Sweat Equity Shares in India for Private and Foreign Owned Companies

Written by CA Nandini Hasija, Krystal7 Consultants. Last updated 23 October 2026.

Sweat equity shares are equity shares a company issues to its directors or employees at a discount, or for know how or intellectual property. Section 54 of the Companies Act, 2013 needs a special resolution. Rule 8 of the Share Capital and Debentures Rules needs a registered valuer's report. Rule 8 also caps the issue at 15 percent of paid up equity capital or INR 5 crore a year. It locks the shares in for three years.

This page covers eligibility, limits, valuation and the FEMA rules for non resident recipients. It also covers income tax, accounting and the comparison with an ESOP, with a worked example.

What are sweat equity shares under the Companies Act, 2013?

Sweat equity shares are equity shares a company issues to its directors or employees at a discount, or for consideration other than cash. The consideration is know how, intellectual property rights or value additions. Section 2(88) of the Companies Act, 2013 defines them, and section 54 sets the conditions.

The definition in section 2(88) has three parts. The shares must be equity shares. The recipients must be directors or employees. The company must issue them at a discount or for a non cash contribution.

Section 53 bars a company from issuing shares at a discount. Section 54 opens with "notwithstanding anything contained in section 53", so sweat equity is the main exception. The shares must belong to a class of shares the company has already issued.

Sweat equity shares rank pari passu with other equity shares. Section 54(2) gives them the same rights, limitations and restrictions as the company's other equity shares. So a sweat equity holder votes and takes dividends like any other equity holder.

Sweat equity lets a foreign owned Indian company give shares for intellectual property or expertise instead of cash. We see it used most for a founding engineer or technical director who built the product before the Indian company existed.

Who can receive sweat equity shares?

Directors and employees of the company can receive sweat equity shares. Rule 8(1) also covers directors and employees of its holding company and its subsidiaries, in India or abroad. A recipient does not need to be a shareholder, and the Companies Act does not exclude promoters.

Clause (i) of the Explanation to rule 8(1) of the Companies (Share Capital and Debentures) Rules, 2014 defines "employee" in three parts:

1. A permanent employee of the company who works in India or outside India.
2. A director of the company, whether a whole time director or not.
3. An employee or director of a subsidiary or holding company of the company, in India or outside India.

The 2014 text of the rule also required the permanent employee to have worked for at least the last one year. The Companies (Share Capital and Debentures) Second Amendment Rules, 2018 omitted those words. So no minimum service applies today, and a new hire can receive sweat equity if the other conditions are met.

Rule 8 does not exclude promoters or directors who hold more than 10 percent of the shares. The ESOP rule does exclude them, as the comparison later on this page shows. So sweat equity is often the only Companies Act route to reward a promoter director with shares.

Recipient	Eligible for sweat equity?	Rule
Permanent employee of the company	Yes	Rule 8(1), Explanation, clause (i)(a)
Whole time or non executive director of the company	Yes	Rule 8(1), Explanation, clause (i)(b)
Employee or director of the Indian or foreign holding company	Yes	Rule 8(1), Explanation, clause (i)(c)
Employee or director of a subsidiary, in India or abroad	Yes	Rule 8(1), Explanation, clause (i)(c)
Promoter who is a director or employee	Yes, no promoter exclusion in rule 8	Rule 8(1)
Independent consultant who is not an employee or director	No	Section 2(88)
Non resident employee or director	Yes, subject to FEMA	Rule 8, NDI Rules

What does section 54 require before a company issues sweat equity?

Section 54(1) needs a special resolution. The resolution states the number of shares, their current market price, the consideration and the class of directors or employees who will receive them. An unlisted company then follows rule 8 of the Share Capital and Debentures Rules. A listed company follows the SEBI regulations.

The text of section 54 lists the conditions in clauses (a), (b) and (d). Clause (c) used to require that the company had been in business for at least one year. The Companies (Amendment) Act, 2017 omitted it. The Government notified that Act on 3 Jan 2018, and the current text of section 54 carries no such condition. So a newly incorporated company can issue sweat equity.

The omission took effect on the date the Government notified for that provision. If you need to test an older issue, check that commencement notification on mca.gov.in.

Clause (d) splits the regime. For listed companies, SEBI's Share Based Employee Benefits and Sweat Equity Regulations apply. For every other company, rule 8 applies. This page deals with unlisted companies, which covers almost every foreign owned Private Limited company.

Rule 8(2) lists what the explanatory statement to the notice must disclose:

1. The date of the board meeting that approved the issue.
2. The reasons for the issue.
3. The class of shares and the total number of shares to be issued.
4. The classes of directors or employees who will receive the shares.
5. The principal terms and the basis of valuation.
6. How long each recipient has been associated with the company.
7. The names of the recipients and their relationship with the promoters or key managerial personnel.
8. The price at which the shares are issued and the consideration, including non cash consideration.
9. The ceiling on managerial remuneration, if the issue breaches it.
10. A statement that the company will follow the applicable accounting standards.
11. The diluted earnings per share.

