With mandatory share dematerialisation now in effect (deadline extended to June 30, 2025), over 1.7 million Indian private companies must manage ESOPs in electronic form. Rule 9B of the Companies Act has fundamentally changed how companies grant, manage, and transfer employee stock options.

This comprehensive guide explains everything HR managers, CFOs, Company Secretaries, and employees need to know about exercising ESOPs in the post-dematerialisation era.

What Changes After Dematerialisation?

Key Differences Between Physical and Demat ESOP Exercise

The shift from physical to dematerialised ESOPs represents a fundamental operational change:

Physical ESOP System (Pre-2025):

• Manual share certificates issued upon exercise

• Physical delivery and storage requirements

• Paper-based transfer procedures

• Processing time: 30-45 days

• Higher fraud and loss risk

Dematerialised ESOP System (Post-June 2025):

• Electronic shares credited directly to demat accounts

• Instant digital crediting (typically T+2 settlement)

• Automated record-keeping through depositories

• Processing time: 10-15 days

• Enhanced security with audit trails

The speed improvement is substantial. What once took over a month now happens in less than two weeks and once done, it can be tracked in real time, is tamper-proof and doesn't have the chance of getting lost/damaged unlike physical share certificates.

Regulatory Compliance Updates Under Rule 9B

Rule 9B, introduced in October 2023, mandates that all private companies (except small companies with paid-up capital ≤₹4 crore and turnover ≤₹40 crore) must issue securities only in dematerialised form by June 30, 2025. This includes:

• Mandatory demat issuance: All new ESOP exercises must result in electronic shares

• Corporate demat accounts: Companies must maintain ESOP pools in dedicated corporate demat accounts

• Zero physical certificates: No physical certificates can be issued for exercised shares post-deadline

• Quarterly reporting: Mandatory Form PAS-6 filing every six months with the Registrar of Companies

Form PAS-6 must be filed within 60 days from the end of each half-year (ending September 30 and March 31), requiring detailed reconciliation of share capital including ESOP exercises, forfeitures, and holdings.

Timeline Implications for Vesting Schedules

While vesting timelines themselves remain unchanged, the mechanics have evolved:

• Vesting confirmation: Automated through ESOP management systems

• Exercise window: Typically shortened from 90-120 days to 60-90 days due to faster processing

• Corporate actions: Bonus issues, stock splits automatically adjust ESOP pools in demat accounts

• Real-time tracking: Companies and employees can monitor vested vs unvested options instantly

Impact on Existing ESOP Agreements

Companies must update their ESOP schemes to include:

• Demat delivery clauses: Explicit mention that shares will be issued in dematerialised form only

• Revised grant letters: Updated templates specifying demat account requirements

• Exercise procedure updates: New documentation reflecting electronic processes

• Enhanced KYC: Stricter identity verification for employee demat accounts

How to Exercise ESOP in Demat Form?

Step 1: Vesting Confirmation and Employee Notification

Once options vest, companies must:

• Send automated vesting notifications through email or ESOP management platforms like Tabulate

• Provide detailed vesting certificates with exact share quantities

• Disclose the fair market value (FMV) as per the latest valuation report

• Specify the exercise window deadline (typically 30-90 days from vesting)

The FMV is crucial as it determines the perquisite tax liability at exercise.

Step 2: Exercise Notice Submission Process

Employees who wish to exercise their stock options must submit their exercise intention through a digital exercise notice (via email or company portal).

The format for the digital exercise notice is usually found in the grant letter or would be specified by the HR or the management at the time of exercise. The exercise notice must be accompanied by the following documents.

Required Documents for exercising ESOP:

• Copy of PAN card and Aadhaar for identity verification

• Demat account details (DP ID and Client ID)

• Signed acknowledgment of tax obligations

Exercise Price Calculation: The exercise price is predetermined in the grant letter, typically:

• Market value at grant date minus discount (if any)

• Nominal value (₹1-₹10 per share) for zero-cost options

• Discounted value per ESOP scheme terms

Step 3: Payment Mechanisms for Exercise Price

Companies offer multiple payment options for employees to exercise their stock options:

1. Bank Transfer: Direct payment to company's designated bank account with clear reference to employee ID and exercise request. The employee can simply provide the transaction reference ID to the company HR or ESOP admins to confirm the payment.

2. Salary Deduction: Deduction over 1-3 months from net salary. This is a less opted option and would have to be captured either on the stock option plan or grant letter or through a written consent by the employee. The exercise of the stock options usually happen once the entire amount has been paid.

