This article is written by Koomar Bihangam Choudhury pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from Lawsikho.
In India, the terms of employment differ among two classes of employees i.e. ‘workmen’ and ‘non-workers’. Workman is defined under Section 2(s) of the Industrial Disputes Act as “any person (including an apprentice) employed in any industry to do any manual, unskilled, skilled, technical, operational, clerical or supervisory work for hire or reward…” However, sub-clauses (iii) and (iv) to Section 2(s) provides that personnel who have managerial, administrative or supervisory functions and who earn compensation above specified thresholds respectively are not included in the category “workman”. Although not defined statutorily anywhere, with help of judicial precedents we can refer to such class of employees as “executive employee”. They are persons whose duties relate to active participation in control, supervision and management of the business, or who administer affairs, or who direct, manage, execute or dispense.
Employee benefits are the non-financial benefits that are offered to the employees apart from their salaries. These benefits are broadly divided into two categories; mandatory and discretionary. Both the categories are governed by various statutes which prescribe the rules for the same. These employee benefits which are mandatory include gratuity, paid leaves, maternity leaves, statutory bonuses etc. while discretionary ones include contractual bonuses, Employee Stock Option Plans (ESOP) etc.
Employment is a subject under the concurrent list of the Indian Constitution and thus under ordinary circumstances both the state as well as the union government has authority to make laws on it. In terms of executive compensations, which are not mandatory under the statute and are rather discretionary, the employers are given flexibility in structuring these; however, they must take into consideration the thresholds stipulated by specific legislation, such as:
- The Minimum Wages Act, 1948 (the lower threshold of wages);
- The Companies Act 2013 (Higher threshold of the remunerations payable to the senior level employees).
- In case of Publicly Traded Companies disclosure under rule number 23(9), 30, 31A and 32(7A) etc. of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations).
In this article, we shall now read about some common employee benefits and employee compensations; statutory provisions thereof; how they are drafted into employment contracts and what their purpose is.
What are mandatory benefits?
At the end of World War I, certain textile mills in India granted 10% of wages as a war bonus to their workers in 1917. The government taking a cue from this established a commission to make recommendations on the profit-based bonus scheme for the employees. The Government of India accepted the recommendations of this Commission and “The Payment of Bonus Act” was introduced in the Parliament in the year 1965. It was amended twice: once in 2015 and once in 2019.
The chief objective of this act was to impose a legal responsibility upon the employer of every establishment covered under the Payment of Bonus Act to pay at least a minimum bonus to employees earning up to a fixed amount of salary, give the formula to calculate that bonus and put a cap on the minimum and maximum sum to be paid as such bonus.
The Payment of Bonus Act, 1965, is only applicable when all of the following conditions are met:
- The company has at least 20 employees.
- The employee’s wages are not more than 21,000 every month.
Earlier this act only covered employees that were earning up to ₹ 10,000 per month. However, the amendment has raised this ceiling to ₹ 21,000. The employers will have to pay employees that fall between the ₹ 10,000 and ₹ 21,000 the pending bonus amounts since 1st April 2014.
Every employee shall be entitled to receive a bonus, in accordance with the provisions of the act, if he has worked for not less than 30 working days in that year. An employee under the Act means any person:
- Who is not an apprentice,
- Who is engaged for hire/reward,
- The terms of his employment are either express or implied, and
- Is doing any skilled or unskilled manual or supervisory or managerial or administrative or clerical or technical work.
- Is not drawing salary/wages exceeding ₹ 21,000 per month.
Calculation and payment of bonus
Every employee not drawing salary/wages beyond ₹ 21,000 per month who has worked for not less than 30 days in an accounting year, shall be eligible for a bonus for a minimum of 8.33% of the salary/wages, even if there is a loss in the establishment. If an employee is earning in a range of ₹7,000 to ₹21,000, then for the purpose of the Payment of Bonus Act the salary shall be deemed to be ₹ 7,000 per month.
Where the allocable surplus exceeds the amount of minimum bonus payable to the employees under Section 10 of the Act, the employer shall be bound to pay bonus in that accounting year in proportion to salary during that accounting year subject to a maximum of 20% of the earned wages in that year.
Section 2(4) of The Payment of the Bonus Act defines “allocable surplus” as
- 67% of the available surplus in an accounting; year; in the case company which:
- Is not a banking company and
- In relation to its employees, it has not made the arrangements under Section 194 of the Income-tax Act for the declaration and payment of the dividends payable out of its profits.
2. In any other case, 60% of such available surplus.
This bonus must be paid within eight months of the closure of the accounting year.
