This article is written by Calista Chettiar, a Second-Year BA. LL.B. (Hons.) student from NMIMS, School of Law, Bangalore.

INTRODUCTION:

The company’s founders, promoters, and employees may choose to get compensation for their labor (sweat) in the form of equity, either at a discount or in exchange for something besides money. Sweat equity is what is meant by this. It assists the company in maintaining its excellent human resources and in raising money without taking on debt. Employees are the bedrock of any company since they put in so much effort and are so diligent in helping it flourish. Many businesses value their staff members and give them various forms of compensation. Employees are encouraged to contribute more to the expansion of the company when they are rewarded. One example of a reward given by a corporation to its employees or directors at a discounted rate or for something other than cash is sweat equity shares. An employee or director exchanges the shares for a value addition, such as offering technical expertise or using intellectual property rights.

MEANING OF SWEAT EQUITY SHARES:

According to Section 2(88) of the Companies Act, 2013, “Sweat Equity Shares” are equity shares that a business issues to its executives or staff at a rebate or for consideration apart from money in return for one‘s knowledge and experience or for the stipulation of constitutional protections in the essence of intellectual property rights or value additions, by whichever name termed.

REASONS FOR ISSUING SWEAT EQUITY SHARES:

1. Exceptional work and efforts put forth by a director or employee in wrapping up an assignment.
2. Technical mastery in the domain.
3. Adding value to the business by making a significant contribution and acquiring Intellectual Property Rights.

WHO ARE ELIGIBLE FOR THE SWEAT EQUITY SHARES?

Within a firm, Sweat Equity Shares are given to the following individuals:

1. Those that work for the company permanently and are based in India or abroad (for the last year).
2. The employee on a long-term basis of the company’s holding company or a subsidiary.
3. Director of the business (Full-time).

CONDITIONS FOR THE ISSUE OF SWEAT EQUITY SHARES:

The following requirements must be completed in order to issue sweat equity shares under Section 54 of the Companies Act of 2013:

1. Sweat Equity problems should be authorized by a specific resolution.
2. The resolution should specify the class of workers or directors to whom the shares are being issued, the number of shares issued, their current market value, and the consideration.
3. A new resolution must be passed if the special resolution is not put into effect within 12 months of being passed.
4. Shares of Sweat Equity would be allocated in accordance with Sebi regulations.
5. Sweat equity shares are subject to the same rights, obligations, limitations, and conditions as equity shares.
6. For a period of three years, the sweat equity shares granted to directors and staff are locked in and non-transferable. The share certificate must make note of the shares’ non-transferability.

LIMIT FOR THE ISSUANCE OF THE SWEAT EQUITY SHARES:

The following is the maximum amount that can be issued in sweat equity shares:

1. 15% of the paid-up equity share capital within a year, or Rs 5 crore, whichever is greater.
2. At any time, 25% of paid-up equity capital.
3. 50% of the paid-up capital for 5 years following the date of incorporation in the case of a start-up company.

PRICING OF SWEAT EQUITY SHARES:

The registered valuer must assign a fair price to the sweat equity shares before they can be issued. Also, the registered valuer must explain how they arrived at a fair price. A registered valuer must be chosen to appraise intellectual property rights, know-how, or value additions in order to issue sweat equity shares. The valuer will provide the board of directors with a report and an explanation for this valuation. Shareholders will also get the gist of the report’s main contents.

WHAT IS THE PENALTY FOR NON-COMPLIANCE WITH THE SAID PROVISION?

If any corporation or board of directors violates the sweat equity share provision, there is no immediate penalty. However, in situations where no specific punishment or penalty is imposed, the common section for punishment under the Companies Act, 2013, shall be taken into consideration. If a firm, any of its officers, or any other person violates any Act provision, condition, or limitation that is subject to any approval or sanction and for which no punishment or penalty is provided elsewhere in this Act, then that is a violation of the Act.

In such situations, the company and every director or officer of the company who is in default or failure to follow the rules shall be punished with a fine that may reach 10,000 rupees, and in the event that the contravention is one that is continuing, the fine shall further increase to 1,000 rupees for each day that the contravention is continuing.

TAXABILITY OF SWEAT EQUITY SHARES:

In two situations, Sweat Equity Shares are taxable in the employee’s grip:

1. When shares are allocated or distributed to employees, they will be subject to taxation under the heading salary in that year.
2. When such sweat equity shares are sold, they will be liable for capital gains taxes in the year that the employee trades the shares.

REASONS TO ISSUE SWEAT EQUITY SHARES:

1. Employee Incentives: For strategic and long-term growth, it is crucial to provide the right kinds of incentives to the workforce. Sweat equity serves as a reward for their labor and inspires them to work more. Startups typically have low money and won’t be able to pay their staff well, which could result in disgruntled workers. The growth and survival of the business may be hampered by this. So, it is crucial to maintain employee satisfaction, and giving sweat equity shares is one of the best business models a company can use. More dividends are paid to the employee when the business is performing well. The staff and directors are also encouraged to do better by this.
2. Retain the talented employees: Three years are allowed to pass after the sweat equity shares are granted to the employees. As a result, the worker will stay with the business longer and do their duties effectively and efficiently. The attrition rate in most businesses is very high, and it is very challenging to keep staff on board for an extended length of time because they frequently depart for better possibilities.
3. Cost-effective technique for businesses: As employees who should receive financial compensation now receive it in the form of equity shares, the company’s expenses are reduced. This significantly lowers the company’s expenditures.
4. Employee involvement in the management of the company – After earning sweat equity shares, the employees will also become the company’s owners. The employees will be allowed to speak up for the company’s operating division and communicate their issues to the senior management. The senior management will be able to make judgments on operations that are well-informed as a result, which will support the company’s long-term success.
5. Tax Incentives: The employee must pay tax on the shares that have been allocated to him in accordance with the Income Tax Act of 1961. The following requirements must be met in order to establish if sweat equity shares are taxable in the hands of employees:

• A specified security or sweat equity as described in Section 2(h) of the Securities Contract (Regulation) Act, 1956, must be the type of security being used;
• After April 1, 2009, shares should be allocated or transferred;
• It ought to be distributed by the employer or previous employer;
• That ought to go to a current or previous employee.

There are therefore restrictions that must be considered when payment is offered in terms of sweat equity. For instance, the criterion of sweat equity for a startup might only be up to 50% of the paid-up capital. Ergo, practically speaking, it is conceivable that it will reach 50% of the paid-up capital if there are more staff and they are all compensated completely through sweat equity. Yet, it is permissible if the employees accept such a stipulation if there ever comes a time when employees might be compensated fully through sweat equity and the limit does not surpass 50%. Because it is considered a “salary,” sweat equity is taxed under the Income Tax Act. As a corollary, such accords are legal provided the set boundaries are met and the firm desires to pay its employees entirely through sweat effort. The entrepreneurs had also been plagued by the danger of losing their ownership in the business or by the worry that it would be challenging to maintain a portion of ownership while also obtaining outside finance and collaborating at the same time. The current policy has loosened the restrictions on the issuance of sweat equity shares, which are now limited to 50% of the paid-up capital. As a result, the founders can organize their cap more effectively and keep an eye on their shareholdings in the company.

REFERENCES:

https://corpbiz.io/learning/procedure-requirements-for-the-issue-of-sweat-equity-share/#:~:text=As%20per%20Section%202(88,property%20rights%20or%20value%20addition.

https://taxguru.in/company-law/law-issuance-sweat-equity-shares.html

https://taxguru.in/company-law/sweat-equity-share-companies-act-2013.html

https://neerajbhagat.com/blog/index.php/start-up-and-sweat-equity-shares/