3. Cashless Exercise: Company automatically sells a portion of shares to cover exercise cost and taxes—common during acquisitions or secondary sales of ESOP or ESOP buybacks.

Tax Note: The difference between FMV on exercise date and exercise price is taxed as a perquisite under "Income from Salary". Companies must deduct TDS at this stage.

Step 4: Share Allotment in Dematerialised Form

Post-payment, the company initiates allotment of the shares:

Process for allotting shares post exercising of ESOP:

1. Board resolution for share allotment (within 30 days of exercise)

2. Filing Form PAS-3 with MCA within 30 days of allotment

3. Instruction to depository for electronic credit to employee's demat account

4. ISIN-based share identification and tracking

Settlement: Shares typically credit to employee accounts within T+2 (2 working days) of allotment approval.

Step 5: Tax Obligations and TDS Procedures

Company's TDS Obligation: TDS must be deducted on the perquisite value at the employee's applicable income tax slab rate (typically 20-30%).

The company follows this process for deducting the TDS during ESOP exercising:

• Deducts TDS before share allotment and transfer of funds during acquisitions/buybacks

• Collects the TDS money upfront along with the exercise amount for employees

• Issues Form 16 reflecting ESOP perquisite and TDS deducted

• Files quarterly TDS returns (Form 24Q)

Did you know that you can actually defer paying ESOP perquisite tax?

Yes, you can avoid having to pay perquisite taxes while exercising ESOPs through a Special Provision for Eligible Startups: Employees of eligible startups (those with Inter-Ministerial Board certification) can defer perquisite tax payment until the earliest of: (a) 5 years from allotment, (b) date of sale, or (c) date of employment termination.

Wondering how taxation works for ESOP when exercised in India? Check out our detailed post on ESOPS and their Taxation in India.

Managing Different ESOP Categories

Vested but Unexercised Options

Where are vested but unexercised options stored?
All unexercised stock options need to be maintained in dematerialised format in the company's corporate demat account as a segregated ESOP pool.

Company's Compliance Requirements:

• Quarterly reconciliation with the ESOP option register

• Automatic lapse procedures for expired options

• Corporate action adjustments (bonus issues, splits) automatically reflected

• Real-time visibility into exercisable vs exercised shares

Exercised Shares

Once exercised and allotted, those shares are:

• Electronically transferred to employee demat accounts within T+2

• Free from physical certificate handling

• Tracked in real-time by both company and employee

• Subject to lock-in periods as per ESOP scheme terms (typically 1-3 years)

Unvested ESOPs

Unvested stock options are considered unallocated to anyone and needs to be maintained in the Central Pool Management:

• Maintained in company's ESOP reserve account

• Automated vesting schedule tracking through an ESOP management software like Tabulate

• Forfeiture handling for departed employees triggers automatic pool return

• Board-approved pool size adjustments for new grants

Forfeited Stock Options

When employees leave before vesting or fail to exercise, those stock options get forfeited:

• Forfeited stock options automatically return to ESOP pool

• Board resolution confirms forfeiture

• Updated option register maintained

• Quarterly reporting of forfeitures in Form PAS-6

Share Transfer to Personal Demat Accounts once Stock Options are Exercised

Employee Demat Account Opening Requirements

Employees cannot get shares allotted in companies that have dematerialised their equity unless they have a valid DEMAT account. Here is the process of creating one.

Documents Needed:

• PAN card (mandatory)

• Aadhaar card or other address proof

• Recent passport-size photograph

• Bank account proof (cancelled cheque)

Choosing a Depository Participant: Employees can open accounts with any SEBI-registered DP bank or financial institution to open a demat account. Popular options include:

• ICICI Bank, HDFC Bank, Kotak Securities

• Zerodha, Upstox, Groww (discount brokers)

• Sharekhan, Angel One

Costs:

• Account opening: ₹0-₹500 (many DPs offer free accounts)

• Annual maintenance charges (AMC): ₹200-₹2000

• Transaction charges: ₹10-₹25 per credit/debit transaction (or as charged by the broker/DP)

Transfer Process from Company to Individual Accounts

The electronic transfer process is straightforward:

Step 1: Company's depository participant (DP) initiates a Delivery Instruction Slip (DIS)

Step 2: Electronic transfer request sent to NSDL/CDSL (depending on depository)

Step 3: Employee's demat account credited within T+2 settlement cycle

Step 4: Both parties receive confirmation statements and SMS alerts

System Integration: Modern ESOP platforms like Tabulate integrate with DP systems to automate the entire transfer workflow without having to physically take care of the process.

