The changes that have been introduced in India regarding executive compensation have brought about widespread consequences for the future of the standards of remuneration to be paid out by companies. The introduction of the remuneration committee by the Companies Act 2013 (the Companies Act) has placed considerable responsibility on them to ensure that there is a balance between the compensation packages for senior representatives and the overall objectives of the company. There has always been a demand by the shareholders of companies to ensure that the pay is proportional to the performance of the executives and some of the changes that have been introduced in recent times have furthered that very cause.
On the other hand, it is also important to acknowledge that there is an extremely competitive environment for employers to acquire the right kind of talent who have the requisite experience and know-how. In this context, we have tried to narrow down the possibilities that employers nowadays consider in determining executive remuneration:
a Compensation packages linked directly to the performance of the company. Compensation matrices in India are shifting towards a far more direct pay and performance model in alignment with the same trend being followed globally. Various instances in the recent past have shown that there have been pay increases that are much higher than the relative performances of the company. Improper justification or non-disclosures to the shareholders regarding ad hoc stock-based grants, substantial bonus payouts, etc., have led to discomfort among the shareholders and sometimes even formal disputes.
b Companies generally set ownership guidelines that require executives to own a certain proportion of the company's equity within a prescribed time frame. This ensures an added line of security by stitching together the fortunes of the executive team and the interests of the company. Since the talent pool often looks for better remuneration opportunities, stock incentives go a long way in fulfilling such objectives of executives and also serve the employer's objectives.
i Income tax for employees
Income tax provisions with respect to taxation of remuneration for Indian employees compared with foreign employees
A person pays tax in India based when income is accrued or deemed to be accrued or is received or deemed to be received in India. Further, it also depends on the residential status of a person for the purpose of levy of income tax in India. Accordingly, the Income Tax Act, 1961 (the IT Act) categorises persons based on residential status in the following manner:
- resident – which is further categorised into ordinary residents (OR) and not ordinary residents (NOR); and
- non-resident (NR).
Residential status of a person is determined on the basis of the number of days resided in India and this is computed separately for each financial year (FY). To be classified as resident in India for the relevant FY, the person must reside in India for period of 182 days or longer in that FY, or the person must have resided in India for a period of 60 days or longer during that FY and was residing in India for 365 days or more during the previous four years immediately preceding the relevant FY.
Further, 60 days as mentioned above would be replaced by 182 days in the following cases:
- a citizen of India who leaves India in any previous year as a member of the crew of an Indian ship as defined in Clause (18) of Section 3 of the Merchant Shipping Act 1958 (44 of 1958), or for the purposes of employment outside India; or
- a citizen of India or a person of Indian origin who, being outside India, comes on a visit to India in any previous year.
Further, classification of a resident as OR would be dependent on the satisfaction of both the conditions mentioned, namely:
- the person has been a resident in India for two of the 10 FYs immediately preceding the relevant FY; and
- the person has also been residing in India for a period of 730 days or more in the seven FYs immediately preceding the relevant FY.
Determination of this residential status of taxpayers is very important at the time of filing of an income tax return and the table below summarises when an income accrues, is received, arises or is deemed to have been accrued, arisen or received within or outside India in the previous year (PY):
|Particulars||Resident and OR||Resident and NOR||NR|
|Income received or deemed to have been received in India, whether the income is earned in India or outside India||Yes||Yes||Yes|
|Income that accrues/arises or is deemed to accrue/arise in India during the previous year, where the income is received in India or elsewhere||Yes||Yes||Yes|
|Income that accrues/arises outside India and is received outside India from a business controlled in India||Yes||Yes||No|
|Income that accrues or arises outside India and is received outside India in the PY||Yes||No||No|
|Income that accrues or arises outside India and is received outside India during the year preceding the year and remitted to India during the PY||Yes||No||No|
Income tax rates ‒ compensatory payments
The scope of compensatory payments coming within the ambit of taxability under the IT Act solely depends on whether it is covered under the definition of income. Income having been defined in the widest possible manner covers within its ambit all forms of payments made.