Provident Fund is a publicly managed old-age income security program. It is basically a social security scheme. It works on a model fixed under the. Under the Employees’ Provident Fund and Miscellaneous Provisions Act, 1952 (“EPF Act”), all organizations with more than 20 employees are required to register with the EPFO. When an individual starts working in an establishment with more than 20 employees, both the individual, i.e. the employee, and the employer are required to contribute a certain percentage of the basic pay to the EPF account.
EPF Model and Working Scheme
Let’s understand how this model works. For example, say an employee earns ₹ 10000 per month. Under the EPF Act, 12% of this amount, i.e. ₹ 1200 gets deducted at the end of each month. Now this money is put into a pool, i.e. the EPF account. The employer of this employee also has to contribute the same percentage, i.e. 12% of this salary at the end of this month. Now, where does this contribution go? 3.67% of the employer’s contribution goes to the EPF account and the rest 8.33% goes to the pension scheme. Thus the EPF account now has (12% + 3.67%) of the basic pay, i.e. a total of ₹ 1567 getting pooled every month.
There are separate provisions for the organizations where there are 20 or less than 20 employees /organizations with losses incurred more than or equal to the net worth (at the end of financial year) /organizations declared sick by the Board for Industrial and Financial Reconstruction. They only have to contribute 10% to the EPF.
Management of fund and calculation of interest thereupon
The government pools together all incoming provident funds and entrusts them to a trust. This trust, also established by the government, invests these funds into various securities and generates average annual interest in the range of 8% to 13%. As per the figures on the official EPF website, the interest rate applicable on the PF is 8.75%, which is paid annually. The compound interest is paid on the opening balance (the amount accumulated till the date of computing) every year on 1st April.
Exception from Income Tax
Under the Income Tax Act, 1961, the interest earned on the EPF investment, and the amount an employee eventually withdraw from the EPF account are exempted from income tax. Also, the employer contribution to the EPF is tax-free.
Withdrawal of the Provident Fund
These are the processes of withdrawing a provident fund
- Retirement or after attaining the age of 55 years.
- If unemployed for two months after resigning or losing a job, 75% may be withdrawn post 1 month of unemployment.
- If the member is permanently settling abroad.
- 90% of the Fund may be withdrawn if the Subscriber has attained the age of 54 and the rest a year later.
Employees’ State Insurance Scheme of India is an integrated social security scheme tailored to provide social protection to workers and their dependents, in the organized sector, in contingencies, such as sickness, maternity and death or disability due to an employment injury or occupational hazard.
The ESI Act, (1948) applies to the following categories of factories and establishments:
- Non-Seasonal, using power and employing 10 or more workers.
- Non-Seasonal, not using power and employing 20 or more workers.
- Seasonal, not using power and employing 20 or more workers.
Although the ESI act is enacted by the centre but by virtue of the seventh schedule of the Indian Constitution, most of the state governments have extended the ESI Act to certain specific classes of establishments; shops, hotels, restaurants, cinemas, preview theatres, motors transport undertakings and newspaper establishments etc., which are employing 20 or more persons.
Financing of the insurance scheme
The ESI Scheme is mainly financed by contributions raised from employees covered under the scheme and their employers, as a fixed percentage of wages. Employees of covered units and establishments drawing wages up to ₹10,000/- per month come under the purview of the scheme for social security benefits. However, employees’ earning up to ₹50/- a day as wages are exempted from payment of their part of the contribution. The State Governments bear a one-eighth share of expenditure on medical benefits within the per capita ceiling of ₹900/- per annum and all additional expenditure beyond the ceiling.
Benefits under ESI
Employees covered under the scheme are entitled to:
- Medical facilities in ESIC hospitals for self and dependents.
- Cash benefits in the event of specific contingencies resulting in loss of wages or earning capacity such as disability.
- Maternity benefits for insured women.
- If an insured person passes away due to employment injury, his dependents are eligible for family pension.
Maternity leave is a statutory leave. It is predominantly covered under the Maternity Benefit Act, 1961 which was enacted to regulate the employment of women in certain establishments for certain periods before and after child-birth and to provide for maternity benefit and certain other benefits. A few other laws also cover maternity leave and provisions thereof.
Leave and pay structure under The Maternity Benefit Act, 1961
- According to the Maternity Benefit Act, female workers are entitled to a maximum of 26 weeks of maternity leave.
- In case of miscarriage or MTP (medical termination of pregnancy), a worker is entitled to 12 weeks of paid maternity leave.
- The parental leave is provided for eight weeks. Prenatal leave is leave that allows an employee time to care for their newly born or adopted child.
- A woman with already two or more children is entitled to 12 weeks of maternity leave. The prenatal leave in this case remains six weeks.