Rule 8(3) gives the resolution a life of twelve months. The company must allot the shares within twelve months of passing it. After that, it needs a fresh resolution.

The company files the special resolution in Form MGT-14 within 30 days under section 117. It files the return of allotment in Form PAS-3 within 30 days, under section 39(4) and rule 12 of the Prospectus and Allotment Rules. Our PAS-3 guide explains the attachments.

How much sweat equity can a private company issue?

Rule 8(4) caps sweat equity in a year at the higher of two figures. One is 15 percent of the existing paid up equity share capital. The other is shares with an issue value of INR 5 crore. Total sweat equity cannot exceed 25 percent of paid up equity capital at any time, and start ups get a higher cap.

The second proviso to rule 8(4) lets a start up issue sweat equity of up to 50 percent of its paid up capital. The window runs for ten years from its incorporation or registration.

The proviso entered the rules on 19 Jul 2016 with a five year window. The Companies (Share Capital and Debentures) Amendment Rules, 2020 of 5 Jun 2020 extended the window to ten years. The same amendment tied "start up" to DPIIT notification G.S.R. 127(E) of 19 Feb 2019, in place of G.S.R. 180(E) of 17 Feb 2016.

Two points trip companies up. First, the annual test uses existing paid up equity capital, not authorised capital. Second, the 25 percent test runs "at any time", so earlier sweat equity issues count against it.

Test	Limit	Measured against	Rule
Annual limit	15 percent, or INR 5 crore of issue value, whichever is higher	Existing paid up equity share capital	Rule 8(4)
Overall limit	25 percent at any time	Paid up equity capital	First proviso to rule 8(4)
Start up limit	50 percent, up to ten years from incorporation	Paid up capital	Second proviso to rule 8(4)
Start up definition	DPIIT recognition under G.S.R. 127(E) of 19 Feb 2019	Not applicable	Second proviso to rule 8(4)

A foreign owned Private Limited company can hold DPIIT start up recognition if it meets the conditions. Our guide to DPIIT recognition for a foreign owned start up covers that test.

How are sweat equity shares valued?

A registered valuer fixes the fair price of sweat equity shares and gives a justification, under rule 8(6). Where the company receives intellectual property, know how or value additions, a registered valuer also values that consideration under rule 8(7). The company sends a gist of both reports to shareholders with the notice.

A registered valuer is a valuer registered with the Insolvency and Bankruptcy Board of India, which section 247 requires for valuations under the Act. Under rule 8(7), the valuer addresses the report on the IP or know how to the board and justifies the value. Rule 8(8) requires the gist of the valuation reports to go out with the general meeting notice.

A foreign owned company often needs more than one valuation for the same issue. Each law asks a different professional.

Purpose	Who values	Valuation date	Rule
Companies Act fair price	Registered valuer	Before the notice goes out, because a gist travels with it	Rule 8(6) and 8(8)
Companies Act value of IP or know how	Registered valuer	Before the notice goes out, because a gist travels with it	Rule 8(7) and 8(8)
FEMA floor price for a non resident	Chartered Accountant, SEBI registered merchant banker or practising cost accountant	Certificate not more than 90 days old on the date of investment	Rule 21 of the NDI Rules; paragraph 8.11 of the Master Direction
Income tax perquisite on unlisted shares	Category I merchant banker	Exercise date, or up to 180 days earlier (allotment date for sweat equity, our reading)	Rule 15(6)(d), 15(8)(g) and 15(8)(l), Income Tax Rules, 2026

We try to commission one firm that holds all the registrations, so the three numbers rest on the same model. Where that is not possible, we reconcile the reports before the board meeting. Our valuation reports service handles this.

What lock in applies to sweat equity shares?

Sweat equity shares are locked in for three years from the date of allotment under rule 8(5). The holder cannot transfer them during that period. The share certificate must state the lock in and its expiry date, in bold or in another prominent manner.

The lock in applies to every sweat equity share, including shares issued by a start up under the 50 percent cap. It runs from allotment, not from the resolution.

A demat issue needs the lock in marked with the depository. Rule 9B of the Prospectus and Allotment Rules requires a private company that is not a small company to issue securities only in demat form. Check the current text of rule 9B on mca.gov.in before you issue. Section 2(85) excludes a holding or subsidiary company from the small company definition, so a foreign owned subsidiary issues sweat equity in demat form. We ask the depository participant to flag the lock in.

Can an Indian company issue sweat equity shares to a non resident?

Yes. Rule 8 of the NDI Rules lets an Indian company issue sweat equity shares to non resident employees or directors. This includes those of its holding company, joint venture or wholly owned overseas subsidiary. The issue must follow rule 8 of the Share Capital and Debentures Rules and stay within the sectoral cap.

