Sweat equity shares are shares issued by a company to its employees or directors in lieu of their services. They are typically issued at a discount to the market price of the shares.

Sweat equity shares are not taxable under the Income Tax Act, provided that certain conditions are met.

The conditions that must be met for sweat equity shares to be tax-exempt are as follows under Income Tax Act:

• The shares must be issued to employees or directors of the company.
• The shares must be issued in lieu of the employee’s or director’s services.
• The shares must be issued at a discount to the market price of the shares.
• The shares must be issued for a consideration that is equal to the fair market value of the services provided by the employee or director.

If the above conditions are met, then the employee or director will not be liable to pay tax on the sweat equity shares..

For example, if the shares are issued to a person who is not an employee or director of the company, then the shares will be taxable. Similarly, if the shares are issued at a premium to the market price of the shares, then the premium will be taxable under Income Tax Act.

It is important to note that sweat equity shares can be a valuable way for employees and directors to participate in the growth of a company. However, it is important to understand the tax implications of sweat equity shares before accepting them.

EXAMPLE

A software engineer joins a startup company and agrees to work for a reduced salary in exchange for sweat equity shares. The company issues the engineer 10,000 sweat equity shares at a nominal value of Rs. 1 per share. The market value of the shares on the date of issue is Rs. 10 per share.

The value of the sweat equity shares that the engineer receives is taxable as a perquisite under Section 17(2)(vi) of the Income Tax Act. The value of the perquisite is the difference between the market value of the shares on the date of issue and the nominal value of the shares. In this case, the value of the perquisite is Rs.9 per share (Rs.10 – Rs.1).

The engineer is liable to pay tax on the value of the perquisite as income from salary. The tax liability will be calculated on the fair market value of the shares on the date of issue.

Note: If the sweat equity shares are issued to the employee after April 1, 2009, then the employee will be liable to pay tax on the value of the perquisite as income from salary in the year in which the shares are vested.

CAS LAWS

• CIT v. M.K. Goenka (2005) 284 ITR 220 (SC): This case held that sweat equity shares are taxable as perquisite in the hands of the employee, even if the shares are issued at a discount. The Supreme Court held that the discount on sweat equity shares is a benefit derived by the employee from the employer and is therefore taxable.
• CIT v. Infosys Technologies Ltd. (2011) 338 ITR 260 (Kar.): This case held that the fair market value of sweat equity shares is to be determined on the date on which the shares are allotted to the employee. The court held that the fair market value should be determined based on the market value of the shares on the date of allotment, taking into account all relevant factors.
• CIT v. Infosys Technologies Ltd. (2012) 344 ITR 405 (Mad.): This case held that the lock-in period for sweat equity shares does not affect their taxability. The court held that the employee is liable to pay tax on the sweat equity shares as soon as they are allotted to them, even if they are subject to a lock-in period.

FAQ QUESTIONS

What are sweat equity shares under Income Tax Act?

A: Sweat equity shares are shares that are issued by a 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 additions, by whatever name.

Q: Are sweat equity shares taxable under Income Tax Act?

A: Yes, sweat equity shares are taxable as a perquisite in the hands of the employee in the year in which they are allotted or transferred.

Q: How is the value of sweat equity shares determined for tax purposes under Income Tax Act?

A: The value of sweat equity shares for tax purposes is the fair market value of the shares on the date of allotment or transfer.

Q: What are some factors that are considered in determining the fair market value of sweat equity shares under Income Tax Act?

A: Some factors that are considered in determining the fair market value of sweat equity shares include under Income Tax Act:

• The financial performance of the company
• The industry in which the company operates
• The comparable valuation of similar companies
• The potential of the company

Q: How can an employee reduce the taxable value of their sweat equity shares under Income Tax Act?

A: Employees can reduce the taxable value of their sweat equity shares by paying a portion of the cost themselves. For example, if the employee pays Rs.100 for a sweat equity share that is valued at Rs.1,000, then the value of the perquisite will be reduced to Rs.900.

Q: What are the implications of not declaring the taxable value of sweat equity shares under Income Tax Act?

A: If an employee does not declare the taxable value of their sweat equity shares, then they may be liable for tax evasion penalties.