Startups Can Now Offer ESOPs For Up To 10 Years Under New MCA Definition

The ministry of corporate affairs (MCA), on Friday (June 5), announced the Companies (Share Capital and Debenture) Amendment Rules of 2020, under which the government has extended the employee stock ownership plans (ESOPs), changed definition of startups and also made some regulatory changes in share capital requirement.

Under the latest amendment, the ministry of corporate affairs has also notified that startups can now offer sweat equity of up to 15% of their paid-up share capital. Besides this, the ministry has decided to change the definition of startups to be in-line with the definition used by the Department for Promotion of Industry and Internal Trade (DPIIT) since last year. Under the new MCA definition, startups can now issue employees stock options for up to 10 years from their incorporation instead of five.

Last year, DPIIT had announced that an entity will be considered as a startup up to a period of 10 years from the date of incorporation, however, the MCA definition deviated from this. The parity in the definition is sure to remove a lot of red tape hurdles for startups.

The designation will also be applicable for companies incorporated as a private limited company, a partnership firm or limited liability partnership. Besides this, the department had also increased the turnover limit from INR 25 Cr to INR 100 Cr.

ESOPs are a popular compensation tool in the Indian startup ecosystem, which provides employees with a  share in the company they are working in. With the ongoing Covid-19 pandemic and reduced cash flow, several companies have been relying on ESOPs to compensate employees for salary deductions.

For instance, foodtech unicorn Zomato, which recently laid off thousands of employees, is letting employees vest their ESOPs. Hotel and hospitality unicorn OYO has allotted ESOPs worth $20 Mn to former and existing staff members. Meanwhile, digital payments unicorn Paytm takes the ESOPs route every year to reward high-performing employees and new hires.

For listed companies, the employee can sell the shares in the open market when their lockin period of ESOP is over on the prevailing market price. Whereas for an unlisted company, employees can sell ESOPs to the employer or other employees only.

Earlier this year, the finance minister Nirmala Sitharaman had proposed tax relaxation on ESOPs for 5 years or till the time the employees leave the company or sell their shares, whichever is earliest. During her budget speech, she also proposed a 100% deduction of profits for 3 consecutive assessment years for a period of 7 years. Whereas big players in the startup ecosystem can avail such deduction within 10 years, if they have a turnover of INR 100 Cr.

“In order to give a boost to the startup ecosystem, I propose to ease the burden of taxation on the employees by deferring the tax payment by five years or till they leave the company or when they sell their shares, whichever is earliest,” the minister said.