across India. We handle drafting ESOP policies, managing shareholder resolutions, ROC filings, and complex FEMA compliance for cross-border grants.
For a clear and practical walkthrough, read our guide, How to Register a Company in India (Link to A1): Step-by-Step Guide (2026), covering everything from choosing the right structure and name approval to incorporation, compliance, and post-registration requirements. For a comprehensive understanding of the legal framework governing businesses in India, read our detailed guide, Corporate Law in India (Link to Pillar): The Complete Guide for Businesses (2026), where we cover everything from company formation and regulatory compliance to governance, contracts, and dispute resolution helping you navigate the corporate landscape with clarity and confidence.
Whether you are adapting to the 2026 amendments or structuring your very first grant, explore our corporate law services or contact us directly at info@altacit.com to align your compensation strategy with the law.
Frequently Asked Questions - ESOP India
Q1: Can a private limited company offer ESOPs in India?
Yes. Under Section 62(1)(b) of the Companies Act 2013, private limited companies can issue ESOPs with prior shareholder approval via special resolution.
Q2: Who determines the exercise price for ESOPs in unlisted companies?
A Registered Valuer determines the Fair Market Value of shares. Companies can set exercise prices at a discount to FMV if shareholders approve the pricing mechanism.
Q3: Can ESOPs be granted to independent directors?
No. The Companies Act 2013 prohibits granting ESOPs to independent directors. You can grant them to whole-time directors and employees.
Q4: What happens to ESOPs when an employee resigns?
Generally, employees have 30 to 90 days to exercise vested options after resigning. Unvested options lapse immediately. Specific terms are governed by your ESOP plan document.
Q5: Are RSUs now legal in India?
Yes. The Corporate Laws Amendment Bill 2026 formally recognises RSUs and SARs, providing a clear statutory basis for issuing these instruments.