Rule 8 of the Foreign Exchange Management (Non Debt Instruments) Rules, 2019 sets four conditions:

1. The scheme follows the SEBI regulations or the Companies (Share Capital and Debentures) Rules, 2014, as applicable.
2. The issue complies with the sectoral cap for the company.
3. Where foreign investment in the company is under the approval route, the issue needs prior government approval.
4. An issue to a citizen of Bangladesh or Pakistan needs prior government approval.

Paragraph 6.13 of the Master Direction on Foreign Investment in India, updated to 15 Jun 2026, repeats these conditions. The rule also covers ESOPs and share based employee benefits.

The land border rule applies on top. The proviso to rule 6(a) of the NDI Rules covers citizens of a country that shares a land border with India. They can invest only under the government route. On our reading, a sweat equity issue to a Chinese citizen employee needs approval, even though rule 8 names only Bangladesh and Pakistan. Our page on Press Note 3 and land border FDI explains the test.

FEMA point	Rule	What it means in practice
Permission to issue	Rule 8, NDI Rules	Sweat equity to non resident employees and directors is allowed
Sectoral cap	Rule 8, first condition	The new shares count towards the foreign holding
Approval route sectors	Rule 8	Prior government approval
Bangladesh or Pakistan citizen	Rule 8	Prior government approval
Citizen of any land border country	Proviso to rule 6(a)	Government route
Pricing	Rule 21, NDI Rules	Floor at fair value, with no express carve out for sweat equity
Reporting of shares allotted	Regulation 4(1), FEMA 395/2019-RB	Form FC-GPR within 30 days (our reading)
Reporting of options granted	Regulation 4(4), Form ESOP	Within 30 days of issue of options

The pricing question

Rule 21 of the NDI Rules says an unlisted company cannot issue equity instruments to a non resident below fair value. The only express carve out we found in rule 21 is for investment on a non repatriation basis. Rule 21 contains no exception for sweat equity, ESOPs or share based employee benefits.

Sweat equity is, by definition, issued at a discount or for non cash consideration. So the two rules sit uneasily. We handle it in one of two ways. Where the recipient contributes IP or know how, we value it so the consideration is at least the fair value of the shares. Where the issue is a pure discount, we raise it with the Authorised Dealer bank before the board meeting and keep its response on file. Our page on FEMA pricing guidelines explains the floor price.

The abolition of angel tax did not remove the FEMA fair value floor, as our guide to angel tax abolished for foreign investors explains.

Reporting

Regulation 4(4) of FEMA 395/2019-RB prescribes Form ESOP for options issued to non resident employees and directors. The form is due within 30 days of issue of the options. The regulation does not mention sweat equity, and sweat equity involves no option. The company allots shares to a non resident. On our reading, that is an issue of equity instruments, reported in Form FC-GPR within 30 days.

Our FC-GPR filing guide lists the attachments. A late filing attracts a late submission fee.

How is sweat equity taxed in India?

The value of sweat equity shares is a perquisite under section 17(1)(d) of the Income Tax Act, 2025. The taxable value is the fair market value of the shares less any amount the employee paid. The employer deducts TDS under section 392 as part of salary for the tax year of allotment.

Section 17 of the Income Tax Act, 2025 replaced section 17(2)(vi) of the Income Tax Act, 1961 from 1 Apr 2026. The parts that matter are:

1. Section 17(1)(d) charges the value of specified securities or sweat equity shares that the employer or a former employer allots or transfers free or at a concessional rate. The clause covers direct and indirect allotments.
2. Section 17(4)(g) defines sweat equity shares in the same terms as the Companies Act.
3. Section 17(4)(h) values them at fair market value on the date the option is exercised. The amount the employee paid, or the employer recovered, comes off.
4. Section 17(4)(a) says fair market value follows the method prescribed in the rules.

Rule 15 keys the valuation to the date the option is exercised, and sweat equity has no option. On our reading, the allotment date stands in for the exercise date, though the Act and the Rules do not say so in terms. The Income Tax Department's ESOP taxation page confirms the same structure for ESOPs under the 1961 Act.

Fair market value

Rule 15 of the Income Tax Rules, 2026 sets the method. For listed shares, rule 15(6)(a) uses the average of the opening and closing price on the date. For unlisted shares, rule 15(6)(d) uses the value a merchant banker determines on the "specified date". Rule 15(8)(l) defines that date as the exercise date, or an earlier date not more than 180 days before it. Rule 15(8)(g) defines the merchant banker as a Category I merchant banker registered with SEBI.

TDS and forms

Section 392 requires the employer to deduct tax on salary at the average rate for the tax year. The perquisite is part of that salary. The employer reports it in Form 138 (old Form 24Q) and issues Form 130 (old Form 16), as listed in the department's form mapping.

