Designing an ESOP scheme in India means deciding how many options to set aside, who gets them, how they vest, what employees pay to exercise them, and what happens when someone leaves. For an unlisted company, those choices must fit Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. Rule 12 requires shareholder approval with prescribed disclosures, at least one year between grant and vesting, no grants to promoters or to directors holding more than 10% (except in eligible startups), and a register of options in Form SH-6.
The company is free to set the exercise price, but that choice drives the employee’s tax at exercise and the company’s accounting expense. This ESOP scheme India guide from Casela Advisors, Chartered Accountants in Andheri East, Mumbai, walks through each design decision and the approval steps. It is based on the law and published sources as of 31 October 2026.
Key takeaways
- Rule 12 sets the frame: eligible employees, one-year minimum vesting, mandatory disclosures, leaver rules and the SH-6 register.
- Pool size has no legal cap, but the scheme must state totals and per-employee limits; grants of 1% or more to one person in a year need a separate resolution.
- Exercise price is the company’s choice. A lower price means more tax for the employee at exercise and a higher Ind AS 102 expense.
- Startups: DPIIT-recognised startups can grant to founders for ten years; employees of startups with an IMB certificate can defer tax.
- Watch the 2026 bill: the Corporate Laws (Amendment) Bill, 2026 would recognise RSUs and SARs, but it is not yet law.
What Does Rule 12 Require of an ESOP Scheme?
Rule 12 applies to employee stock option schemes of companies that are not listed. It is the checklist an ESOP scheme must satisfy before a single option is granted. A private limited company follows it with one relaxation on the type of resolution, covered below.
| Requirement | Rule 12 | What it means for design |
|---|---|---|
| Shareholder approval | Rule 12(1); separate resolutions under 12(4) | Plan a general meeting; private companies may use an ordinary resolution under the 2015 exemption |
| Explanatory statement | Rule 12(2) | Fix the totals, eligible classes, vesting, exercise price or formula, lock-in, limits and valuation method before the notice goes out |
| Exercise price | Rule 12(3) | Company’s choice, in line with its accounting policies |
| Variation | Rule 12(5) | Special resolution; no change prejudicial to option holders |
| Vesting and lock-in | Rule 12(6) | At least one year to vest; any lock-in on exercised shares is set by the company |
| Transfer and leavers | Rule 12(8) | Options are personal; rules fixed for death, permanent incapacity and resignation |
| Disclosure | Rule 12(9) | Board’s Report covers grants, vesting, exercise, lapses and named employees |
| Register | Rule 12(10) | Form SH-6, kept at the registered office or another place the board approves |
📋 Listed companies follow the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 instead of Rule 12. This guide covers unlisted companies only.
A scheme can be changed after approval, by special resolution, for options not yet exercised, as long as the change is not prejudicial to the option holders. The notice must disclose the full variation, the reason for it and who benefits, and variations during the year are also disclosed in the Board’s Report.
Who Can Receive Options Under an ESOP Scheme?
Options go to employees, and Rule 12 defines that group narrowly. Founders and large shareholders are the usual surprise.
Permanent employees
Working in India or outside India
Directors
Other than independent directors
Subsidiary or holding company staff
Needs its own special resolution
Promoters and promoter group
Except in eligible startups
Directors holding over 10%
Except in eligible startups
Consultants and contract staff
Advisers are not employees for Rule 12
How Big Should the ESOP Pool Be?
There is no statutory percentage. Rule 12 only requires the scheme to state the total number of options, the maximum per employee and the aggregate limit. The pool is a commercial choice, and these points usually shape it:
A pool can be approved in full and granted in tranches. Options that lapse can usually return to the pool if the scheme says so.
How Should Vesting Work in an ESOP Scheme?
Vesting is the schedule on which an employee earns the right to exercise. Rule 12(6) sets a floor of one year from grant to the first vesting, and the company designs everything after that.
- Minimum: one year from grant to the first vesting. A one-year cliff followed by monthly or quarterly vesting meets this; counting service before the grant date towards that first year does not.
- Performance vesting: allowed, if the explanatory statement and grant letter describe the conditions.
- Acceleration: some schemes vest options early on a sale of the company or a change in control. This is a scheme choice; spell it out, since a later change may be a variation.
- Exercise period: set a maximum period after vesting, and a separate window for leavers. The window is the company’s choice, but it must be stated.
What Happens to Options When an Employee Leaves?
