The intersection of corporate governance and executive compensation has become a focal point of regulatory scrutiny in India. As companies increasingly leverage Employee Stock Purchase Options (ESOPs) to attract and retain top-tier leadership, understanding their classification as “managerial remuneration” under the Companies Act, 2013 is critical for compliance.

The Regulatory Framework of Managerial Pay

Remuneration for directors, managing directors, and managers is governed primarily by Section 197 of the Companies Act, 2013, read alongside Schedule V. These provisions establish strict statutory caps on the total payout a company can make to its leadership team as hereunder:

If the inclusion of ESOP perquisite values causes a director’s total pay to breach the limits set in Section 197 or Regulation 17 of the SEBI (LODR) Regulations, the company must obtain shareholder approval via a special resolution.

Statutory Remuneration Limits (Public Companies)

Condition	Maximum Remuneration Limit
Single MD/WTD/Manager	5% of Net Profits
Multiple MD/WTD/Managers	10% of Net Profits
Overall Limit for all Directors	11% of Net Profits
Remuneration payable to Directors who are neither MD/WTD or Manager
For all NED	1% of Net profits if there is one Managing director/Whole time Director
For a NED	3% of Net profits if there is no Managing director/Whole time Director

*The percentage displayed above be paid in excess with the approval of Shareholders by passing special resolution. In case a Company has defaulted in paying its due or failed to pay its dues, permission from the lenders will be necessary.

When the company has inadequate profits/no profits: In case a company has inadequate profits/no profits in any financial year, no amount shall be payable by way of remuneration except if these provisions are followed:

Where the effective capital is	Maximum Annual Remuneration Limit
Negative or less than 5 crores	60 lacs
5 crores and above but less than 100 crores	84 lacs
100 crores and above but less than 250 crores	120 lacs
250 crores and above	120 lacs plus 0.01% of the effective capital in excess of 250 crores

Please Note

• These restrictions do not apply to the sitting fees of the directors (managing director, whole time director/manager).

• Remuneration in excess of the aforementioned limits may be paid only if a special resolution is passed by the shareholders.
• Remuneration as per the above limits may be paid if:
  • A managerial personnel is functioning in a professional capacity
  • The managerial person does not have an interest in the capital of the company/holding company/subsidiary company either directly, or indirectly, or through any statutory structures*
  • The managerial person does not have a direct/indirect interest or related to the directors /promoters of the company/holding company/subsidiary company any time during the last 2 years either before/on/after the date of appointment
  • He/she is in possession of a graduate level qualification along with expertise and specialized knowledge in the field in which the company mainly operates.
  • If any employee holds less than 0.5% of the company’s paid-up capital under any scheme (including ESOP) or by way of qualification, for this purpose he/she is considered to not have interest in the share capital of the company

 

Special Considerations

To ensure transparency, Section 197(12) and Rule 5 of the Appointment and Remuneration Rules, 2014, mandate extensive disclosures in board reports, including:

• The ratio of each director’s pay to the median employee salary.
• Annual percentage increases in remuneration for Key Managerial Personnel (KMPs).
• Comparisons between managerial pay hikes and those of non-managerial staff.

While international jurisdictions like the US and UK rely heavily on shareholder oversight and disclosure rather than government-mandated caps, India utilizes a hybrid model. Historically, exceeding pay limits required Central Government approval; today, this power rests with the shareholders through Special Resolutions.

 

Decoding ESOPs as Remuneration

A common query in corporate boardrooms is whether stock options—which involve no immediate cash outflow—qualify as remuneration.

1. The Statutory Definition

Sec 2(37) of Companies Act, 2013 defines “employees stock option” which means, ‘the option given to the directors, officers or employees of the company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price.’

As defined under 2(78) of the Companies Act, 2013 means; “any money or its equivalent given or passed to any person for services rendered by him and includes perquisites as defined under the Income-tax Act, 1961.” It is evident from this definition that only when any money or its equivalent is ‘given’ or ‘passed’ to any person for services rendered by him and includes perquisites as defined under Income Tax Act, such money or its equivalent shall be considered as ‘remuneration’ for the purpose of the Act. The term ‘give’ means to transfer or yield to or bestow upon another or to make another the recipient of something or bestow gratuitously whereas the term “pass” means to move from one person to another or to go by transfer.

