31 October 2014 EY Regulatory Alert Securities and Exchange Board of India notifies regulations for Share Based Employee Benefits Executive Summary Regulatory Alerts cover significant regulatory news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest regulatory issues. For more information, please contact us. The Securities and Exchange Board of India (SEBI) has notified the SEBI (Share Based Employee Benefits) Regulations, 2014 (New ESOP Regulations) on 28 October 2014. These regulations have been implemented for regulating all schemes introduced by companies for the benefit of their employees, involving dealing in shares (directly or indirectly) which are listed on a recognized stock exchange in India. The objective of the regulations is to facilitate smooth operation of such schemes and prevent any possible manipulation. The earlier SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 (ESOP Guidelines) is repealed with certain exceptions. The notification has been posted on the SEBI s website and can be downloaded by accessing the following link: http://www.sebi.gov.in/cms/sebi_data/attachdocs/1414568485252.pdf
Background ESOP Guidelines were issued by SEBI to enable listed companies to reward their employees by framing stock option and stock purchase schemes and ensure that such schemes were within the regulated framework. In 2013, vide its various circulars 1, 2 SEBI restricted companies from acquiring their own shares from the secondary market, in view of their concern that the companies frame such schemes and administer such schemes through the trust with the purpose of inflating, depressing, maintaining or causing fluctuation in the price of its securities by engaging in fraudulent and unfair trade practices. Subsequently, in November 2013, SEBI issued a discussion paper to review the ESOP Guidelines. It was proposed to replace the ESOP Guidelines with a set of regulations to ensure better enforceability, provide for a regulatory framework for all kinds of employee benefit schemes involving securities of the company, address the concerns raised with regard to composition of employee welfare trusts, disclosures, etc. and to enable secondary market transactions with adequate safeguards. In the SEBI Board meeting held in June 2014, SEBI approved the proposal to review the ESOP Guidelines and replace it with new regulations covering all employee benefit schemes dealing in shares. Accordingly, SEBI notified the New ESOP Regulations on 28 October 2014. This alert covers key features of the New ESOP Regulations, largely the changes to erstwhile ESOP Regulations. Applicability The New ESOP Regulations shall apply to all the schemes namely: 1 Circular CIR/CFD/DIL/3/2013 dated 17 January 2013 Circular CIR/CFD/DIL/7/2013 dated 13 May 2013 Employee Stock Option Schemes (ESOS); Employee Stock Purchase Schemes (ESPS) Stock Appreciation Rights Schemes (SAR) General Employee Benefits Schemes (GEBS); and Retirement Benefit Schemes (RBS). The provisions of these regulations shall apply to any listed company in India which has a scheme: for direct or indirect benefit of employees; involving dealing in or subscribing to or purchasing securities of the company, directly or indirectly; satisfying, directly or indirectly, any one of the following conditions: scheme is set up by the company or any other company in its group; scheme is funded or guaranteed by the company or any other company in its group; scheme is controlled or managed by the company or any other company in its group. Definitions Group is defined as two or more companies which, directly or indirectly, are in a position to: exercise 26% or more of the voting rights in the other company; or appoint more than 50% of the members of the board of directors in the other company; or control the management or affairs of the other company. Several new definitions have been added and also amended. Some of the key amendments are as under: Definition of 'employee' is now in line with the definition of employee under Companies (Share Capital and Debenture) Rules, 2014 i.e. it excludes independent directors and
includes employees of an associate company. Definition of market price is amended to mean latest available closing price on a recognised stock exchange on which the shares of the company are listed on the date immediately prior to the relevant date. Relevant date is the date of the meeting of the compensation committee on which the grant is made (for grant) or the date on which the notice of exercise is given to the company or to the trust by the employee (for exercise). Secondary acquisition is defined to mean acquisition of existing shares of the company by the trust on a recognised stock exchange for cash consideration. Implementation of the Schemes through Trust Formation and Approvals A company may implement scheme(s) either directly or by setting up an irrevocable trust(s). Constitution The following individuals shall not be appointed as trustee(s): 1. A director, key managerial personnel or promoter of the company or its holding, subsidiary or associate company or any relative of such director, key