Why corporates choose to implement stock schemes via Trust route

Employee Stock Awards (stock awards) is awell-knowncompensation reward strategy implemented by many organisations for their employees.While the advantages of introducing a stock awards scheme are manifold, many companies are not aware of the business and regulatory considerations of such awards.

Since the stock scheme would involve issuance of shares to the employees, the provisions of the Companies Act, of the Securities and Exchange Board of India ('SEBI') regulations and that of tax lawswill also need to be considered.

Indian companies need to comply with Companies Act, 2013, read withCompanies (Share Capital and Debentures) Rules, 2014 ('Rules') for implementation of stock award schemes. Additionally, listed companies also need to comply with specified SEBI regulations. Many corporates create a stock pool by issuance of new shares.

However, this would result in increased share capital (i.e. dilution). Hence, many companies may choose to meet the requirement through secondary purchase. Let us dwell on why corporates may choose to implement the scheme through a Trust and the process required for the same.

Trust Route

There are several business or regulatory considerations that may drive corporates to use an Employee Trust ('Trust') for implementation and management of such employee stock award scheme(s).Some of these are -

• Better governance and implementation by an independent entity
• Intention to meet the stock requirement through secondary acquisition (i.e. purchase of listed shares from the market to be allotted to the employees
• Provision of an easy route for encashment for employees of unlisted companies as there is no market for their securities

However, traditionally it has been observed that the Trust route has been subject to misuse and hence there are certain regulatory factors which need to be considered foremployee stock award scheme(s). Corporates would need to establish a Trust under the Indian Trust Act. Further,approval of shareholders has to be taken upfront for implementation via the Trust.

Some other important factors to be considered are:

• The Trust will need to be funded by the company for purchase / subscription to the shares of the company. For this purpose:

1. The scheme for provision of money has to be approved via a special resolution in a general meeting;
2. If shares are listed, such purchase shall be made only through recognised stock exchanges and not by way of private offers or arrangements;
3. For unlisted shares, purchase price valuation to be made by a registered valuer;
4. Specified limits on the value of shares that can be purchased/subscribed to be met;
5. Additional disclosures to be given in the explanatory statement to be annexed to the notice convening the general meeting, etc.

• For a listed company, there are certain additional conditions mentioned under the SEBI regulations. We have mentioned a few of them below:

1. If the scheme involves secondary acquisition or a gift or both, then it is mandatory for the company to implement the scheme through the Trust;
2. It is possible to implement several schemes via a single Trust. However, such Trust shall keep and maintain proper books of accounts, records and documents for each such scheme;
3. Specified persons cannot be appointed as trustees (e.g.- director, key managerial personnel, promoters etc.);
4. Trustee of such a Trust will not have voting rights for shares held by such Trust ;
5. Trust is not permitted to deal in derivatives and should undertake only delivery-based transactions;
6. For the purposes of disclosures to the stock exchange, the shareholding of the Trust shall be shown as 'non-promoter and non-public' shareholding;
7. Secondary acquisition in a financial year by the Trust shall not exceed specified limits;
8. The shares acquired through secondary acquisitions are required to be held for a minimum 6 months period subject to conditions as provided in the SEBI regulations;
9. The Trust shall be required to make disclosures and comply with the other requirements applicable to insiders or promoters under the SEBI (Prohibition of Insider Trading) Regulations;
10. Specified accounting and disclosure requirements also need to be complied with by the Trust; etc.

As can be seen from above, for use of the Trust route it is imperative to understand applicable regulatory considerations, apart from business considerations. Further, the Trust may also have potential tax implications that need to be examined. The stock award income will be taxable in the hands of employees as per specified provisions. Thus, apart from the above regulatory considerations, it is also imperative to evaluate overall tax implications because of the use of Trust route.

(Information for the editor for reference purposes only)

(Aarti Raote is Partner with Deloitte India, Jimish Vakharia, is Senior Manager and Mayur Deokar, is Deputy Manager, Deloitte Haskins & Sells LLP)