Guest Post :   Sweat Equity Shares: Sweat Equity Shares are a perquisite or a perk that an employee enjoys. The valuation of these shares is based upon the following conditions.

Sweat Equity Shares are those shares which are issued to the employees or directors of a company. The company provides these shares to its employees in lieu of cash, in lieu of information exchange, or as an exchange for either intellectual property rights or any other service or know-how that the employees may be capable of offering in exchange. The transfer of these Sweat Equity Shares should have taken place on or after the 1st of April 2009. The company is liable to pay fringe benefit taxes on the shares if the transfer has taken place between the 1st of April 2007 and the 31st of March 2009. These shares are either directly issued to the employee without any payment in return, or at a discounted rate.

In light of the provisions mentioned above being fulfilled, the employee will be responsible to pay taxes in the assessment year applicable to the year that he receives the said perk in the form of these Sweat Equity Shares. The fair value of these shares needs to be determined in order to calculate the value of the said perk. The date on which the employee gains access to the shares is the date which will be used to calculate the fair market valuation of the shares and the amount that the employee receives for the shares will be subtracted.

If the said company’s shares are listed on an accepted stock exchange in India, the calculation of the average price of the shares at the opening and closing of the stock exchange on the said date will be used to estimate the fair market value. If the shares are listed on a number of stock exchanges then the average of the opening and closing prices of the stock exchange that trades the highest volume of shares of the company will be calculated to determine the fair market value. In the event that the option is exercised on a day when the recognized stock exchanges are closed, the closing price of the company’s share on the closest date of a working day at the stock exchange will be considered the fair market value.

If on the date of exercising the option the company shares are not a part of the listings on an acceptable stock exchange a merchant banker decides on the fair market value on the specified date. The specified date here could be any date prior to the date on which the option was exercised provided that the date should not be more than 180 days prior to this date.

Here is an illustration that will help in understanding the entire concept of Sweat Equity Shares –

Mr. Sharma joins company A April 1 1990
Mr. Sharma is granted an option April 1 2004
Tenure of Grant April 1 2004 to March 31 2008
The tenure during which Mr. Sharma can exercise the option to purchase 500 shares of A at a rate of Rs. 30 per share which was decided before April 1 2008 to March 31, 2013
Vesting date April 1 2008
Fair market value on Vesting date Rs. 100 per share
Option is exercised to apply for 400 shares March 20, 2012
Fair market value on March 20, 2011 Rs. 700 per share
Date of allotment April 1 2012
Fair market value on the date of allotment Rs. 760 per share
Mr. Sharma’s Demat account is credited April 2 2012

Taking the above illustration as an example:

Mr. Sharma is liable to pay tax towards this perk of Sweat Equity Shares of Company A since the shares were allotted on or after the 1st of April, 2009.

Value of the perk             400 Shares x Rs. 670 per share = Rs. 2, 68, 000/-                                                                                                                  (Rs. 700 minus Rs. 30 being the previously determined price)

Therefore, the cost of acquiring the shares to Mr. Sharma is the fair market value of the Sweat Equity Shares on the date the option was exercised i.e. Rs. 700 per share. This price will determine the Capital Gains of Mr. Sharma as and when the shares are transferred.

By Aashish Ramchand : Co-founder of a new start-up MakeMy Returns, an e-filing and online tax advisory website (recognized by Govt. of India). A chartered accountant by profession.