The IT Act breaks down income received into two different forms of classification based on the manner of engagement of person in India by an employer. Accordingly, compensation received by way of an employer–employee relationship (employment) would be classified under the head 'income from salaries' and the levy of tax would be in accordance with the tax rates applicable, as revised by The Finance Act 2017. The income tax payable by a person will be based on the amount of income received by that person. Please refer to the table below for the financial year 2018–2019 (Assessment Year 2019–2020):
|Income slab||Tax rate|
|Income up to 250,000 Indian rupees||No tax|
|Income from 250,000 to 500,000 rupees||5%|
|Income from 500,000 to 1 million rupees||20%|
|Income more than 1 million rupees||30%|
A surcharge will be applicable over and above the income tax:
|Income slab||Tax rate|
|Income greater than 5 million rupees||10%|
|Income greater than 10 million rupees||15%|
Further, education cess and secondary higher education cess will be charged as well.
The practice of engaging contractors by employers is prevalent throughout India and there is a distinction between a contract of service and a contract for service. It is on the basis of the nature of the engagement that one can be classified as an employee or an independent contractor. An independent contractor or consultant engaged by an employer and compensation paid in lieu of services rendered by such consultant would be in the form of fees for services performed and will be taxed under the head 'Profits and Gains from Business/Profession' as there is no employment relationship and tax can be deducted at the rate of 10 per cent on compensation paid over 30,000 rupees.
Compensatory payments taxable as capital gains or other special income tax rates
Any profits or gains arising from the transfer of a capital asset effected in the previous year shall be chargeable to income tax under the heading 'Capital gains', and shall be deemed to be the income of the previous year in which the transfer took place. Capital gain means any profit or gain that arises due to the transfer (in any manner, including sale, exchange, relinquishment, etc.) of a capital asset from one person to another.
Notwithstanding anything mentioned above, the following has to be noted:
- the profits or gains arising from the transfer by way of conversion by the owner of a capital asset into, or its treatment by him or her as stock-in-trade of a business carried on by him or her shall be chargeable to income tax as his or her income of the previous year in which such stock-in-trade is sold or otherwise transferred by him or her and the fair market value of the asset on the date of such conversion or treatment shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset;
- where any person has had at any time during previous year any beneficial interest in any securities, then, any profits or gains arising from transfer made by the depository or participant of such beneficial interest in respect of securities shall be chargeable to income tax as the income of the beneficial owner of the previous year in which the transfer took place and shall not be regarded as income of the depository who is deemed to be the registered owner of securities by virtue of the Depositories Act 1996;
- the profits or gains arising from the transfer of a capital asset by a person to a firm or other association of persons or body of individuals (not being a company or a cooperative society) in which he or she is or becomes a partner or member, by way of capital contribution or otherwise, shall be chargeable to tax as his or her income of the previous year in which the transfer takes place and, for the purposes of Section 48, the amount recorded in the books of account of the firm, association or body as the value of the capital asset shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset;
- the profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a cooperative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body of individuals, of the previous year in which the said transfer takes place, the fair market value of the asset on the date of the transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer; and
- where the capital gain arises from the transfer of a capital asset, being a transfer by way of compulsory acquisition under any law, or a transfer the consideration for which was determined or approved by the central government or the Reserve Bank of India (RBI), and the compensation or the consideration for the transfer is enhanced or further enhanced by any court, tribunal or other authority.
Compensatory payments made in the form of capital assets which in turn appreciate in value would attract capital gains tax under the heading 'Income from Capital Gains' of the IT Act.
Taxability of capital gains would depend on the nature of the asset and they are divided into short-term capital assets (STCAs) and long-term capital assets (LTCAs). STCAs are assets which are held for not more than 36 months or less and LTCAs are assets held for more than 36 months. The criterion of 36 months has been reduced to 24 months in the case of immovable property (land, building and house property), but this change is not applicable to movable property (jewellery, debt-oriented mutual funds, etc.) They will be classified as a long-term capital asset if held for more than 36 months from the financial year 2017–2018.