Section 392(3) gives an eligible start up, as referred to in section 140, more time. The start up deducts the tax within the time that section 289(3) specifies for the employee. That time is 14 days after the earliest of three events:

1. The end of 60 months from the end of the tax year of allotment.
2. The sale of the shares.
3. The end of employment.

Under the 1961 Act, the first event was 48 months from the end of the assessment year. The assessment year ended 12 months after the previous year ended, so both periods end on the same day. The window is unchanged.

Non resident recipients and non employees

A non resident employee who works in India pays tax in India on salary for that work, including the perquisite. Where the person works partly abroad, we apportion the perquisite by days worked in India and check the treaty article on employment income.

The perquisite clause applies only where the shares come from an employer. A non executive director who is not an employee falls outside it. On our reading, a discount given to such a director is income from other sources under section 92(2)(m). That clause replaced section 56(2)(x) of the 1961 Act, and fair market value then follows rule 57.

Where a non resident contributes IP or know how for the shares, the value can be royalty or fees for technical services sourced in India. The company then deducts tax under section 393(2) at the section 207 rate or a lower treaty rate. We get a written tax opinion before any such issue.

When the shares are sold

A later sale falls under capital gains. The cost of the shares is the value taxed as a perquisite. Section 49(2AA) of the 1961 Act said so. Section 73(1) of the 2025 Act carries the rule forward. Serial 4 of its table fixes the cost at the fair market value taken into account under section 17(1)(d). The department's ESOP page says the holding period runs from the date of allotment.

Event	Who is taxed	Provision	Treatment
Allotment to an employee	Employee	Section 17(1)(d), Income Tax Act, 2025	Perquisite equal to fair market value less amount paid
Valuation of unlisted shares	Employer computes	Rule 15(6)(d), Income Tax Rules, 2026	Category I merchant banker, up to 180 days before
TDS on the perquisite	Employer deducts	Section 392(1)	Average rate for the tax year
Eligible start up	Employer deducts later	Section 392(3)	Time under section 289(3): 60 months from the end of the tax year, a sale or the end of employment, whichever is first
Allotment to a non employee director	Director	Section 92(2)(m), our reading	Shortfall against fair market value under rule 57
IP or know how from a non resident	Non resident	Section 393(2), section 207	Withholding on royalty or technical fees, our reading
Later sale of the shares	Holder	Capital gains; section 73(1), serial 4	Cost equals the perquisite value

Our guide to RSU and ESOP tax for employees of a foreign parent covers cross border share awards in more depth.

How does the company account for sweat equity?

Rule 8 sets the accounting. Where the company receives a depreciable or amortisable asset, such as software or a patent, it records the asset at the valued amount. Otherwise, it expenses the value as employee compensation under the applicable accounting standard. Any excess of the share value over the asset value is also compensation.

Rule 8 sets out the accounting in four provisions:

1. Rule 8(9): non cash consideration in the form of a depreciable or amortisable asset goes to the balance sheet under the accounting standards. Other non cash consideration is expensed.
2. Rule 8(10): sweat equity to a director or manager counts as managerial remuneration under sections 197 and 198. This applies where the non cash consideration is not an asset.
3. Rules 8(11) and 8(12): the accounting value of sweat equity is treated as a form of employee compensation. Where the shares are issued for an asset, the excess over the asset value is compensation.

Companies on Ind AS apply Ind AS 102, Share based Payment, which measures equity settled awards at fair value. Companies on Indian GAAP generally follow the ICAI guidance on share based payments.

The usual entry for shares issued free is a debit to employee benefit expense at fair value. The credit goes to share capital at face value and the balance to securities premium.

Section 197 limits managerial remuneration only in public companies. On our reading, a Private Limited subsidiary of a foreign company is not a deemed public company under the proviso to section 2(71). The foreign parent is not a company under the Act. So rule 8(10) rarely bites on a foreign owned private subsidiary, though the expense still reduces book profit.

What records and disclosures does the company keep?

The company keeps a register of sweat equity shares in Form SH-3 at its registered office, under rule 8(14). It discloses the issue in the board's report under rule 8(13). It also files Form MGT-14 for the special resolution and Form PAS-3 for the allotment.

Rule 8(13) sets the content of the board's report. It states the class of directors or employees, the class and number of shares, the reasons and the principal terms. It also gives the total shares as a percentage of capital, the consideration and the diluted earnings per share.

The company secretary, or a person the board authorises, authenticates the SH-3 entries. We keep the valuation reports, the notice with the explanatory statement and the lock in note on the certificate in the same file. The statutory auditor reviews them, and a Registrar office can ask for them when it examines the PAS-3.

Sweat equity or ESOP, which suits a foreign owned company?

An ESOP gives an option that vests over at least one year and is exercised for cash. Sweat equity gives shares at once, for IP, know how or a discount, with a three year lock in. Promoters can receive sweat equity but are excluded from ESOPs, except in a start up within ten years of incorporation.