Most Common Reasons for Rejection and Solutions to Fix That

Issue 1: Demat Account Details Mismatch

• Cause: Incorrect DP ID, Client ID, or account number

• Solution: Verify details directly with your DP before submission

Issue 2: KYC Non-Compliance

• Cause: Incomplete or outdated KYC documentation

• Solution: Complete In-Person Verification (IPV) and submit all required documents

Issue 3: Name Mismatch

• Cause: Name on PAN differs from demat account name

• Solution: Provide name change certificate or request demat account name correction

Issue 4: Frozen Demat Account

• Cause: Dormant account due to inactivity

• Solution: Contact DP to reactivate account with fresh KYC

ESOP Buyback Procedures for Dematerialised Shares

Legal Framework for ESOP Buybacks

Section 68 of the Companies Act, 2013 explicitly permits companies to buy back their own shares and ESOPs. For unlisted companies, this provides critical liquidity to employees who cannot sell shares in open markets.

Key Conditions:

• Buyback must be funded from free reserves or proceeds of fresh security issuance

• Board approval and (in some cases) shareholder approval required

• No fresh buyback can be made within 1 year of a previous buyback

• Companies cannot exceed 25% of total paid-up capital and free reserves in any buyback

Buyback Pricing Mechanisms and Valuation

Buyback pricing for unlisted companies requires:

Registered Valuer Assessment: Fair market value (FMV) must be determined by a SEBI-registered merchant banker or chartered accountant using:

• Discounted Cash Flow (DCF) method

• Comparable company multiples

• Net asset value method

• Recent funding round valuations (for startups)

Typical Pricing Approaches:

• At FMV: Standard approach for arms-length buybacks

• At discount: 10-20% discount to FMV due to illiquidity

• Premium pricing: In competitive talent markets, some companies offer premiums

Process for Dematerialised Share Buybacks

Step 1: Board resolution approving buyback price, quantity, and funding source

Step 2: Company sends buyback offer to eligible employees

Step 3: Employees accept or decline (voluntary participation)

Step 4: Electronic share transfer from employee demat account to company's corporate demat account

Step 5: Payment processing within 7-15 days of share transfer

Step 6: Company updates Register of Buyback (Form SH-10) with consideration paid, date of cancellation, and extinguishment of shares

Tax Implications for Employees

Capital Gains Taxation: When employees sell shares in a buyback, gains are calculated as sale price minus FMV on exercise date.

Holding Period Determines Tax Treatment:

• Short-term (shares held ≤24 months for unlisted companies): Taxed at applicable income tax slab rates

• Long-term (shares held >24 months): Taxed at 12.5% on gains exceeding ₹1.25 lakh

Example Calculation:

• FMV at exercise: ₹500 per share

• Buyback price: ₹800 per share

• Shares sold: 1,000

• Holding period: 30 months (long-term)

Capital gain = (₹800 - ₹500) × 1,000 = ₹3,00,000 Tax = 12.5% on (₹3,00,000 - ₹1,25,000) = ₹21,875

Timeline and Compliance Framework

Complete ESOP Exercise Timeline Post-Dematerialisation

Day 0: Vesting confirmation sent to employee

Days 1-90: Exercise window (employee must submit exercise notice)

Days 91-120: Payment processing and exercise price collection

Days 121-150: Board resolution and Form PAS-3 filing

Days 151-153: Electronic crediting to employee demat account (T+2)

Total: 4-5 months from vesting to share receipt (compared to 6-8 months pre-dematerialisation)

Quarterly Compliance Reporting Requirements

Form PAS-6 Filing: Must be filed within 60 days of each half-year end (September 30 and March 31), detailing issued capital, shares in demat form, and changes including ESOP exercises, forfeitures, and buybacks.

Penalties for Non-Compliance: Initial penalty of ₹10,000 for the company, plus ₹1,000 per day of continuing default (maximum ₹2,00,000 for company and ₹50,000 per officer in default).

Audit and Verification Processes

Internal Audit Requirements:

• Quarterly ESOP process audit

• Reconciliation of granted, vested, exercised, and forfeited options

• Demat account balance verification

Statutory Auditor Verification:

• Annual verification of ESOP grants and exercises

• Tax compliance verification (TDS deducted correctly)

• Balance sheet disclosure verification

Secretarial Audit:

• Company Secretary must certify Form PAS-6

• Compliance with Rule 9B and ESOP scheme terms

• Board resolution adequacy check

Tax Implications and Reporting

Tax Benefits for Eligible Startup ESOPs

Employees of eligible startups (recognized under Section 80-IAC with Inter-Ministerial Board certification) can defer perquisite tax on ESOP exercise until the earliest of: 5 years from allotment, sale of shares, or termination of employment.