- A commissioning mother is also entitled to a 12-week leave from the date the child is handed over to her. A commissioning mother is defined as a biological mother who uses her egg to create an embryo implanted in any other woman (i.e. the surrogate mother).
- The Act also provides for adoption leave of 12 weeks for a woman who adopts a child under the age of 3 months.
- The Act further requires an employer to inform a woman worker of her rights under the Act at the time of her appointment. The information must be given in writing and in electronic form (email).
Leave and pay structure under other statutory provisions
- Female civil servants are entitled to maternity leave for a period of 180 days for their first two liveborn children.
- Under the National Food Security Act 2013, pregnant women and lactating mothers are entitled to receive maternity benefits of at least ₹ 6,000.
Gratuity means, “Something voluntarily given in return for a favour or especially a service.” In India, it is regulated under the Payment of Gratuity Act, 1972. The Act provides for payment of gratuity at the rate of:
- 15 days wages for each completed year of service subject to a maximum of ₹ 10 lakh in case of the non-seasonal establishment.
- 7 days wages for each season in case of seasonal employment.
“The act does not affect the right of an employee to receive better terms of gratuity under any award or agreement or contract with the employer.”
When gratuity is paid?
Gratuity shall be payable to an employee when;
- He has rendered continuous service for not less than five years and
- His employment is now terminated by virtue of:
- His superannuation, or
- His retirement, or
- His resignation, or
- On his death or disablement due to accident or disease.
How is gratuity calculated?
Gratuity is calculated at 15 days wages last drawn by the employee for each completed year of service. The monthly wage is divided by 26 and multiplied by 15. In computing a completed year of service the period in excess of six months shall be taken as a full year.
What are the types of discretionary benefits?
What is known as Employee Stock Option Plan?
Employee Stock Option Plan (“ESOP”) is an employee benefit plan which is provided in lieu of bonus for good performance or sometimes in case of budding startups were paying a huge salary is not feasible at the beginning, in lieu of paying less salary as compared to the market rate. ESOP works on the model where the company issues future shares to the employees at a predetermined rate. This share is vested in the employee for a fixed period of time. This is known as the vesting period. It is basically a period after which the employee can use his stock option. When this vesting period is over the employee may choose either to buy the shares if the current market rate is higher than that was predetermined and sell it, thus making a profit or he may choose to not exercise this option if the market rate is lower than that was predetermined and wait for the rates to go up. This waiting period may be locked by the Company but even if the waiting period is over and the employee does not want to exercise his right, he cannot be obliged to do so.
ESOP only confers a right and does not create an obligation on the employees for the purchase of shares.
Advantages of ESOP
The granting of ESOP has some major benefits:
- The company doesn’t have to pay large salaries and huge bonuses in liquid form.
- The employee benefits only if the market rates of the company are higher at the time of vesting so he can earn profit. The rates can only be higher if the company is performing better and the company can perform better only if the employee is working better. Thus this creates a mental incentive in the mind of the employee to work more productively and creates a win-win situation for both him and the company.
- This creates ownership in the company for the employee which morally incentivizes him and shall boost his work performance.
- Provides a tangible representation of how much their contribution is worth to the employer.
Who can issue ESOP?
Any company registered under the Companies Act can issue ESOP. All companies other than listed companies issue ESOP in accordance with the provisions of the Companies Act, 2013 and Companies (Share Capital and Debentures) Rules, 2014. In the case of listed companies, ESOPs are issued in accordance with the Securities and Exchange Board of India (“SEBI”) Employee Stock Option Scheme Guidelines.
To whom can ESOP be issued?
According to the provisions of the Companies Act, ESOP can be issued to directors, employees or officers of the company or of its holding or subsidiary company. Companies (Share Capital and Debentures) Rules, 2014 provides us with the definition of employee in the case of ESOP. They are:
- A permanent employee of the company who has been working in India or outside India.
- A whole-time or part-time director of the company.
- An employee of a subsidiary or of a holding company of the company or of an associate company
Following are not entitled to ESOP:
- An independent director,
- An employee who is a promoter or,
- A person who belongs to the promoter group or,
- A director who directly or indirectly holds more than ten percent of the outstanding equity shares of the company either through himself or through his relative or through any body corporate.
How are ESOPs issued?
Following are the key components of an ESOP scheme draft:
- The introductory clause provides us with a brief of what the draft is about and what are the important clauses in the document.
- Objectivity clause which provides the purpose of the ESOP as well as the name of the company and periodical basis on which ESOP will be implemented.
- The clause stating whether the ESOP scheme shall be implemented directly or through the creation of the trust.