Point	Sweat equity shares	ESOP in an unlisted company
Companies Act basis	Section 54 and rule 8	Section 62(1)(b) and rule 12
Approval	Special resolution	Special resolution
What the person gets	Shares on allotment	An option, then shares on exercise
Consideration	IP, know how, value additions or a discount	Exercise price in cash, set by the company
Valuation under the Companies Act	Registered valuer	Not required by rule 12 for the exercise price
Statutory cap	15 percent or INR 5 crore a year, 25 percent overall, 50 percent for start ups	No fixed cap in rule 12
Promoters and directors holding more than 10 percent	Eligible	Excluded, except start ups within ten years
Minimum vesting	None	One year between grant and vesting
Lock in	Three years, mandatory	As the scheme decides
Register	Form SH-3	Form SH-6
FEMA report for a non resident	Form FC-GPR on allotment (our reading)	Form ESOP on grant, FC-GPR on allotment
Income tax event	Allotment	Exercise and allotment

Rule 12 of the Share Capital and Debentures Rules keeps three groups out of ESOPs. They are promoters, the promoter group and directors who hold more than 10 percent of the shares. A start up can still grant them options for ten years from incorporation. The Companies (Share Capital and Debentures) Amendment Rules, 2019 of 16 Aug 2019 extended that window from five years to ten years. The same amendment tied "start up" to DPIIT notification G.S.R. 127(E) of 19 Feb 2019. Our ESOP and ESPS advisory service handles both kinds of scheme.

For a foreign owned subsidiary, we usually recommend ESOPs for staff and sweat equity for a person who brings IP. An ESOP in the Indian company also sits alongside any RSU plan of the foreign parent, which needs no Companies Act approval in India.

Founders from a YC batch weighing sweat equity against ESOPs can see the wider India setup in our guide to India subsidiary for YC startups.

What changed in 2026

We found no 2026 amendment to section 54 or rule 8 of the Share Capital and Debentures Rules. The tax provisions moved to the Income Tax Act, 2025 from 1 Apr 2026. The land border beneficial ownership test changed through a Press Note of 15 Mar 2026 and a FEMA notification after it. This page carries a publish date of 27 Jan 2026. The changes in the table came after that date, and the text states the law as on 23 Oct 2026.

Old rule	New rule	Date	Instrument
Perquisite under section 17(2)(vi), Income Tax Act, 1961	Section 17(1)(d), with valuation in section 17(4)(h)	1 Apr 2026	Income Tax Act, 2025
Fair market value under rule 3(8), Income Tax Rules, 1962	Rule 15(6) to 15(8)	1 Apr 2026	Income Tax Rules, 2026
TDS on salary under section 192	Section 392(1)	1 Apr 2026	Income Tax Act, 2025
Start up deferral under section 192(1C)	Section 392(3), with time under section 289(3)	1 Apr 2026	Income Tax Act, 2025
Form 16 and Form 24Q	Form 130 and Form 138	1 Apr 2026	Income Tax Rules, 2026
Gift of shares below value under section 56(2)(x)	Section 92(2)(m), with valuation under rule 57	1 Apr 2026	Income Tax Act, 2025
Land border beneficial ownership not defined in the FDI policy	Beneficial ownership tied to PMLA rule 9(3) thresholds and control	15 Mar 2026 (Press Note); effective from the date of the FEMA notification, now in Explanation 2 to rule 6(a)	Press Note 2 (2026 Series) and the FEMA notification

The Cabinet approved the land border change on 10 Mar 2026. Its release says investors with non controlling beneficial ownership of up to 10 percent from a land border country can use the automatic route. Press Note 2 (2026 Series) of 15 Mar 2026 amended paragraph 3.1.1 of the FDI policy. It defines the beneficial owner by the PMLA and rule 9(3) of the PML Rules. It does not itself state the 10 percent figure. It takes effect from the date of the FEMA notification.

The NDI Rules on rbi.org.in, updated up to 2 Sep 2026, carry that test as Explanation 2 to rule 6(a). The Gazette notification of the NDI (Third Amendment) Rules, 2026 (S.O. 3030(E) of 12 Jun 2026) lists two earlier 2026 amendments: S.O. 2174(E) of 1 May 2026 and S.O. 2186(E) of 2 May 2026. Read both on egazette.gov.in for the exact insertion date. The rule still catches a recipient who is personally a citizen of a land border country.

Worked example

Sweat equity to an Indian CTO

A Bengaluru software company is a Private Limited company. A Delaware parent holds all its shares. Its paid up equity capital is INR 1,00,00,000, in 10,00,000 shares of INR 10. The company is not a DPIIT start up. The figures are illustrative.

The board wants to give its CTO, a resident employee, 1,40,000 sweat equity shares for value additions. A registered valuer fixes the fair price at INR 400 a share. A Category I merchant banker values the shares at INR 400 on 2 Jun 2026. The company allots them on 14 Jul 2026, 42 days later.