Some assets are considered short-term capital assets when these are held for 12 months or less. This rule is applicable with respect to (1) equity or preference shares in a company listed on a recognised stock exchange in India, (2) securities (such as debentures, bonds, government securities) listed on a recognised stock exchange in India, (3) units of UTI, whether quoted or not, (4) units of equity-oriented mutual fund and (5) zero coupon bonds, whether quoted or not.
Depending on the nature of the capital asset, taxes are levied accordingly on the short-term and long-term capital gains. Long-term capital gains are taxable at the rate of 20 per cent. However, short-term capital gains are taxable depending on whether securities transaction tax (STT) is applicable or not. If STT is not applicable, then the short-term capital gains are included in the total income and is taxed in accordance with the income tax slab mentioned above. If STT is applicable, then short-term capital gains is taxable at the rate of 15 per cent. However, it must be noted that any long-term capital gains arising from the transfer of specific shares (i.e., equity share in a company or unit of an equity-oriented fund or unit of a business trust) would not be computed for the purpose of total income if the transfer attracts STT and is entered into after the commencement of Chapter VII of the Financial (No. 2) Act 2004.
Income tax consequences
The Companies Act allows for the share application money that is received by the company to not be the full value of the relevant shares. However, the board in case of a company limited by shares may call upon such person to make payments on such unpaid shares or partly paid shares and if such payment is not made within the stipulated time period, the shares shall be forfeited in favour of the company. The board is authorised to sell or otherwise dispose of such shares in a manner they deem fit. When the company forfeits the share application money, it is considered as a capital receipt in the hands of company. The definition of income under Section 2(24) of the IT Act does not include such receipts. Specifically, it was held that the amount forfeited from shareholders for default of payment of call money was capital receipt. Further, the amount received on reissue of forfeited shares and credited to share premium account was also a capital receipt.2
The promise to deliver shares is not by itself prohibited explicitly under the IT Act; however, prohibitions have been placed regarding directors and key managerial personnel from forward dealing in the company, its holding, subsidiary or associate company. Such forward dealings include a (1) a right to call for delivery or make delivery at a specified price and within a specified time for a specific number of shares or debentures, and (2) a right, the manager may elect to call for delivery or make delivery at a specified price and within a specified time for a specific number of shares or debentures.
Given the above, if any director or key managerial person acquires shares or debentures in contravention with Section 194, that person would be liable to surrender the same to the company and shall be penalised as stated in the Companies Act.
Income tax consequences
In addition to what is discussed above, deferral of remuneration or consideration paid to an employee will be liable to income tax in the financial year in which it is received or accrued or arises in the hands of the employee. The scope of remuneration is relevant to consideration paid in monetary or non-monetary forms. Section 5 of the IT Act deals with the calculation of total income for the purpose of inclusion of income and therefore the financial year in which the remuneration is received by the employee would be considered as the previous year for calculation of income tax.
Income tax consequences
Regarding funding of incentives or similar compensatory arrangements that are intended to be paid in the future, say a trust, the compensation or benefit to be granted in the relevant manner is transferred to the trust by the company to be held in accordance with a contractual agreement and further, the beneficial interest of the compensation or benefit is vested upon the beneficiaries of the trust. Such beneficial interest will be converted into absolute ownership only upon fulfilment of the contractual obligations. Thus, the shares of the company in the event of a trust are generally (industry practice) held as follows: (1) before exercise by the employees, the trust holds the shares on its own account; (2) post exercise, the trust holds the shares on behalf of the employees; (3) these shares, though held by the trust, are recorded in the name of the trustees.
The tax implications for such transactions include the following:
- In the hands of the company, transfer of shares from the company to the trust would attract capital gains (Section 45 of the IT Act). Further, the Finance Act 2017 has brought in a new section 50CA. This section provides for considering the fair value of the shares for computing capital gains, where shares are sold at less than the fair value.
- In the hands of the trust, as per Section 56(2)(x)(c) of the IT Act, where any person receives shares for a consideration that is less than the fair market value of those shares, the difference between the fair market value and the consideration so paid shall be treated as other income in the hands of the buyer.