Rule 12(8) fixes the floor. Schemes often add “good leaver” and “bad leaver” terms on top of it; check that they do not cut across Rule 12(8).
| Event | What happens to the options |
|---|---|
| Resignation or termination | Unvested lapse Vested options can be exercised within the period the scheme specifies |
| Death | Vest Options vest in the legal heirs or nominees |
| Permanent incapacity | Vest All options granted vest on that date |
| Transfer, pledge or encumbrance | Not allowed Options are personal to the employee |
How Do You Set the ESOP Exercise Price?
Rule 12(3) leaves the price to the company, in line with its accounting policies. Each choice has consequences elsewhere: a lower price means a larger taxable perquisite for the employee and a higher share-based payment expense for the company.
Pays little cash, but the perquisite at exercise is almost the full fair market value.
CompanyHighest share-based payment expense under Ind AS 102.
Lower perquisite than face value; some cash to pay at exercise.
CompanyMiddle-range expense.
No perquisite unless the value rises by exercise; more cash needed.
CompanyLower expense; value to employees depends on growth.
The perquisite at exercise uses the fair market value on the exercise date, which for unlisted shares must be determined by a SEBI-registered Category I merchant banker (on that date or up to 180 days earlier). The accounting expense uses a grant-date fair value under Ind AS 102 or the ICAI Guidance Note. These are separate valuations; our business valuation guide explains which law needs which valuer, and the registered valuer services page describes the valuer’s role.
⚠️ When is tax paid? Not at grant or vesting. At exercise, the fair market value of the shares less the exercise price is taxed as a salary perquisite, and the employer deducts TDS. Employees of eligible startups with an Inter-Ministerial Board certificate can defer the tax (see the startups section).
Who Approves an ESOP Scheme, Step by Step?
Approval runs from the board to the shareholders, followed by filings. Our ESOP advisory page lists the support available for each step.
- Check the articles. Confirm the articles of association permit ESOPs, and increase authorised capital if the pool needs it.
- Draft the scheme and explanatory statement with the Rule 12(2) disclosures.
- Hold a board meeting to approve the scheme and the notice. Issuing securities is a power under section 179(3) that must be exercised at a meeting, not by circular resolution.
- Hold the general meeting to pass the resolution, plus separate resolutions for subsidiary or holding company employees and for any 1% grants.
- File Form MGT-14 within 30 days for the special resolution.
- Issue grant letters, and enter each grant in the SH-6 register.
- On exercise: obtain the merchant banker valuation, allot the shares, file Form PAS-3 within 30 days, deduct TDS and update SH-6.
- Each year: make the Board’s Report disclosures. For non-resident employees, file Form ESOP within 30 days of issue; see our guide to FEMA compliance for startups.
| Record or form | Purpose | When |
|---|---|---|
| SH-6 register | Register of options | Update after each grant, vesting, exercise and lapse |
| Form MGT-14 | Special resolution approving the scheme | Within 30 days |
| Form PAS-3 | Return of allotment for shares issued on exercise | Within 30 days of allotment |
| Board’s Report | Disclosures on grants, vesting, exercise, lapses and variations | Every year |
| Form ESOP (RBI FIRMS) | Options issued to non-resident employees | Within 30 days of issue |
⚠️ Common design errors These usually surface in investor due diligence, when they are hardest to fix:
- Granting options to consultants or contract staff, who are not employees under Rule 12.
- Granting to a promoter or a director holding more than 10% outside the startup window.
- Vesting in less than a year.
- Grants approved by circular resolution.
- An SH-6 register that is missing or out of date.
- A later change that hurts option holders.
What Changes for Startups in an ESOP Scheme?
Startups get two separate benefits, one under company law and one under tax. They depend on different certificates, so check both before designing the scheme. Registration is covered on our Startup India registration page.
Company law
In a startup covered by the DPIIT notification referred to in Rule 12, promoters, the promoter group and directors holding more than 10% can receive options for ten years from incorporation or registration.
Tax
If the startup also holds an Inter-Ministerial Board certificate (the section 80-IAC benefit, now section 140 of the Income-tax Act, 2025), employees pay tax on the perquisite within 14 days of the earliest of three dates: 48 months from the end of the assessment year of allotment, the sale of the shares, or leaving the company. DPIIT recognition alone is not enough.
Planning
Because the tax deferral turns on the IMB certificate, check the company’s status before choosing a low exercise price, since that choice increases the perquisite.
