Sweat equity shares are equity shares issued to directors or employees at a discount or for consideration other than cash, in recognition of their contribution—know-how, intellectual property, expertise or value addition. Section 54 and Rule 8 of the Companies (Share Capital and Debentures) Rules, 2014 govern the issuance.
The Limits
The issuance is subject to the limits in Rule 8: the sweat equity shares issued in a year cannot exceed 15% of the existing paid-up equity capital, or shares of the aggregate value of ₹5 crore, whichever is higher. The overall limit is 25% of the paid-up equity capital at any time. A DPIIT-recognised startup has a higher limit of 50% of the paid-up capital, subject to the conditions. The issuance requires a special resolution, and the explanatory statement must disclose the basis of valuation, the identity of the recipients and the consideration.
The Lock-In
Sweat equity shares are subject to a statutory lock-in of three years from the date of allotment. During the lock-in, the shares cannot be transferred, and the fact of the lock-in, with the expiry date, must be stamped on the share certificate and entered in the register of members.
The Tax Trigger
The perquisite tax under Section 17(2)(vi) of the Income-tax Act is triggered at the date of allotment, on the difference between the fair market value and the amount paid by the recipient. The tax is on paper shares, in cash; the recipient may have a tax liability before any liquidity event. The subsequent sale attracts capital gains, with the fair market value at allotment as the cost of acquisition.
The Practical Discipline
The company should obtain the registered-valuer report, pass the special resolution, file the MGT-14 and the PAS-3, and maintain the sweat-equity register. The recipient should be advised of the perquisite-tax trigger at allotment, because the cash-flow mismatch is a common surprise.
Call to Action: We advise companies and recipients on sweat-equity structuring, Rule 8 limits, lock-in and perquisite-tax planning. For a sweat-equity review, contact office@anujdesaiassociates.com, Ph No. 9619456656, Website https://anujdesaiassociates.com, LinkedIn linkedin.com/in/ca-anuj-desai-122547230.