managerial personnel or promoter; or 2. A person who beneficially holds 10% or more of the paid-up share capital of the company. A corporate entity can be appointed as a sole trustee, whereas, there has to be minimum of 2 trustees where an individual or one person company is appointed as a trustee. Functioning The trust needs to ensure that the appropriate approval has been obtained from the shareholders of the company to enable the trust to implement the scheme and undertake secondary acquisition for the purposes of the scheme. The trust shall not deal with derivatives. If the scheme is to be implemented through a trust, the same has to be decided upfront at the time of taking approval of the shareholders for setting up of scheme. If the scheme involves secondary acquisition or gift or both, it is mandatory for the company to implement such scheme(s) through trust(s). SEBI may specify the minimum provisions to be included in the trust deed. Trust deed and any modifications shall mandatorily be required to be filed with the stock exchange in India where the shares of the company are listed. Secondary acquisition in a financial year by the trust shall not exceed 2% of the paid up equity capital of the company as at the end of the previous financial year. The total number of shares under secondary acquisition held by the trust should not exceed the below mentioned prescribed limits: Sr No. Particulars Limits 23 1 For ESOS, ESPS or 5% SAR 2 GEBS or RBS 2% 3 All schemes in aggregate 5% Un-appropriated stock of shares acquired through secondary market, not backed by grants, needs to be 2 As a percentage of the paid up equity capital as at the end of the financial year immediately prior to the year in which the shareholders approval is obtained for such secondary acquisition
appropriated by the end of the subsequent financial year. However, for existing trusts, where shares are not appropriated within 1 year of the notification of these regulations, the same shall be disclosed to the stock exchange at the end of such period and the same shall be sold on the stock exchange within a period of five years from the date of notification of these regulations. There is a minimum 6 month holding period for shares acquired through secondary market subject to certain exceptions. Approval of shareholders by way of separate special resolution would be required for secondary acquisition. The trust shall sell shares in secondary market only under prescribed circumstances. benefits in the event of sickness, accident, disability, death or scholarship funds, or such other benefit as specified by such company. Shares of the company or its listed holding company held under GEBS shall not exceed 10% of the book value or market value or fair value of the total assets of the scheme, whichever is lower, as per the last balance sheet for the purpose of GEBS. Retirement Benefit Scheme RBS means any scheme of a company, framed in accordance with these regulations, dealing in shares of the company or the shares of its listed holding company, for providing retirement benefits to the employees subject to compliance with existing rules and regulations as applicable under laws relevant to retirement benefits in India. Other Key Highlights Stock Appreciation Rights Scheme SAR is a right given to an employee entitling him to receive appreciation for a specified number of shares of the company where the settlement of such appreciation may be made by way of cash or shares of the company. In case of equity settled SAR scheme, if the settlement results in fractional shares, the consideration for fractional such shares should be settled in cash. There shall be a minimum vesting period of 1 year for SARs. No right or benefits available to a shareholder shall be available to an employee who has been granted SARs. General Employee Benefit Schemes GEBS means any scheme of a company framed in accordance with these regulations, dealing in shares of the company or the shares of its listed holding company, for the purpose of employee welfare including healthcare benefits, hospital care or benefits, or Shares of the company or its listed holding company held under the scheme shall not exceed 10% of the book value or market value or fair value of the total assets of the scheme, whichever is lower, as per the last balance sheet for the purpose of RBS. Miscellaneous SEBI may on its own or on an application made by a company, for reasons recorded in writing, grant relaxation from strict compliance with any of these regulations subject to such conditions as SEBI deems fit to impose in the interests of investors in securities and the securities market. Companies shall follow requirements of Guidance Note on Accounting for employee share- based Payments or Accounting Standards as prescribed or may be prescribed by the Institute of Chartered Accountants of India. Transition Provisions To ensure smooth transition for complying with the new regulatory framework, all listed companies which have existing employee benefit schemes
