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Employee Stock Options (ESOP)

How to set up an ESOP pool, grant and vest options, and what employees should know about tax.

Chapter 31 of 35Part 4 · Growing, changing and closing6 min read
Please note. General information to help you understand the rules. It is not legal, tax or financial advice for your particular case, and laws and portal procedures change; we confirm the current position before acting on your matter.

Overview

An Employee Stock Option Plan lets employees buy shares at a fixed price after they vest. For private companies it is governed by section 62 of the Companies Act and the share capital rules, including a minimum vesting period and limits on granting options to promoters and large shareholders (with relaxations for eligible startups). Options are usually taxed when exercised and again when the shares are sold. Eligible startups’ employees may be able to defer the tax on exercise; check the current conditions.

Who this is for

  • Companies hiring senior or early employees
  • Founders planning a pool before fundraising

Step by step

  1. Design the planPool size, eligibility, vesting schedule, exercise price and window, and treatment on exit.
  2. Approve itPass a special resolution of shareholders with the disclosures the rules require.
  3. Grant optionsIssue grant letters recording the number of options, vesting and exercise price.
  4. Maintain recordsKeep an ESOP register and disclose details in the board report.
  5. Handle exerciseAllot shares on exercise, deduct tax where required and file the return of allotment.

Documents you will need

  • ESOP scheme document
  • Shareholder special resolution
  • Grant letters
  • Valuation report for fair market value

The process

The scheme is approved internally and filings follow when shares are allotted. Tax on exercise is handled through payroll.

Authorities involved

  • Registrar of Companies: Receives resolutions and allotment returns.
  • Income Tax Department: Taxes the perquisite and capital gains.

Common mistakes

  • Granting options before shareholders approve the plan.
  • Vesting periods shorter than the legal minimum.
  • Not explaining the tax impact to employees.

Checklist

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Frequently asked questions

Can founders receive ESOPs?

Promoters and directors holding large stakes are generally excluded, with a time-limited relaxation for eligible startups. Check the current share capital rules.

Official sources

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