Eligibility Criteria for Startups:

• Incorporated as a private limited company

• Turnover less than ₹100 crores in any financial year

• Entity working toward innovation or improvement of products/processes

• Holds recognition from Department for Promotion of Industry and Internal Trade (DPIIT)

Employee Benefits:

• Deferred tax liability (no immediate cash outflow for taxes)

• Tax payment aligned with liquidity event (sale or exit)

• Better financial planning flexibility

TDS Obligations for Companies

At Exercise: Employers must deduct TDS under Section 192 on the perquisite value (FMV minus exercise price) at the employee's applicable tax slab rate.

Quarterly TDS Returns:

• Form 24Q must be filed quarterly

• Include ESOP perquisites in salary computation

• Provide Form 16 to employees with ESOP income breakup

Payment Timeline:

• TDS must be paid to government by 7th of the following month

• Failure attracts interest at 1-1.5% per month plus penalties

Employee Tax Obligations and Planning

Advance Tax Payments: Employees must pay advance tax if TDS is insufficient (happens in cashless exercise scenarios where only partial TDS is deducted).

Capital Gains Planning:

• Hold shares for >24 months to get lower long-term capital gains rate

• Consider Section 54 exemptions for reinvestment in residential property

• Plan sales across multiple financial years to optimize tax brackets

GST Implications on Service Charges

ESOP Administration Services: External ESOP administrators and consultants charge 18% GST on their fees.

Input Tax Credit: Companies can claim input tax credit on GST paid, reducing the effective cost of ESOP administration.

Common Challenges and Solutions

Challenge 1: Technical Issues with Demat Transfers

Problem: System integration failures between ESOP platforms and depositories leading to delayed transfers.

Solutions:

• Implement API-based integrations with NSDL/CDSL

• Maintain backup manual processes for critical failures

• Negotiate strong SLAs with technology vendors (99.5% uptime minimum)

• Conduct quarterly system testing and disaster recovery drills

Challenge 2: Employee Onboarding for Demat Accounts

Problem: Employees lack awareness about demat accounts and hesitate to open them.

Solutions:

• Conduct regular employee education webinars

• Provide step-by-step account opening guides with screenshots

• Arrange bulk account opening tie-ups with preferred DPs

• Offer HR helpdesk support for account-related queries

• Consider bearing demat account opening costs for employees

Challenge 3: Valuation Disputes

Problem: Disagreements between employees and company on fair market value for buybacks.

Solutions:

• Engage independent registered valuers for transparent FMV assessment

• Include arbitration clauses in ESOP agreements

• Provide detailed valuation report explanations to employees

• Consider multiple valuation methodologies for reasonableness check

Challenge 4: System Integration

Problem: Disconnected HR, payroll, and ESOP management systems cause data inconsistencies.

Solutions:

• Implement integrated ESOP-HR-payroll platforms with real-time sync

• Establish monthly reconciliation procedures

• Assign dedicated ESOP administrator for data quality

• Use professional implementation partners for system setup

Best Practices for Companies

ESOP Policy Updates Post-Dematerialisation

Essential Updates:

• Add explicit demat delivery clauses in scheme documents

• Update exercise procedure sections with new timelines

• Include demat account opening requirements in grant letters

• Add provisions for handling rejected demat transfers

Review Frequency: Annual policy reviews to incorporate regulatory changes.

Employee Communication Strategies

Proactive Communication:

• Quarterly ESOP statements showing vested, unvested, and exercisable options

• Pre-vesting reminders (60 days before vesting)

• Tax education sessions explaining perquisite and capital gains implications

• One-on-one counseling for high-value ESOP holders

Communication Channels:

• Dedicated ESOP portal for self-service information

• Email notifications for all ESOP events

• Quarterly town halls addressing common questions

• Printed ESOP handbooks for new joiners

Technology Platform Selection

Key Features to Evaluate:

• Integrated demat connectivity with NSDL/CDSL

• Real-time vesting and exercise tracking

• Automated tax calculation and TDS processing

• Employee self-service portal with mobile app

• Compliance automation (Form PAS-6, PAS-3 filing)

• Scenario modeling for exercises and buybacks

Leading Platforms: Qapita, Trica Equity, Tabulate, EquityList

Legal Compliance Checklist

Monthly:

• Update option register with new grants, exercises, forfeitures

• Reconcile corporate demat account balances

Quarterly:

• File TDS returns (Form 24Q)

• Conduct internal ESOP compliance review

Half-Yearly:

• File Form PAS-6 within 60 days of half-year end

• Board meeting to review ESOP status

Annually:

• Obtain fresh FMV valuation report

• Statutory and secretarial audit of ESOP processes

• Review and update ESOP policy

Frequently Asked Questions

Can I exercise ESOPs if I don't have a demat account?