- In the hands of the employees, as per Section 17 of the IT Act, the employee's beneficial interest in the trust shall be considered as perquisite and taxed as salary only when shares are issued or transferred to him or her. Since Section 17 is applicable for the employees, the provisions of Section 56 (Income from other sources) shall not be applicable.
ii Social taxes for employees
Provident fund contributions
The social security contributions in India include provident fund, pension scheme and deposit linked scheme and is governed by the Employees Provident Fund and Miscellaneous Provision Act 1952 (EPFA). Every establishment employing 20 or more persons will be required to be in compliance with EPFA unless the establishment is exempted as per the provisions of EPFA. The objective of EPFA is to provide retirement and insurance benefits to employees. The EPF Act deals with the Employees' Provident Funds Scheme 1952, the Employees' Pension Scheme 1995 and the Employees' Deposit-Linked Insurance 1976.
Further, in 2008 international workers have been brought within the purview of EPFA. An international worker coming to work in an Indian establishment to which EPFA applies, then the international worker is required to make provident fund contribution. However, in the event an international worker is coming from a country with which India has a social security agreement (SSA) and the international worker is contributing towards social security of the home country and enjoys the status of a detached worker is excluded from contributing in India provided the international worker obtains a certificate of coverage from the home country. Additionally, the international worker can withdraw their accumulated provident fund balances on ceasing to be an employee in an establishment covered under EPFA. However, if a person is not covered under an SSA, he or she may withdraw the provident fund balance on retirement from service in the company at any time after 58 years of age or in the event of death, specified illnesses or incapacitation.
Every Indian employee whose basic wages are 15,000 rupees per month or less has to contribute to the employees' provident fund. The employer must take steps to ensure that the employer's and employee's contributions with respect to such employees are made regularly every month. The contribution which shall be paid by the employer and the employee to the employees' provident fund shall be 12 per cent of the basic wages (plus dearness allowance and retaining allowance). The benefit of an employees' provident fund for employees drawing basic wages of more than 15,000 rupees per month is discretionary in the hands of the employer. Further, in case of international workers, the components of remuneration for employees' provident fund contributions, will be the same as those applicable to domestic Indian employees. The provident fund contribution in respect of international workers is required to be made on full salary (i.e., without any wage ceiling, unlike domestic Indian employees).
The contributions made by the employee and the employer towards provident fund, pension scheme and life insurance as per the provisions of EPFA is exempted for income tax. However, 150,000 rupees is the maximum limit of the aggregate of the deduction that may be claimed under , and of the Income Tax Act 1961, which includes provident fund contributions.
In terms of the Payment of Gratuity Act 1972 (the Gratuity Act), an employee is entitled to gratuity on superannuation, retirement or resignation, provided the employee has rendered continuous service for not less than five years. Gratuity is also payable in case of death or disablement due to accident or disease; however, the completion of five years of continuous service is not required in this regard. It is pertinent to note that the Gratuity Act does not provide for any specific exemption in regard to international workers who are employed by the Indian company.
Gratuity is payable to an employee at the rate of 15 days' wages for every completed year of service (any period in excess of six months will be considered a full year of service). In case of an employee drawing monthly wages, gratuity shall be calculated by dividing the monthly rate of wages last drawn by him or her by 26 and multiplying the quotient by 15, for each completed year of service. The maximum amount of gratuity that an employee is statutorily entitled to is 2 million rupees. An employer may, however, make a higher gratuity payment, at his or her discretion. However, the gratuity received under the Gratuity Act is exempt from tax to the extent the employee is entitled to gratuity as per the formula stated above under the Gratuity Act or 2 million rupees, whichever is less.
iii Tax treatment of remuneration paid by the employer
The IT Act provides for deductions from computing income under the heading profits and gains of business or profession with regard to certain forms of expenses incurred by the employer. In respect of this, Section 36 of the IT Act deals with deductions, which include (1) all sums paid to an employee as a bonus or commission for services rendered (provided such sums would not have been payable to the employee as profits or dividend), (2) sums paid by the employer by way of contribution towards a recognised provident fund or superannuation fund subject to conditions set by the board and any contribution towards a pension scheme, provided it does not exceed 10 per cent of the salary of the employee, and (3) sums paid by the employer by way of contribution towards an approved gratuity fund for the exclusive benefit of the employees under an irrevocable trust. Additionally, any other form of remuneration paid by an employer to the employee for the purpose of the business or profession would be allowed to be deducted as expenditure wholly and exclusively for the purposes of the business or profession. Further, income tax in India is levied in the relevant assessment year (AY) on income accrued, arisen or received or deemed to have been accrued, arisen or received in India in the previous year.
