Sweat Equity Share means equity shares issued by the company to employees or Directors at a discount, or for consideration other than cash for providing knowhow or making available rights in the nature of intellectual property rights or value additions by whatever name called.
Sweat Equity shares in India :
Generally at the time of incorporation, IPO or other similar instances the company issues equity shares for a certain price i.e. monetary consideration (this is subject to the company being limited by shares). The cash that is collected through such a mechanism forms the capital of the company. Contrastingly, sweat equity is issued by the company to its directors /employees at a discount or for consideration other than cash i.e. to say that the consideration is generally kind and not cash (S.79A, Explanation II). Sweat equity shares are quite akin to Employee Stock Option Plans (ESOPs), but there are some differences between the two. For e.g. sweat equity shares is grant of shares at discount or without any monetary consideration whereas ESOPs are grant of an option to purchase shares at a predetermined price.
It is in this regard the SEBI came out with a regulation in 2002 titled SEBI (Issue of Sweat Equity) Regulations, 2002. Needless to say the regulation only applies to listed companies..
Similarly for unlisted companies in 2003 the MCA came out with rules titled Unlisted Companies (Issue of Sweat Equity) Rules, 2003. As per the Rules the minimum price of sweat equity shares and the valuation of intellectual property are to be determined by an independent valuer. The MCA rules also imposes a restriction on the company not to issue sweat equity shares for more than 15% of the total paid up share capital in a year or shares of the value of 5 crores; whichever is higher.
The law with regard to sweat equity shares revolves mostly around the conditions for issuance of such shares. However one may be curious to know what happens after the employee is allotted the sweat equity shares. In this regard the law only prescribes that the sweat equity shares shall be locked in for a period of three years after the date of allotment i.e. to say that the employee or the director cannot dispense of these shares within a period of three years (See clause 12 and clause 10 of the 2002 SEBI regulations.
Legal Provisions relating to Sweat Equity Shares – Companies Act,1956.
1.The Shares should be of a class of shares already issued.
2.The issue of shares authorized by a special resolution passed by the company in the general meeting.
3.The resolution should specify :
The number of shares
The Current market price
The consideration if any
The class of directors or employees to whom such equity shares are to be issued
At least one year should have elapsed from the date of commencement of the business
If the company is a listed company, then the issue should comply with SEBI regulations.
[Company means company incorporated, formed & registered under this act & includes subsidiary company incorporated in a country outside India]
Legal Provisions relating to Sweat Equity Shares – Income Tax Act, 1961
Sweat Equity shares as per the Income Tax Act, 1961 has 2 aspects.
> Capital Gains.
Whenever an employee receives a sweat equity shares, the value of such shares will be taxable as a perquisite under the head Salaries as per section 17.
The value of taxable perquisite in case of shares allotted to the employee is equal to the fair market value (FMV) of the shares as on the date of which the option is exercised as reduced by the amount actually paid or recovered from each employee.
It may be noted that FMV as on the date of exercise of the option is relevant.
FMV shall be the average of opening price and closing price of the share on the recognized stock exchange which records the higher volume of trading in the share.
Whenever the Sweat Equity Shares are transferred it is subject to Capital Gains Tax. In this regard the aspects to be noted are “Period of Holding” & “Cost of Acquisition”.
Period of Holding:
It shall be reckoned from the date of allotment or transfer of such equity shares.
Cost of Acquisition:
It shall be the FMV value as computed for the determining the perquisite as mentioned above (Salaries).
Points to be noted:
If such shares are transferred within a period of 12 months from the date of allotment, then such gains will be treated as Short term Capital Gains
If such shares are transferred after holding for a period of 12 months then such gains will be treated as (LTCG) Long term Capital Gains.(However the Equity Shares are listed and chargeable to securities transaction tax, it is exempt from LTCG.)
Tax Planning in relation to Sweat Equity Shares:
Whenever the shares are allotted by the company it will be charged as perquisite under the head Salaries. Whenever it is transferred it will be charged under the head Capital Gains.
In order to avoid such Capital Gains Tax impact, employees can resort to gifting the same shares to the members of the family who does not have the taxable income. As there is no gift tax levy, there is no tax on such gifts.
Subsequently when such shares are transferred by such family members will not suffer capital gains to the exempt of their basic exemption limit.
[However this benefit is not available for shares allotted under ESOP option, since the gift of such ESOP by the employee is treated as Transfer and subject to Capital Gains Tax.]