No. Post-dematerialisation mandate (June 30, 2025), all exercised shares must be credited to demat accounts only. Companies cannot issue physical certificates. You must open a demat account before exercising your options.

What happens to my vested ESOPs if I resign before exercise?

Typically, ESOP schemes provide a 30-90 day window post-resignation to exercise vested options. After this period, unexercised options lapse as per scheme terms. Check your grant letter for exact timelines.

How are corporate actions handled for ESOP pools?

Bonus issues and stock splits automatically adjust ESOP pools in demat accounts. For example, if you have 1,000 unvested options and the company declares a 1:1 bonus, your unvested options become 2,000. Rights issues require separate board approval and typically aren't applicable to unvested options.

Can foreign employees exercise ESOPs in dematerialised form?

Yes, Non-Resident Indians (NRIs) can exercise ESOPs through NRI demat accounts (NRE or NRO accounts). Additional compliance includes:

• Form OPI filing by the Indian employer with RBI within 60 days of exercise

• FEMA compliance for repatriation of sale proceeds

• Documentation of source of funds for exercise price payment

What if my company doesn't have ISIN for ESOP shares?

Companies cannot file Form PAS-6 or issue shares in demat form without obtaining an ISIN from NSDL or CDSL. Employees must wait until the company completes ISIN registration. This typically takes 30-45 days after applying to the depository.

How is fair market value determined for unlisted company ESOPs?

FMV must be determined by a registered valuer using internationally accepted methods:

• Discounted Cash Flow (DCF): Projects future cash flows and discounts to present value

• Comparable Company Method: Uses valuation multiples of similar listed/unlisted companies

• Net Asset Value: For asset-heavy businesses

• Recent Funding Rounds: Often used for startups (with appropriate adjustments)

Can I transfer exercised ESOP shares immediately?

No. ESOP schemes typically impose lock-in periods of 1-3 years from the exercise date. During lock-in, shares are credited to your demat account but marked as "frozen for debit"—you own them but cannot sell. After lock-in expiry, shares become freely transferable (subject to company's right of first refusal if applicable).

What happens to ESOPs during company merger or acquisition?

This depends on scheme terms and merger agreement. Common scenarios:

• Conversion: Your ESOPs convert to acquiring company's ESOPs at agreed exchange ratio

• Cash-out: Company buys back all ESOPs at FMV before merger

• Accelerated vesting: Unvested options immediately vest allowing exercise before deal closure

Always review the merger announcement carefully for ESOP treatment details.

How are ESOP buybacks processed in demat form?

The process is entirely electronic:

1. Company makes buyback offer specifying price and quantity

2. Employees accept via written consent

3. Employee's DP initiates transfer from employee demat account to company demat account

4. Settlement happens within T+2

5. Company credits buyback consideration to employee's bank account within 7-15 days

No physical certificates change hands at any stage.

What if there are signature mismatches during ESOP exercise?

Similar to regular demat procedures, companies will:

• Request fresh signature specimens on company letterhead

• Require notarization or attestation by authorized persons

• In case of married women with name changes, request marriage certificate

• For persistent mismatches, require legal affidavits confirming identity

Next Steps

The dematerialisation of shares has fundamentally transformed ESOP management in India. While it adds complexity to compliance requirements, it also brings substantial benefits:

For Companies:

• Faster processing reduces administrative burden

• Reduced fraud risk through electronic audit trails

• Improved employee experience with real-time tracking

• Better corporate governance through transparent reporting

For Employees:

• Secure ownership without physical certificate risks

• Instant portfolio tracking

• Simplified share transfers and buybacks

• Professional wealth management integration

How Tabulate Can Help

Tabulate offers a comprehensive ESOP lifecycle management platform designed for the post-dematerialisation era:

Key Features:

• Complete ESOP exercise management

• Seamless NSDL/CDSL integration for automated demat transfers

• Real-time vesting, exercise, and compliance tracking

• Automated TDS calculations and Form 16 generation

• Employee self-service portal with tax planning tools

• Expert consultation and implementation support

Get Started: Schedule a demo at https://incentiv.finance/tabulate or contact our ESOP specialists at [email protected].

Disclaimer: This guide is for informational purposes only and does not constitute legal, tax, or financial advice. Companies should consult qualified professionals for specific guidance on their ESOP programs.