The latest Report of the Company Law Committee presented in 2022 has recommended numerous changes in the Companies Act, 2013. Apart from removing ambiguities, streamlining process for audit, mergers etc., tightening compliances and promoting further ease of doing business, the report has also introduced certain new concepts. Restricted Stock Units (RSUs) and Stock Appreciation Rights (SARs) are two such new concepts. These may be issued to employees of a company in addition to monetary remuneration. The report has recommended insertion of enabling provisions in the CA 2013 for issuance of RSUs and SARs.
What are RSU and SRA?
The committee was of the opinion that in addition to monetary remuneration, the employees a company may be paid compensation that is linked to its shares, thus granting the employees ownership rights in the company. These schemes allow employees to subscribe to the company’s equity capital.
Restricted Stock Units (RSUs) have in the recent years become quite popular among venture companies as a hybrid of stock options and restricted stock. These, however, do not give the employee an option to purchase or subscribe to the company’s shares directly. Rather under this scheme there will be a vesting period and the employee will be entitled to the shares at the end of the vesting period, subject to the conditions related to the duration of employment and performance of the employee being met. In effect it is a promise by the employer to grant restricted stock to an employee at a specified point in the future in (delayed) recognition of the employee’s contribution. These are also known as restricted securities and are fully transferable from the issuing company to the receiving employee until certain conditions (or restrictions) have been met. Only upon satisfaction of those conditions, the restriction is removed, and the stock becomes transferable to the said employee.
Stock Appreciation Rights (SARs), on the other hand, are incentive or deferred compensation tied to the performance of the company’s stock. This right provides the employees the monetary equivalent of the appreciation in the value of a specified number of shares over a specified period. It is like an award which provides the employee the opportunity to profit from the appreciation in share value of the company over a certain period of time. It may also be paid by way of shares of the company. It is like a bonus where the company performs well financially over period. Although SARs resembles employee stock options, unlike the latter an employee does not need to buy or hold shares of the company to benefit from an increase in the stock value. In many jurisdictions worldwide SARs is also referred to as phantom stock. But while phantom stock may pay dividends, SARs cannot.
While SARs have been defined under the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021, there is no existing definition or regulation for RSUs as of now. The Committee’s recommendation is to recognize both the concepts under the Companies Act, 2013.
How to issue RSA and SAR?
In order to make RSUs and SARs a reality, the Company Law Committee in its report has proposed amendment to section 62(1) of the Companies Act, 2013. The committee has proposed that if a company proposed to use these schemes, it will require the issue of further securities by the company. Such issuance can only be done after the approval of the shareholders by a special resolution. The enabling framework in the Companies Act, 2013 should also contain provisions of an annual omnibus approval by the shareholders of the company to avoid fresh approvals each time such allotment is planned.
Accounting and Tax Implications
These plans are like deferred cash compensation and have a lot of accounting and tax implications. As for accounting, the companies will have to figure out how to pay for the shares that the employees want to cash in. Further, the issuing company should not only make the promise to pay, it should actually put aside the funds. Worldwide, restricted stock has an edge over employee stock options, because of favourable accounting rules and income tax treatment. If the recommendations of CLC sees the light of the day, a lot of necessary amendments will also have to be made in the Income Tax Act.