ESOP Valuation Requirements in India: A Legal and Procedural Guide

Kartikeyan Khator
Jun 14
5 min read

Updated: 11 minutes ago

Employee Stock Option Plans (ESOPs) are a powerful tool for talent retention and wealth creation. However, issuing and exercising ESOPs in India comes with specific compliance and valuation requirements under various laws, including the Companies Act, Income Tax Act, and FEMA (in case of foreign employees).

This guide breaks down the valuation and filing requirements at three crucial stages - Grant, Vesting, and Exercise - to help you stay compliant.

Companies Act
1. At the time of ESOP Grant
  1. Valuation: A formal valuation by a Registered Valuer (RV) is not mandatory under the Companies Act at the grant stage. However, it is recommended.
  2. Filing: Form MGT-14 must be filed within 30 days of passing the Special Resolution by shareholders approving the ESOP scheme under Section 62(1)(b) and the applicable rules.
2. At the time of Yearly Vesting
  1. Valuation: No valuation is legally required at the vesting stage. However, it is a strongly recommended best practice, as auditors may request updated valuations during statutory audit, especially if there is a material impact on financial reporting. In such cases, the valuation should be conducted by a Registered Valuer. While the Companies Act doesn't prescribe a specific valuation methodology, companies often use the Black-Scholes model or Binomial model to determine the fair value of options for accounting and disclosure purposes. Note: These models are generally used for expense recognition under Ind AS 102 (Share-Based Payments), and though not legally required, are frequently adopted to align with good governance and investor expectations.
  2. Filing: No statutory filing is required at the vesting stage under the Companies Act.
3. At the time of Exercise
  1. Valuation: Valuation is mandatory and must be carried out by a Registered Valuer (RV). This is because new shares are being issued to the employees, and pricing must comply with fair value principles as per Section 62 and relevant rules.
  2. Filing: Form PAS-3 must be filed within 30 days of allotment of shares upon exercise of ESOPs, along with the Registered Valuer's valuation certificate.
Income Tax Act
1. At the time of ESOP Grant
  1. Valuation: No valuation is required under the Income Tax Act at the time of grant, as grant of options is not a taxable event.
  2. Filing: No statutory filing or reporting requirement arises at this stage.
2. At the time of Yearly Vesting
  1. Valuation: No valuation is needed, as vesting does not constitute a taxable event under the Income Tax framework. The perquisite tax liability arises only upon actual exercise.
  2. Filing: No tax reporting is required at this stage.
3. At the time of Exercise
  1. Valuation: This is the critical stage from a taxation standpoint. At the time of exercise, the perquisite value (i.e., the difference between the fair market value (FMV) on the date of exercise and the exercise price) is taxed as salary income under Section 17(2)(vi). For unlisted shares (i.e. Startups and Private Companies), the FMV must be determined by a Category I Merchant Banker, and the valuation should not be older than 180 days from the date of exercise (as per Rule 3(8)(iii) of the Income Tax Rules). For startups registered with IMB u/s 80-IAC of the Act, a tax deferral option is available under Section 192(1C) for up to 5 years or until exit or until sale of shares, whichever is earlier.
  2. Valuation Models: Although the Income Tax Rules do not mandate a specific model, Merchant Bankers commonly use approaches such as the Discounted Cash Flow (DCF) method, or where appropriate, adopt market-based methods. The Black-Scholes and Binomial models are generally not used for tax purposes.
  3. Filing: No separate form is filed with the tax authorities for ESOP exercises, but the employer must reflect the perquisite value in Form 16, and the employee must disclose it in their income tax return.
Foreign Exchange Management Act (FEMA)
1. At the time of ESOP Grant
  1. Valuation: Not required at the time of grant. FEMA compliance focuses on actual inflow and allotment of shares, not the option grant.
  2. Filing: The company is required to submit Form ESOP to the RBI (via its AD Bank) within 30 days of granting ESOPs to non-resident employees. This falls under the Foreign Exchange Management (Non-debt Instruments) Rules, 2019.
2. At the time of Yearly Vesting
  1. Valuation: Not required under FEMA, as no cross-border transaction or allotment of shares is involved at this stage.
  2. Filing: No FEMA filing is applicable during vesting.
3. At the time of Exercise
  1. Valuation: This is a key compliance stage under FEMA. When ESOPs are exercised by foreign employees and shares are allotted, the company must obtain a valuation of the equity shares. The valuation can be done by either a Category I Merchant Banker or a Chartered Accountant, and must adhere to fair value principles. The valuation report must not be older than 90 days from the date of allotment.
  2. Valuation Models: The DCF method is most commonly used. However, depending on the stage of the company and availability of data, alternative approaches like Net Asset Value (NAV) may be accepted. Option pricing models such as Black-Scholes are not typically used for FEMA valuations.
  3. Filing: The company must file Form FC-GPR via the RBI’s FIRMS portal within 30 days of allotting shares to the foreign employee.
  Note: If a resident of India, receives ESOPs of a foreign entity, being an employee or director of an Indian office/branch/subsidiary/entity in which the foreign entity has direct or indirect equity holding, then the employer is also required to file Form OPI on a half yearly basis, within 60 days from the end of the half-year.

Summary

Here's a snapshot view of the above-mentioned statutory filings and valuation requirements in relation to ESOPs:

Statute	Activity	At the time of Grant	At the time of Yearly Vesting	At the time of Exercise
Companies Act	Valuation	No (but recommended) - RV (Refer Note 4 below)	No (but can be asked by Auditor during Audit) - RV (Refer Note 4 below)	Yes - RV
	Filing	MGT-14 (within 30 days of passing Special Resolution by Shareholders)	None	Form PAS-3 (within 30 days of share allotment)
Income Tax	Valuation	NA	NA	Yes - MB
	Filing	None	None	None
FEMA (in case of foreign employee)	Valuation	NA	NA	Yes - MB/CA
	Filing	Form ESOP (within 30 days from the date of issue of the ESOPs)	None	Form FC-GPR (within 30 days of share allotment)

Note 1: As a common practice, valuation certificate should not be older than 6 months from the relevant date

Note 2: Valuation date should not be older than 180 days from the date of Exercise, from a Category 1 Merchant Banker

Note 3: Valuation date should not be older than 90 days from the date of allotment

Note 4: If the company has raised funds in the recent past, fair valuation done at that time should be sufficient for valuing ESOPs

Whether you’re granting ESOPs for the first time or managing ongoing compliance, understanding the valuation and filing requirements under Indian laws is essential. Engaging a qualified Registered Valuer or Merchant Banker, depending on the stage and applicable statute, will help ensure both regulatory compliance and transparency in employee compensation.