- The clause stating the eligibility of employees to be granted. Identifying key principles of selection criteria under-compensation policy which is published herein and are thus known to the employee encourages fairness and transparency.
- The clause stating the statutory regulations.
- The clause stating the general risks, e.g. loss due to investment in an ESOP.
- Warranty clause: Upon granting of stocks, employees rather than immediately getting shares, gets options in the form of warrants to purchase such shares at a future date. Out of all warrants, only a few get vested at a time.
- The clause stating the predetermined exercise price of the shares, should the employee decide to convert his warranties into shares.
- The clause stating tax liability.
- Termination clause.
- Confidentiality clause.
2. Passing resolution
- The issuance of the Employees Stock Option Scheme has to be approved by the shareholders of the company by passing a special resolution.
- Important features of a special resolution:
- This meeting shall be a general meeting and hence under the Companies Act, at least twenty-one days’ notice either in writing or through electronic medium shall be served to all the members in advance.
- The intention to propose the resolution as a special resolution must be duly specified in the abovementioned notice calling the general meeting.
- The votes cast in favour of the resolution must be at least 3/4th, i.e. 75% of the total votes cast.
- This special resolution must be filed with the Registrar of Companies, along with Form MGT-14 on the MCA website.
- In the case of a listed company, in-principle approval of stock exchanges where the shares of the company are listed is also required for listing of the shares that may be issued once the options are exercised.
- The company shall have to make the following disclosures annexed to the notice for the passing of the resolution:
- The total number of stock options to be granted;
- Identification of all eligible employees who are entitled to ESOP.
- The appraisal process for determining the eligibility of employees to the Employees Stock Option Scheme;
- In regard to vesting:
- Requirement of vesting,
- Period of vesting,
- The maximum period under which all stocks must be vested,
- Explanation of formula or criteria as to how this period was determined.
[Note: According to Section 12 (6) (a) of the Companies (Share Capital and Debentures) Rules, 2014 there shall be a minimum period of one year between the grant of options and vesting of the option.]
- The lock-in period, if any. The companies have the authority to specify the lock-in period for the shares issued pursuant to the exercise of ESOP.
- The maximum number of stocks granted to each employee and the total number of stocks granted.
- The method which the company shall use to value its options;
- Terms and conditions of lapsing of stock options for the employees (termination clause),
- The specified time period within which the employee shall exercise the vested options in the event of a proposed termination of employment or resignation of the employee. As stated earlier ESOP grants only rights and no obligations to employees for the purchase of shares and even after the expiry of this period employee cannot be obliged to exercise his options.
- A statement to the effect that the company shall comply with the applicable accounting standards.
- ESOPs are granted to the employee under the ESOP Scheme which is prepared by the compensation committee which decides the name of employees eligible for this scheme.
- Legal documents which are necessary to granting of ESOP:
- Employee agreement which provides discretionary power to the board to grant such employee stock options.
- An ESOP plan highlighting all the features of the plan.
- Trust Deed: An ESOP may be administered by an independent irrevocable trust. This means that from the stage of granting of the ESOP till the exercising the option to purchase the stock, the shares shall be held by this trust which shall subscribe to these shares from the company or purchase it from the existing shareholders. This can be financed by the company itself. Once the employee decides to exercise his option, he can purchase it from the trust. If this trust route is adopted by the company to issue ESOP, a trust deed for the creation of such a trust is required.
- Letter of Grant: The stock options are conferred on the employee through a letter authorized by the board.
- A letter of acceptance by the employee
- ESOP is granted to the employees participating in the ESOP scheme. Vesting means the time period during which the employee can exercise his options to buy stocks. The minimum period after the grant of ESOP before the employee can exercise his option is one year under the Companies (Share Capital and Debentures) Rules, 2014. The maximum period can be fixed by the company.
- The company is free to fix:
- Vesting date.
- The manner of vesting and exercise of options.
- Eligibility of employee to whom ESOP may vest.
- The vesting may be made conditional on the fulfilment of certain obligations.
- Once the ESOP is vested, the employee before the expiry of the vesting period as predetermined by the company can exercise his option to buy the stocks.
- Once he exercises his option the company must allow him the share and it shall lead to his ownership of the shares of the company.
- If the employee decides not to exercise his option, at the end of the vesting period, the options expire.
- If shareholders apply for shares:
- In accordance with Section 39(4) and 42(9) of the Companies Act, 2013, and rule 12 and 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014, companies need to allot the shares and file e-form PAS-3 for allotment of shares. This e-form is required to be filled to the Registrar on the MCA portal including the complete list of all stockholders, with their full names, addresses, number of securities allotted and such other relevant information as may be prescribed.