Test	Working	Result
Annual cap A: 15 percent of paid up equity capital	10,00,000 shares × 15 percent	1,50,000 shares
Annual cap B: issue value of INR 5 crore	5,00,00,000 ÷ 400	1,25,000 shares
Annual cap (higher of A and B)	Higher of 1,50,000 and 1,25,000	1,50,000 shares
Overall cap: 25 percent of paid up equity capital	10,00,000 × 25 percent	2,50,000 shares
Proposed issue	Within the annual cap and the overall cap	1,40,000 shares
Value of the shares	1,40,000 × 400	INR 5,60,00,000
Amount paid by the CTO	Nil	INR 0
Perquisite under section 17(1)(d)	5,60,00,000 minus 0	INR 5,60,00,000
Share capital credited	1,40,000 × 10	INR 14,00,000
Securities premium credited	1,40,000 × 390	INR 5,46,00,000
Stamp duty at 0.005 percent	5,60,00,000 × 0.005 percent	INR 2,800

Section 17(4)(h) deducts only the amount the employee actually paid. On our reading, know how or value additions given in the course of employment are not an amount paid. So the whole fair market value is a perquisite. If an employee assigns separate IP to the company for the shares, we take a tax opinion on that transfer first.

The valuation date of 2 Jun 2026 is within 180 days of the allotment, so rule 15(8)(l) is met. The company books employee benefit expense of INR 5,60,00,000. It adds the perquisite to the CTO's salary for tax year 2026-27 and deducts TDS at her average rate.

Suppose her average rate for the tax year works out at 38 percent, which is an assumption for this example. TDS on the perquisite is then INR 2,12,80,000. The CTO receives no cash from the shares. So the company deducts the TDS from her other salary or asks her to pay it in. We agree the cash route with the employee before the board meeting.

After the issue, the parent holds 10,00,000 of 11,40,000 shares, which is 87.72 percent. The CTO holds 12.28 percent. The shares stay locked in until 14 Jul 2029.

Sweat equity to a non resident director for know how

The same company wants to give 25,000 shares to a director of the Delaware parent. He is a US citizen who lives in the US. He licenses a data model and trains the Indian team. Software is a 100 percent automatic route sector, and he is not a land border citizen.

A Chartered Accountant certifies the fair value of the shares at INR 1,00,00,000 (25,000 × INR 400). The registered valuer values the know how at INR 1,05,00,000 in a report to the board under rule 8(7). The consideration is not less than fair value, so the rule 21 floor is met.

The annual cap is the problem. We use the cautious reading, which measures the 15 percent on the capital before the CTO's issue. On that reading, only 10,000 shares remain under the 15 percent test for that year (1,50,000 minus 1,40,000). The overall cap leaves 1,10,000 shares (2,50,000 minus 1,40,000). So the company can issue 10,000 shares now and the balance in the next year, or reduce the issue. A reading that measures the cap on the enlarged capital leaves more room, but rule 8(4) does not settle the point.

Once allotted, the company files Form FC-GPR within 30 days and Form PAS-3 within 30 days. The know how payment is a separate tax question. We would treat the value as fees for technical services or royalty and deduct tax under section 393(2) before allotment, subject to the treaty.

Common mistakes

1. Using authorised capital for the 15 percent test. Rule 8(4) uses existing paid up equity capital. Fix: compute the caps from the latest allotment register.
2. Ignoring earlier sweat equity in the 25 percent test. The overall cap applies at any time. Fix: keep a running total in the SH-3 register.
3. Allotting more than twelve months after the resolution. Rule 8(3) limits the resolution to twelve months. Fix: pass a fresh special resolution if the allotment slips.
4. Relying on one valuation for three laws. The Companies Act, FEMA and income tax each name a different valuer. Fix: commission reports from a firm that holds the needed registrations, or reconcile them.
5. Missing the 180 day window for the tax valuation. Rule 15(8)(l) allows a merchant banker report up to 180 days before allotment. Fix: date the report within the window.
6. Forgetting the TDS cash gap. The perquisite is taxed with no cash paid to the employee. Fix: agree how the employee funds the TDS before allotment.
7. Leaving the lock in off the certificate or the demat record. Rule 8(5) requires it to be shown prominently. Fix: print it on the certificate and ask the depository participant to mark it.
8. Treating a non resident issue as purely a company law step. FEMA conditions and reporting apply. Fix: check the sector, the approval route and the land border test, and file Form FC-GPR within 30 days.
9. Issuing to an independent consultant. Section 2(88) limits sweat equity to directors and employees. Fix: appoint the person first, or pay for the IP and convert the payable into shares at fair value.

To plan a sweat equity issue in a foreign owned company, see our ESOP and sweat equity advisory service.

