Introduction

Companies (Share Capital and debentures) Rules, 2014 are prescribed by the Central Government under the Companies Act, 2013. Rule 8 of the said Rules provides for issue of sweat equity shares. Section 54 (1) of the Companies Act, 2013 provides that a company may issue sweat equity shares of a class of shares already issued if contain conditions specified therein are fulfilled. Section 2 (88) gives the meaning of sweat equity shares as equity shares issued by the company to 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 additions by whether name called.

Pre-requisites

The conditions for issuing sweat equity shares as embodied in section 54 (1) are:

• Passing of special resolution by the company in general meeting;
• The resolution must specify the number of shares, current market price and consideration, if any;
• Class of directors or employees to whom such equity shares are to be issued;
• Not less than one year has, at the date of the issue, elapsed since the date on which the company was entitled to commence business; and
• Where the equity shares of the company are listed on a recognized stock exchange, the sweat equity shares are issued in accordance with the regulations made by the Securities and Exchange Board in this behalf and if they are not so listed, the sweat equity shares are issued in accordance with such rules as may be prescribed.

Meaning of employee and value additions

Explanation to Rule 8(1) defines the meaning of these terms. “Employee” means a permanent employee of the company working in India or outside India, or a director of the company, whether a whole time director or not or an employee or a director as defined above of a subsidiary, in India or outside India, or of a holding company of the company. “Value additions” means actual or anticipated economic benefits derived or to be derived by the company from an expert or a professional for providing know-how or making available rights in the nature of intellectual property rights, by such person to whom sweat equity is being issued for which the consideration is not paid or included in the normal remuneration payable under the contract of employment, in the case of an employee.

Applicability

This rule is applicable to issue of sweat equity shares by a company other than a listed company, which is not required to comply with the Securities and Exchange Board of India Regulations on sweat equity.

Particulars to be included in explanatory statement

Rule 8(2) specifies what particulars should be included in the explanatory statement annexed to the notice of the general meeting whereat the special resolution is to be passed for issue of sweat equity shares. These particulars are:

• The date of the board meeting at which the proposal to issue sweat equity shares was approved by the Board of Directors of the company;
• The reasons or jurisdiction for the issue;
• The class of shares under which sweat equity shares are intended to be issued;
• The total number of shares to be issued as sweat equity;
• The class or classes of directors or employees to whom such equity shares are to be issued;
• The principal terms and conditions on which sweat equity shares are to be issued, including basis of valuation;
• The time period of association of such person with the company;
• The name of the directors or employees to whom the sweat equity shares will be issued and their relationship with the promoter or and Key Managerial Personnel;
• The price at which the sweat equity shares are proposed to be issued;
• The consideration including consideration other than cash, if any to be received for the sweat equity;
• The ceiling on managerial remuneration, if any, be breached by issuance of such sweat equity and how it is proposed to be dealt with;
• A statement to the effect that the company shall conform to the applicable accounting standards; and
• Diluted Earning Per Share pursuant to the issue of sweat equity shares, calculated in accordance with the applicable accounting standards.

Validity of taking approval of the shareholders

Rule 8(3) further specifies that the special resolution authorizing the issue of sweat equity shares shall be valid for making the allotment within a period of not more than twelve months from the date of passing of the special resolution.

Restrictions of the issue

Rule 8(4) provides that the company should not issue sweat equity shares for more than 15% of the existing paid up equity share capital in a year or shares of the value of 5 crores of rupees, whichever is higher. Issuance of sweat equity shares in a company must not exceed twenty five percent, of the paid up equity capital of the company at any time. A startup company, as defined in notification number dated 17^th February, 2016 issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India, may issue sweat equity shares not exceeding fifty per cent of its paid up capital up to five years from the date of its incorporation or company registration.

Lock in of sweat equity

Rule 8(5) provides that the sweat equity shares issued to directors or employees shall be locked in or non-transferable for a period of three years from the date of allotment and the fact that the share certificates are under lock-in and the period of expiry of lock in shall be stamped in bold or mentioned in any other prominent manner on the share certificate.

Pricing

Rule 8(6) provides for pricing of sweat equity shares. The price of such shares to be issued to employees and directors should be valued at a price determined by a registered valuer as the fair price giving jurisdiction for such valuation. Rule 8(7) provides that the valuation of intellectual property rights or of know how or value additions for which sweat equity shares are to be issued, shall be carried out by a registered valuer, who shall provide a proper report addressed to the Board of directors with justification for such valuation. Rule 8(8) provides that a copy of gist along with elements of the valuation report obtained must be sent to the shareholders with the notice of the general meeting.

Issue for consideration other than cash

Rule 8(9) provides that where sweat equity shares are issued for a non-cash consideration on the basis of a valuation report in respect thereof obtained from the registered valuer, such non-cash consideration shall be treated in the following manner in the books of account of the company.

• Where the non-cash consideration takes the form of a depreciable or amortizable asset, it shall be carried to the balance sheet of the company in accordance with the accounting standards; or
• Where clause (a) is not applicable, it shall be expensed as provided in the accounting standards.

Sweat equity shares part of remuneration

Rule8 (10) provides that the amount of sweat equity shares issued should be treated as part of managerial remuneration for the purposes of section 197 and 198 of the Act, if the following conditions are fulfilled, namely:-

• The sweat equity shares are issued to any director or manager; and
• They are issued for consideration other than cash, which does not take the form or an asset which can be carried to the balance sheet of the company in accordance with the applicable accounting standards.

Value of sweat equity shares

Rule 8 (11) provides that in respect of sweat equity shares issued during an accounting period, the accounting value of sweat equity shares shall be treated as a form of compensation to the employee or the director in the financial statements of the company, if the sweat equity shares are not issued pursuant to acquisition of an asset.

Sweat equity pursuant to acquisition

Rule 8 (12) provides that if the shares are issued pursuant to acquisition of an asset, the value of the asset, as determined by the valuation report, shall be carried in the balance sheet as per the Accounting Standards and such amount of the accounting value of the sweat equity shares that is in excess of the value of the asset acquired, as per the valuation report, shall be treated as a form of compensation to the employee or the director in the financial statements of the company. Accounting value shall be the fair value of the sweat equity shares as determined by a registered valuer under sub-rule (6).

Maintaining a register

Rule 8 (14) provides that the company must maintain a register of sweat equity shares in Form No. SH. 3 and must forthwith enter therein the particulars of Sweat Equity Shares issued under section 54.

Disclosures in the Director’s report

Under Rule 8 (13) certain details of issue of sweat equity shares as mentioned below are to be disclosed in the Director’s Report for the year in which such shares are issued:

• The class of director or employee to whom sweat equity shares were issued;
• The class of shares issued as Sweat Equity Shares;
• The number of sweat equity shares issued to the directors, key managerial personnel or other employees showing separately the number of such shares issued to them, if any, for consideration other than cash and the individual names of allottees holding one percent or more of the issued share capital;
• The reasons or jurisdiction for the issue;
• The principal terms and conditions for issue of sweat equity shares, including pricing formula;
• The total number of shares arising as a result of issue of sweat equity shares;
• The percentage of the sweat equity shares of the total post issued and paid up share capital;
• The consideration (including consideration other than cash) received or benefit accrued to the company from the issue of sweat equity shares;
• The diluted Earnings Per Share (EPS) pursuant to issuance of sweat equity shares.

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