- Companies need to issue share certificates to the shareholders within 30 days after allotment.
- The company needs to pay the required stamp duty.
- Once options are exercised, the following things must be also taken into consideration:
- Inter alia disclosure about the details of the ESOP by the board of directors in the director’s report every year.
- A Register of Employee Stock Options must be maintained in Form No. SH.6 and the company shall forthwith enter therein the particulars of option granted under clause (b) of sub-section (1) of section 62 of the Companies Act, 2013.
- Deduction of tax at source by company.
- If shareholders apply for shares:
“Sweat equity shares” means such equity shares as are issued by a company to its directors or employees at a discount or for consideration, other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called.
The procedure of issue of sweat equity
- The issuance of sweat equity shall be authorized by special resolution which means in:
- A general meeting with 21 days prior notice to all the shareholders and
- By a 3/4th majority.
- This special resolution shall be valid for twelve months from the date of passing of such resolution.
- The company shall not issue sweat equity shares if:
- It is more than 15% of the existing paid-up equity share capital in a year or
- Such shares have a value of five crores, whichever is higher.
- The issuance of sweat equity shares in the company shall not exceed twenty-five percent of the paid-up equity capital of the company at any time.
- The directors or the employees who have been allotted sweat equity cannot transfer it for a period of three years from the date of allotment.
- The sweat equity shares to be issued shall be valued at a price determined by a registered valuer as the fair price giving justification for such valuation.
Employee Stock Purchase Scheme (ESPS)
ESPS is a mechanism by which a listed company issues shares to its employees at a discount. Shares are issued immediately and the employee does not have to wait or have any vesting period. The shares which are issued a discount cannot be transferred by the employees for at least one year. In the case of ESPS, each employee who is eligible must be specifically identified while obtaining the shareholder approval, unlike ESOPs, where shareholder approval is taken for the ESOP scheme in general.
What is a listed company?
A listed company “means a company which has any of its securities listed on any recognized stock exchange”. Following an amendment in 2021, the following are excluded from the definition of the listed companies:
- Unlisted public or private companies which have listed their non-convertible debt securities or non-convertible redeemable preference shares or both.
- Public companies whose equity shares are exclusively listed on a stock exchange.
Importance of executive compensation and employee benefit arrangements
In a global economic forum, the yardstick of employee benefits and executive compensation has a direct bearing on an organization’s productivity and a nation’s economic growth. Employees and executives are core assets or human resources who provide their manpower, skills, brains and management to ensure sustainable productivity and profitability of the organization.
To attract the best employees and executives a greater need is felt by the economic planners and the company management to boost the employee benefits and attractive package of compensations for the executives at par with the international standards. This was primarily done to contain brain drain and executive poaching. Therefore besides the salary of the employee, the organizations started providing benefits in kind that include various non-wage compensations. By offering these attractive benefits to the employees to increase the economic security of staff members the organization also improved workers retention across the organization because such benefits also improved employee’s loyalty and increased job satisfaction as schemes like ESOP creates ownership in the shares of the company.
In a global scenario, there is greater mobility and freedom to the skilled employees and hence talented executives can leave a company and move to another one with better perks. To maintain stability in the organization and discourage this trend, the employee benefits scheme has played a pivotal role.
And at last but not least, India is governed by its constitution. And the constitution mandates India to be a socialist country. Thus providing statutory benefits to all the working class in the country is a statutory obligation on the part of the government. Through such benefits, it not only fulfils its duty towards the citizens but also improves the lifestyle of the employees which in turn will boost the nation’s economy as it shall boost both the productivity as well as purchase capacity of the working class. The only thing which the government must now focus on is the on-ground implementation of these schemes which still eludes many workers due to lack of knowledge and wide corruption. With the emergence of digitalization of various schemes and robust awareness campaigns, slowly, this shall also be achieved.
We have now studied various mandatory and discretionary employee benefits and executive compensations that are prevalent in India. We also reviewed their statutory threshold and rules governing them. Some of the benefits such as maternity benefits, employee insurance and provident funds are very essential as they provide a security cushion to the beneficiaries in a country where the majority of the population is dependent on the State for various welfare schemes. Also in Indian Society which is often said to be run by its middle-class salaried class, such benefits come as a saviour in times when a financial crisis strikes this class.
The discretionary benefits like ESOP have their own virtues as they put the employee in a position where he can directly contribute to the growth of his share simultaneously with that of the company, thus creating a win-win situation for both.
Thus these benefits and compensations are one of the key factors of economic development of our country as they cover various ranges of beneficiaries, from daily wage workers to CEOs, from a mother to dependents of the deceased and from a fresher to a retiree. They are diverse, as is our beloved motherland.
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