to which New ESOP Regulations apply have been provided with a time period of one year from the date of these regulations coming into effect, to comply with the regulations, subject to the following exceptions: A longer transition period of five years has been provided for the following: (i) Re-classifying shareholding of existing employee benefit schemes separately from 'promoter' and 'public' category. (ii) Bringing down its holding in shares to permissible limits by the trusts for the purpose of implementing employee benefits scheme which are acquired from secondary market. (iii) Bringing down its holding in shares to permissible limits by the trusts for the purpose of implementing GEBS or RBS. The prohibition on acquiring securities from secondary market as laid down in earlier circular 4 shall continue till the existing schemes are aligned with the New ESOP Regulations. Comments It is a welcome step that SEBI has issued these New ESOP Regulations which provide detailed guidelines for regulation of employee share based benefits schemes. In these regulations, SEBI has clarified that listed companies can now use trust route to implement schemes through secondary market acquisitions, without diluting their existing share capital. To address their concern of fraudulent and unfair trade practices, SEBI has provided strict regulatory framework on set up and administration of such trusts. Listed companies which have such schemes dealing with shares are required to review the existing schemes and align the same with the New ESOP Regulations within one year from the date of its applicability. Additionally, listed companies who are proposing to implement such schemes should also ensure compliance with these regulations. Unlisted companies proposing to go in for Initial Public Offering would also need to ensure compliance with these regulations in certain situations. Contacts Sonu Iyer Tel: +91 11 4363 3160 Email: sonu.iyer@in.ey.com Amarpal S. Chadha Tel: +91 80 6727 5258 Email: amarpal.chadha@in.ey.com Surabhi Marwah Tel: +91 11 4363 3167 Email: surabhi.marwah@in.ey.com Mayur Shah Tel: +91 22 6192 1104 Email: mayur.shah@in.ey.com Alok Agrawal Tel: +91 80 6727 5073 Email: alok.agrawal@in.ey.com Shalini Jain Tel: +91 11 4363 3166 Email: shalini.jain@in.ey.com SEBI has also widened the coverage of the types of schemes covered under the regulations including Stock Appreciation Rights Scheme, General Employee Benefits Scheme and Retirement Benefits Scheme in addition to the traditional Employee Stock Option Scheme and Employee Stock Purchase Scheme. 4 CIR/CFD/POLICYCELL/3/2014 dated 27 June 2014
Our offices Ahmedabad 2nd floor, Shivalik Ishaan Near. C.N Vidhyalaya Ambawadi, Ahmedabad 380 015 Tel: + 91 79 6608 3800 Fax: + 91 79 6608 3900 Bengaluru 12th & 13th floor U B City Canberra Block No.24, Vittal Mallya Road Bengaluru 560 001 Tel: + 91 80 4027 5000 + 91 80 6727 5000 Fax: + 91 80 2210 6000 + 91 80 2224 0695 Prestige Emerald, No. 4, 1st Floor, Madras Bank Road, Lavelle Road Junction, Bangalore - 560001 Chandigarh 1st Floor SCO: 166-167 Sectr 9-C, Madhya Marg Chandigarh 160 009 Tel: + 91 172 671 7800 Fax: + 91 172 671 7888 Chennai Tidel Park, 6th & 7th Floor A Block (Module 601,701-702) No.4, Rajiv Gandhi Salai Taramani Chennai 600 113 Tel: + 91 44 6654 8100 Fax: + 91 44 2254 0120 Hyderabad Oval Office 18, ilabs Centre, Hitech City, Madhapur, Hyderabad 500 081 Tel: + 91 40 6736 2000 Fax: + 91 40 6736 2200 Kochi 9th Floor ABAD Nucleus NH-49, Maradu PO, Kochi 682 304 Tel: + 91 484 304 4000 Fax: + 91 484 270 5393 Mumbai 14th Floor, The Ruby 29 Senapati Bapat Marg Dadar (west) Mumbai 400 028 Tel + 91 22 6192 0000 Fax + 91 22 6192 1000 5th Floor Block B-2, Nirlon Knowledge Park Off. Western Express Highway Goregaon (E) Mumbai 400 063 Tel: + 91 22 6192 0000 Fax: + 91 22 6192 3000 NCR Golf View Corporate Tower B Near DLF Golf Course, Sector 42 Gurgaon 122 002 Tel: + 91 124 464 4000 Fax: + 91 124 464 4050 6th floor, HT House 18-20 Kasturba Gandhi Marg New Delhi 110 001 Tel: + 91 11 4363 3000 Fax: + 91 11 4363 3200 4th & 5th Floor, Plot No 2B, Tower 2, Sector 126, Noida 201 304 Gautam Budh Nagar, U.P. India Tel: + 91 120 671 7000 Fax: + 91 120 671 7171 Pune C 401, 4th floor Panchshil Tech Park Yerwada (Near Don Bosco School) Pune 411 006 Tel: + 91 20 6603 6000 Fax: + 91 20 6601 5900 Ernst & Young LLP EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is one of the Indian client serving member firms of EYGM Limited. For more information about our organization, please visit www.ey.com/in. Ernst & Young LLP is a Limited Liability Partnership, registered under the Limited Liability Partnership Act, 2008 in India, having its registered office at 22 Camac Street, 3rd Floor, Block C, Kolkata 700016. 2014 Ernst & Young LLP. Published in India. All Rights Reserved. ED None This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither Ernst & Young LLP nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. Kolkata 22, Camac Street 3rd Floor, Block C Kolkata 700 016 Tel: + 91 33 6615 3400 Fax: + 91 33 2281 7750 EY refers to global organization, and/or one or more of the independent member firms of Ernst & Young Global Limited Join India Tax Insights from EY on