📝 Note: This article is general information based on the law and published sources as of 31 October 2026. It is not professional advice. ESOP schemes depend on the company’s articles, investor agreements and facts; the company law, tax, accounting and FEMA position can differ. Consult a Chartered Accountant or Company Secretary before adopting or varying a scheme.
What Should You Watch Into 2027?
- The Corporate Laws (Amendment) Bill, 2026. Introduced on 23 March 2026, with the Joint Parliamentary Committee reporting on 3 August 2026. It would let section 62(1)(b) cover other schemes linked to the value of share capital, such as RSUs and equity-settled SARs. It is not yet law, and Rule 12 would need updating after it passes.
- Notified section numbers under the Income-tax Act, 2025 and Income-tax Rules, 2026 for ESOP perquisites and valuation, for grant letters and Form 16.
- The startup definition. How Rule 12’s reference to the 2019 DPIIT startup notification is read now that G.S.R. 108(E) of 4 February 2026 has replaced it.
For Queries on ESOP Schemes
Casela Advisors, Chartered Accountants, Andheri East, Mumbai, advises startups and businesses on company formation, FEMA, MCA compliance, tax and audit. If you have a question about this guide, you can reach the firm using the details below. This article is for general information only and is not professional advice or a solicitation of work.
Phone: +91 98190 00227 · Email: info@caselaadvisors.com · Contact page
What Are the Most Asked Questions About Designing an ESOP Scheme?
Is there a legal limit on the size of an ESOP pool in an unlisted company?
Rule 12 sets no percentage cap. The scheme must state the total number of options, the maximum per employee and the aggregate limit, and the company needs enough authorised capital to issue the shares. Grants to an identified employee that reach 1% or more of issued capital in a year need a separate special resolution. Beyond that, pool size is a commercial decision, often agreed with investors in the shareholders’ agreement.
What is the minimum vesting period for ESOPs?
At least one year between the grant of options and their vesting, under Rule 12(6). The schedule after that, such as a one-year cliff followed by monthly or annual vesting, is a choice set out in the scheme.
Can a company set any exercise price?
Yes. Rule 12(3) lets the company decide the exercise price, in line with the accounting policies that apply to it. The choice still has consequences: a lower price means a larger taxable perquisite for the employee at exercise and a higher share-based payment expense for the company.
Who is eligible to receive ESOPs?
Permanent employees working in or outside India, directors other than independent directors, and employees of a subsidiary or holding company (with a separate special resolution). Promoters, members of the promoter group and directors who hold more than 10% of the outstanding equity are excluded, except in eligible startups. Consultants, advisers and contract staff are not employees for Rule 12.
Can startup founders receive ESOPs?
Yes, for a limited time. In a startup covered by the DPIIT notification referred to in Rule 12, the exclusion of promoters, the promoter group and directors holding more than 10% does not apply for ten years from incorporation or registration.
Does an ESOP scheme need a special or an ordinary resolution?
An unlisted public company needs a special resolution. Under the MCA exemption for private companies of June 2015, a private company can approve the scheme by ordinary resolution. In either case, grants to employees of a subsidiary or holding company, and grants of 1% or more of issued capital to an identified employee in a year, need a separate resolution.
What happens to options when an employee leaves?
Under Rule 12(8), unvested options lapse on resignation or termination, and vested options can be exercised within the period the scheme specifies. On death, the options vest in the legal heirs or nominees. On permanent incapacity, all options granted vest on that date. Options cannot be transferred, pledged or encumbered.
Can an ESOP scheme be changed after it is approved?
Yes, by special resolution, for options not yet exercised, as long as the change is not prejudicial to the option holders. The notice must disclose the full variation, the reason for it and who benefits. Variations during the year are also disclosed in the Board’s Report.
When does the employee pay tax on ESOPs?
Not at grant or vesting. At exercise, the fair market value of the shares less the exercise price is taxed as a salary perquisite, and the employer deducts TDS. For unlisted shares, the fair market value must come from a SEBI-registered Category I merchant banker. Employees of eligible startups with an Inter-Ministerial Board certificate can defer the tax.
Which registers and filings does an ESOP scheme need?
The main ones are:
- the register of options in Form SH-6, updated after each grant, vesting, exercise and lapse;
- Form MGT-14 for the special resolution;
- Form PAS-3 for shares allotted on exercise;
- Board’s Report disclosures each year;
- Form ESOP on the RBI’s FIRMS portal within 30 days if options go to non-resident employees.
Related Reading
Disclaimer: This article is for general information only and is not professional advice or a solicitation of work. It reflects the law and published sources as of 31 October 2026.
