Sweat equity shares are equity shares a company issues to its directors or employees at a discount, or for no cash, in return for know-how, intellectual property or other value they bring. They are allotted outright, not as options, so unlike an ESOP there is no waiting to exercise; the benefit is taxed as a perquisite on allotment.

Conditions under the Companies Act

Section 54 of the Companies Act, 2013 and Rule 8 of the 2014 share capital rules govern unlisted companies; listed companies have a separate SEBI rulebook, issued in 2021, that covers sweat equity alongside employee share schemes. For an unlisted company the main conditions are:

• A special resolution of shareholders, with allotment completed within 12 months of it.
• A price set by a registered valuer, with a written justification for the value of the know-how or contribution.
• A cap of 15% of existing paid-up equity capital in a year or shares with an issue value of Rs 5 crore, whichever is higher, and 25% of paid-up equity in total at any time.
• A DPIIT-recognised startup can go up to 50% of paid-up capital within ten years of incorporation (raised from five years by a 2020 amendment).
• A three-year lock-in from the date of allotment.

Rule 8 counts a permanent employee who has worked for at least one year, a director (whole-time or not), and staff or directors of the holding or subsidiary company as eligible.

How it is taxed

The perquisite is fair market value on allotment minus anything the employee paid. Suppose a product head receives 10,000 shares free when the merchant banker’s valuation is Rs 150 a share: Rs 15,00,000 is added to salary for the year, and the employer must deduct TDS on salary on it even though no cash changed hands. The old Act’s perquisite clause covers this for FY 2025-26, and the 2025 Act carries it over from tax year 2026-27 with the same definition of sweat equity. On sale, the Rs 150 becomes the cost for capital gains, and the holding period runs from allotment.

Frequently asked questions

Can a founder get sweat equity?

Yes, a founder who is a director can be allotted sweat equity, which is one reason startups use it to reward a technical co-founder. Shareholder approval and the valuation step still apply.

Can an eligible startup defer the tax?

Yes. The deferral for eligible startups covers sweat equity as well as options, so TDS under Section 192 (Section 392(3) from tax year 2026-27) moves to the earliest of sale, exit, or the end of the statutory window.

Is sweat equity the same as a joining bonus in shares?

No. A share grant has to come through one of the routes the law allows. Sweat equity is tied to a contribution such as know-how or IP, while routine retention is better handled through options, RSUs or variable pay.

For the payroll arithmetic behind any non-cash benefit, the perquisite valuation page walks through each method.