Introduction of Sweat Equity shares under Companies Act 1956

Introduction of Sweat Equity Shares under Companies (Amendment) Act, 1999

The concept of Sweat Equity Shares has been introduced by Companies (Amendment) Act, 1999 by inserting new section i.e. Section 79A in the Companies Act, 1956.

Section 79A of the Companies Act, 1956 enables Companies to reward their employees by way of issuing Sweat Equity Shares.

Those Companies which are not listed in any Recognized Stock Exchange shall issue Sweat equity shares in accordance with Unlisted Companies (Issue of Sweat Equity Shares) Rules, 2003.

Meaning of Sweat Equity Shares

In Literal meaning ‘Sweat Equity’ denotes an interest in a property earned by a talent in return by labour towards upkeep or restoration.

As per explanation II of Section- 79A, Sweat Equity Shares means equity shares issued by the Company to its employees or Directors at a discount or for consideration other than cash, for providing Know-how, or making available rights in the nature of intellectual property rights or value addition, by whatever name called.

As per explanation I of Section- 79A, Company means the company incorporated, formed, and registered under this Companies Act, 1956 and includes its subsidiary company incorporated in a country outside India.

Employees: Employees means:

• A permanent employee of the company

• A Director of the company employed as a Whole time Director or an Executive Director of the Company.

Purpose of Sweat Equity Shares

Main purpose to issue Sweat Equity Shares by a Company is to retain the talent of the work-force.

Conditions required to be fulfilled before issuing Sweat Equity Shares

1.    Lock in Period:

Sweat Equity shares issued to employees and Directors shall be locked in for a period of 3 years from the date of allotment.

2.    Pricing:

The pricing of Sweat equity shares to be issued to employees and Directors shall be at the fair price calculated by Independent Valuer.

3.    Special Resolution:

Issue of Sweat Equity Shares is authorized by a Special Resolution passed by a Company in General Meeting.

4.    Explanatory Statement Conditions:

Explanatory Statement to be annexed with the notice for the General Meeting pursuant to Section 173 shall contain the following particulars:

• The date of meeting at which proposal of Sweat Equity Shares was approved by the Board

• The reasons/justification for the issue

• The number of shares, consideration for such shares and class or classes of persons to whom such Equity shares are to be issued.

• The value of Sweat Equity Shares along with the valuation report and the price at which Sweat Equity Shares will be issued.

• The names of persons to whom Equity shares to be issued and their relationship with the Company.

• Ceiling of managerial remuneration, if any, will be affected by issuance of such Equity.

• A Statement to the effect that Company shall conform to the accounting policies.

• Diluted Earnings per share pursuant to the issue of Securities to be calculated in accordance with the accounting standards.

5.    Special resolution Conditions: shall specify the:

• Number of Equity Shares to be issued

• Current Market Price of Equity Shares of the Company

• Consideration, if any, payable on such Sweat Equity shares

• Class or Classes of Directors or Employees to whom the same is to be issued.

  6.    Second Special Resolution:

Approval of Shareholders by way of separate resolution in the general meeting is obtained by the company in case of Grant of Sweat Equity Shares to identified employees and promoters during any one year equal to or exceeding 1% of the issued capital of the Company at the time of Grant of Sweat Equity Shares.

7.    Time Limit:

In case of a Public Company, there must be a gap of at least one year from the commencement of business before issue of Sweat Equity Shares.

8.    Private and Unlisted Companies Rules:

shall follow the Unlisted Companies (Issue of Sweat Equity Shares) Rules, 2003, made by the Ministry of Corporate Affairs.

9.    Same Class of Shares:

A company may issue Sweat Equity Shares of a class that have already been issued.

10. Register:

The Company shall maintain a register of Sweat Equity Shares issued under Section 79 A in the form of specified format.

11. Limit:

The Company shall not issue Sweat Equity Shares more than 15% of the total Paid up Capital of the Company in a year or Shares of the value of Rs.5 crores, whichever is higher except with the prior approval of Ministry of Corporate Affairs.

12. Auditor Certificate / Certificate from a practicing Company Secretary:

The Board shall at each AGM shall place before shareholders a certificate from auditors of the Company that Sweat Equity shares have been allotted in accordance with the resolution with the company in the General Meeting and unlisted companies (issue of Sweat Equity Shares), Rules, 2003.

Resolution proposed to be passed by Circulation

Issuance of Sweat Equity Shares

RESOLVED that subject to the authorization by the Company in the general meeting and pursuant to the relevant provisions of the Companies Act 1956 and the Unlisted Companies (Issue of sweat equity shares) Rules, 2003   …….. number of shares of Rs10 be and are hereby issued at a discount of ———- to ………………….., Director of the company.

RESOLVED Further that an Extra Ordinary General Meeting of the Company be convened on ———-2012 at ……………………………………. at ………… to pass the necessary resolution for issue of sweat equity shares as contained in the notice  convening the meeting and in this connection, the draft notice of the meeting along with the Explanatory Statement, placed on the table and initialed by the Chairman for the purpose of identification be and is hereby approved  and ………………………….., Director be and is hereby authorized to issue the  notice   to the members of the Company as per the provisions of the Companies Act and to do any other act or deed as may be required for carrying into effect the shifting of the registered office.

Special Resolution proposed to be passed by Shareholders In the Extra Ordinary General Meeting of the Company 

Issuance of Sweat Equity Shares

RESOLVED that pursuant to the relevant provisions of the Companies Act 1956 and also pursuant to Unlisted Companies (Issue of sweat equity shares) Rules, 2003 ….Sweat equity shares at Rs 10 per share be and are hereby issued at a discount of ———– to ………………………………………, Director of the company.

RESOLVED FURTHER that the …………………….., Director of the Company be and is hereby authorised to take each and every action in order to implement the aforesaid resolution and/or anything that is related to it or ancillary or incidental to it.

Income Tax Implication

As per the provision of section 17(2) (vi) sweat equity share allotted or transferred by employer to employee at free of cost or concessional rate shall be taxable in the hands of employee as perquisite under the head salary.

The taxable value of such sweat equity share shall be the fair market value as reduced by the amount actually paid by the employee. The Fair Market value shall be determined by merchant banker registered with SEBI.  Such Merchant banker generally follows Discounted Cash Flow Method (DCF), EBITDA Multiple method, NAV method, etc to determined fair market value.

Example to understand the above provision explained as under:-

E.g. 10,000 share issued by company at the Rate of Rs. 10 each, the fair market value calculated by merchant banker is Rs. 40 per share.  Difference between issue price and fair market value shall be taxable value in the hands of employee as perquisite which is Rs.  3, 00,000 ((40-10)*10,000) and income tax liability on such perquisite shall be Rs. 90,000 (calculated at the rate of 30% excluding Education cess)