Sweat Equity
Sweat equity shares are issued to employees or directors for services, IP, or know-how, instead of cash. They are taxed as perquisite at FMV on the date of allotment.
What is Sweat Equity?
Sweat equity is when a company issues shares for non-cash consideration, like services rendered, intellectual property contributed, or value addition by a key person. Section 54 of the Companies Act and SEBI regulations govern sweat equity issuance. Tax-wise, sweat equity shares are perquisites under Section 17(2) of the Income Tax Act. The employee is taxed on the FMV of shares on the date of allotment, since they paid nothing or less than FMV. This perquisite is added to salary and TDS applies. When the employee later sells the shares, the gain (sale price minus FMV at allotment) is capital gains, taxed based on holding period. Founders often get sweat equity instead of salary in early-stage startups.
Example
Founder gets 1L sweat equity shares of FMV ₹50 each. Perquisite at allotment = 1L x 50 = ₹50L taxed at slab via TDS. After 3 years, sells at ₹200. Capital gain = 1L x (200-50) = ₹1.5Cr taxed as LTCG.
How Sweat Equity is used
Coordinate with finance on FMV valuation report (registered valuer). Add the perquisite value in the payroll month of allotment. Issue Form 16 with the perquisite breakup.
Sweat Equity FAQs
How is sweat equity different from ESOP?
ESOP is an option to buy shares later at a set price. Sweat equity is shares issued upfront for services or IP, no exercise involved.
Is sweat equity taxable?
Yes. FMV on allotment is taxable as perquisite. Sale gain is capital gains.
Who can get sweat equity?
Permanent employees and directors who have served at least one year in the company, plus founders in some cases. Companies Act has specific rules.