Checklist

1. Confirm the recipient is a director or employee within rule 8(1).
2. Check the class of shares already issued and the articles.
3. Compute the 15 percent, INR 5 crore and 25 percent caps from paid up equity capital.
4. Check the FEMA position for any non resident recipient: sector, approval route, land border status and pricing.
5. Commission the registered valuer's reports on the share price and on any IP or know how.
6. Commission the merchant banker valuation for the perquisite, within 180 days of the planned allotment.
7. Hold the board meeting and approve the notice with the rule 8(2) explanatory statement.
8. Pass the special resolution and file Form MGT-14 within 30 days.
9. Allot the shares within twelve months, in demat form, with the three year lock in marked.
10. File Form PAS-3 within 30 days and, for a non resident, Form FC-GPR within 30 days.
11. Add the perquisite to salary, deduct TDS under section 392 and report it in Form 138.
12. Enter the issue in the Form SH-3 register and disclose it in the board's report.

Frequently Asked Questions

What are sweat equity shares?+

Sweat equity shares are equity shares a company issues to its directors or employees at a discount, or for know how or intellectual property instead of cash. Section 2(88) of the Companies Act, 2013 defines them. Section 54 and rule 8 of the Companies (Share Capital and Debentures) Rules, 2014 set the conditions for issuing them.

Can a private limited company issue sweat equity shares?+

Yes. Section 54 applies to every company, and an unlisted company follows rule 8 of the Share Capital and Debentures Rules. The company needs a special resolution, a registered valuer's report and allotment within twelve months. The shares must be of a class already issued, and they carry a three year lock in.

Who can receive sweat equity shares in a private company?+

Directors and permanent employees of the company can receive them. So can directors and employees of its holding company or subsidiaries, in India or abroad. Rule 8(1) defines the eligible group. Rule 8 does not exclude promoters, so a promoter who is a director or employee can receive sweat equity.

What is the limit on sweat equity shares?+

Rule 8(4) allows, each year, the higher of 15 percent of the existing paid up equity share capital or shares with an issue value of INR 5 crore. Total sweat equity cannot exceed 25 percent of paid up equity capital at any time. A DPIIT recognised start up has a higher cap.

How much sweat equity can a start up issue?+

A start up under DPIIT notification G.S.R. 127(E) of 19 Feb 2019 may issue sweat equity of up to 50 percent of its paid up capital. The window runs for ten years from its incorporation or registration, under the second proviso to rule 8(4). The Companies (Share Capital and Debentures) Amendment Rules, 2020 of 5 Jun 2020 extended it from five years.

Is a valuation report mandatory for sweat equity shares?+

Yes. Rule 8(6) requires a registered valuer to fix the fair price of the shares with a justification. Where the company receives IP, know how or value additions, rule 8(7) requires a registered valuer's report on that too. Rule 8(8) requires a gist of both reports to go to shareholders with the notice.

What is the lock in period for sweat equity shares?+

Three years from the date of allotment, under rule 8(5) of the Companies (Share Capital and Debentures) Rules, 2014. The holder cannot transfer the shares during that period. The share certificate must show the lock in and its expiry date prominently, and a demat holding should carry the lock in with the depository.

Can sweat equity shares be issued to a non resident director?+

Yes. Rule 8 of the NDI Rules allows sweat equity to non resident employees and directors. It covers those of the company, its holding company, joint venture or overseas subsidiary. The issue must follow the Share Capital and Debentures Rules and stay within the sectoral cap. Approval route sectors and Bangladesh or Pakistan citizens need government approval.

Which FEMA form reports sweat equity issued to a non resident?+

On our reading, Form FC-GPR within 30 days of allotment, under regulation 4(1) of FEMA 395/2019-RB. The company issues equity instruments to a non resident. Form ESOP under regulation 4(4) covers options granted to non resident employees and directors. Sweat equity involves no option, so Form ESOP does not fit it.

How are sweat equity shares taxed for an employee?+

The value is a perquisite under section 17(1)(d) of the Income Tax Act, 2025. Section 17(4)(h) taxes the fair market value less any amount the employee paid. For unlisted shares, rule 15(6)(d) of the Income Tax Rules, 2026 uses a Category I merchant banker's valuation. The employer deducts TDS under section 392.

Can an eligible start up defer TDS on sweat equity?+

Yes. Section 392(3) of the Income Tax Act, 2025 lets an eligible start up deduct tax on a section 17(1)(d) perquisite later. The start up must be one referred to in section 140. Section 289(3) sets the time. It is 14 days after the earliest of three events: 60 months from the end of the tax year, a sale of the shares, or the end of employment. The 1961 Act used 48 months from the end of the assessment year, which is the same date.

How is sweat equity shown in the books?+

Under rule 8, IP or software received for sweat equity goes to the balance sheet as an asset at its valued amount. Other non cash consideration is expensed as employee compensation. Companies on Ind AS measure the award under Ind AS 102 at fair value, crediting share capital and securities premium.