Further,  in terms of clause (vi) of Section 17(2) of the Income Tax Act, 1961 (“IT Act”), perquisites includes –

 (vi) the value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer, or former employer, free of cost or at concessional rate to the assessee.

Explanation.—For the purposes of this sub-clause,— (a) “specified security” means the securities as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and, where employees’ stock option has been granted under any plan or scheme therefore, includes the securities offered under such plan or scheme.

. The definition of the term “perquisite” under Section 17(2)(vi) of the Income Tax Act includes the value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer, or former employer, free of cost or at a concessional rate to the assessee. Market price of the shares on the exercise date, less the exercise price paid by the employee is treated as perquisite and withholding tax is levied at applicable rates.

2. The Timing of “Remuneration

Determining when an ESOP becomes part of the remuneration limit is essential for calculating statutory caps for the purposes of Section 197 of the Act and Regulation 17 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“Listing Regulations”):

• Grant & Vesting Stages: At these stages, the employee merely holds a right. He need not exercise this option. Since nothing has been “given or passed” to the individual, these stages do not trigger the remuneration definition by Section 2(78) of the Act.

        In the event where the options are granted, but not yet vested in the director who has retired or resigned or terminated as on that day shall                expire. However, if the options are vested but not yet exercised, they can be exercised subject to the terms and conditions of the ESOP scheme             of the company.

        Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 and Regulation 9 of the SEBI (Share Based Employee Benefits) Regulations,             2014.

• Exercise Stage: This is the pivotal moment. When an employee exercises the option, the “perquisite value”—calculated as the Market Price on the exercise date minus the Exercise Price—is officially treated as remuneration.
  
  

         It is evident from the analysis of this provision that neither the date of grant nor the vesting date are relevant in the context of the definition of            remuneration under Section 2(78) of the Act as nothing is given or passed to the person receiving the ESOP till the date of exercise. It is,                    therefore, the exercise date which is the relevant date for calculation of limit of managerial remuneration under Section 197 of the Act and                  Regulation 17 of the Listing Regulations.

         Once the perquisite value of ESOPs is treated as ‘remuneration’ under the Act, then the provisions of Section 197 of the Act and Regulation 17(6)           (ca) of Listing Regulations would become applicable, which requires shareholder approval by a special resolution. If the monetary limits on                    remuneration specified in those respective provisions are breached, then the same will be subject to the various conditions laid down under                  Section 197 of the Act, including conditions relating to no default of the company in payment of any dues to any bank or public financial                      institution, etc.

3. Compliance and Approval Requirements

• Independent Directors: To safeguard impartiality, the law strictly prohibits granting ESOPs to Independent Directors.

• When a Non-Executive Director is exercising ESOPs, the company is required to pay GST @18% on the perquisite value of ESOPs as it would work on a reverse charge basis. This will be in addition to 10% withholding tax under Section 194J of the Income Tax Act. Circular No: 140/10/2020 dated June 10, 2020 issued by the Central Board of Indirect Taxes and Customs.

• Post-Employment Exercise: If a director exercises vested options after resigning, it currently falls into a regulatory “grey area” where it may escape the calculation of managerial remuneration for that financial year.

Conclusion

ESOPs are not merely recruitment tools but a formal component of the “Cost to Company” (CTC). By aligning executive wealth with shareholder interests, they serve as a powerful motivator. However, the complexity of their valuation and the timing of their recognition require diligent legal and accounting oversight to ensure that the “exercise” of rights does not lead to an accidental breach of corporate law.

At our firm, we provide end-to-end, lifecycle management for Employee Stock Option Plans (ESOPs), seamlessly bridging the gap between strategic corporate intent, legal compliance, and employee wealth creation.

we guide organizations through every milestone of the ESOP cycle—from the initial framing of the ESOP plan, securing Nomination and Remuneration Committee (NRC) and shareholder approvals, to managing precise valuations, vesting, and eventual allotments.

 

Disclaimer: This article provides a comprehensive overview of equity incentives under Indian law for informational and educational purposes. It does not constitute formal legal or tax advice. Corporate boards must consult an independent Registered Valuer and qualified legal counsel to customize schemes matching their specific corporate structures.

Article By:

CS Neha Sarpal

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