Can promoters receive sweat equity shares?+

Yes, if they are directors or employees. Rule 8 of the Share Capital and Debentures Rules has no promoter exclusion. Rule 12, which governs ESOPs, excludes promoters and directors holding more than 10 percent, except in a start up. Sweat equity is often the only route for a promoter director to receive shares for IP.

What is the difference between sweat equity and ESOP?+

Sweat equity under section 54 gives shares at once for IP, know how or a discount, with a three year lock in and statutory caps. An ESOP under section 62(1)(b) gives an option that vests after at least a year and is exercised for cash. Promoters are excluded from ESOPs but not from sweat equity.

Which register records sweat equity shares?+

The company keeps a register of sweat equity shares in Form SH-3 under rule 8(14) of the Share Capital and Debentures Rules. It sits at the registered office or another place the board decides. The company secretary or an authorised person authenticates the entries. ESOPs go in a separate register in Form SH-6.

Can sweat equity be issued against intellectual property?+

Yes. Section 2(88) allows sweat equity for making available rights in the nature of intellectual property. A registered valuer values the IP under rule 8(7). Under rule 8(9), the company records a depreciable or amortisable IP asset in its balance sheet. Any excess of the share value over the IP value is employee compensation.

Sources

• Income Tax Department (text of the Companies Act, 2013), section 2, https://www.incometaxindia.gov.in/w/section-2-148
• Income Tax Department (text of the Companies Act, 2013), section 54, https://www.incometaxindia.gov.in/w/section-54-111
• Income Tax Department (text of the Companies Act, 2013), section 62, https://www.incometaxindia.gov.in/w/section-62-101
• Legislative Department, India Code, Companies Act, 2013 with subordinate legislation, including the Companies (Share Capital and Debentures) Rules, 2014, the Second Amendment Rules, 2018, the Amendment Rules, 2019 of 16 Aug 2019 and the Amendment Rules, 2020 of 5 Jun 2020, https://www.indiacode.nic.in/handle/123456789/2114
• Press Information Bureau, The Central Government notifies the Companies (Amendment) Act, 2017, 8 Jan 2018, https://www.pib.gov.in/newsite/PrintRelease.aspx?relid=175458&reg=48&lang=2
• Department for Promotion of Industry and Internal Trade, Startup India, Recent Regulatory Amendments (MCA notification of 16 Aug 2019 on the ESOP window), https://www.startupindia.gov.in/content/sih/en/reources/startup_india_notes/regulations_and_policies/recent_regulatory_amendments.html
• Reserve Bank of India, Foreign Exchange Management (Non Debt Instruments) Rules, 2019, updated up to 2 Sep 2026, https://rbi.org.in/scripts/bs_viewcontent.aspx?Id=5083
• Reserve Bank of India, Master Direction on Foreign Investment in India, updated up to 15 Jun 2026, https://www.rbi.org.in/scripts/bs_viewmasdirections.aspx?id=11200
• Reserve Bank of India, Foreign Exchange Management (Mode of Payment and Reporting of Non Debt Instruments) Regulations, 2019, amended up to 13 Jun 2026, https://rbi.org.in/Scripts/NotificationUser.aspx?Id=11723&Mode=0
• Income Tax Department, Income Tax Act, 2025, section 17, https://www.incometaxindia.gov.in/w/section-17-225
• Income Tax Department, Income Tax Rules, 2026, rule 15, https://www.incometaxindia.gov.in/w/rule-15-23
• Income Tax Department, Income Tax Act, 2025, section 392, https://www.incometaxindia.gov.in/w/section-392-6
• Income Tax Department, Income Tax Act, 2025, section 393, https://www.incometaxindia.gov.in/w/section-393-6
• Income Tax Department, Income Tax Act, 2025, section 289, https://www.incometaxindia.gov.in/w/section-289-74
• Income Tax Department, Income Tax Act, 2025, section 73, https://www.incometaxindia.gov.in/w/section-73-122
• Income Tax Department, Taxation of Employee Stock Option Plan (ESOP), https://www.incometaxindia.gov.in/w/taxation-of-employee-stock-option-plan-esop-
• Income Tax Department, FAQs and Guidance Notes on Forms as per Income Tax Rules, 2026, https://www.incometaxindia.gov.in/faqs-and-guidance-notes-on-forms-as-per-income-tax-rules-2026
• Press Information Bureau, Cabinet approves changes in guidelines on investments from countries sharing land border with India, 10 Mar 2026, https://www.pib.gov.in/PressReleseDetailm.aspx?PRID=2237806&reg=3&lang=2
• Department for Promotion of Industry and Internal Trade, Press Note No. 2 (2026 Series), 15 Mar 2026, https://www.dpiit.gov.in/static/uploads/2026/03/b9da5830b052c2f2d788593e97d07c63.pdf
• Ministry of Finance, Foreign Exchange Management (Non Debt Instruments) (Third Amendment) Rules, 2026, S.O. 3030(E), 12 Jun 2026, https://egazette.gov.in/WriteReadData/2026/273406.pdf