Additionally, remuneration paid to persons in cash, equity and other forms of property are liable to tax deductions in India. For the purpose of collecting tax from every source of income payable to another, tax deduction at source (TDS) was introduced. In furtherance of the same, a person who is liable to make payment of a specified nature to any other person must deduct tax at source and remit the same into the account of the central government. The TDS rates for assessment year 2019–2020 are as set out below:
|Relevant provisions under the Income Tax Act 1961||Particulars||TDS rates|
|192||Payment of salary by employer||Applicable slab rates (as discussed above)|
|193||Interest on securities||10%|
|194||Dividend (other than under Section 115-O)||10%|
|194A||Income by way of interest other than interest on securities||10%|
|194C||Payments to contractors/sub-contractor (individuals)||1%|
|194J||Sums paid by way of fees for professional technical services, royalty, remuneration/fee/commission to a director or for not carrying out any activity in relation to any business, for not sharing any know-how, patent, copyright, etc.||10%|
iv Other special rules
Taxation on payments made to employees
Corporate restructuring in India attracts taxability with regard to the corporate entities engaged in the restructuring. However, Section 47 of the IT Act places certain forms of corporate restructuring outside the scope of transfer for the purpose of capital gains and hence the levy of tax under those circumstances is not taxable. Additionally, the liability of taxation does not flow down to the payments (in any form) being made to the employees of the corporate entity. TDS provisions would apply accordingly, and the corporate entity would be required to deduct tax accordingly. The employees' remuneration would be liable to income tax at the slab rate prescribed by the income tax department under the heading salaries. There are no specific rules applicable for the payments or remunerations made to employees in connection with the restructure.
Special tax rules
In circumstances where the employer makes payments for premium applicable to keep in force insurance on the health of employees under a scheme framed either by the General Insurance Corporation of India or any other insurer and approved by the Insurance Regulatory and Development Authority, such payments are permitted to be deducted for the purpose of calculation of income under the heading of profits and gains of business and profession.
III EMPLOYMENT LAW
Enforceability of non-compete
By virtue of a typical non-compete clause in India, the employee undertakes to adhere to the condition that during the course of employment and after the employee leaves the services of the employer, the employee will not associate him or herself with a competitor of the employer in any capacity. The provisions of the Indian Contracts Act 1872 (the Contract Act), however, explicitly state that all contracts that are in restraint of trade are void and unenforceable. It is important to understand that courts in India distinguish between non-compete covenants that are operative during the term of the contract and those that operate post the term of the contract. The courts have consistently taken a view that a non-compete or restrictive covenant operating during the term of the employment contract is enforceable while those operating beyond the term of the employment contract are not.
Given the improbability of enforcement of a post-employment non-compete, most former employers attempt to seek injunction from courts preventing an employee from joining a competitor on the grounds of anticipated breach of confidentiality obligations. The employers are also able to get adequate relief from courts more often than not in cases where very senior and significant employees are involved. The reasoning for the courts to grant such injunctions has been that senior employees of the company have extensive knowledge of the company's business and marketing practices, customer and vendor relationships and matters of a confidential nature that are proprietary and highly valuable to the company, and any disclosure of the same would substantially damage the legitimate business interests of the company. That said, the courts, on the basis of the facts of each case, have also analysed what information could be construed as confidential information. For instance, customer contact information is not always construed to be confidential as no entity is allowed to create monopolies or prevent competition on the basis that they have created an exhaustive list of clients or customers. In general, courts have tested this from the point of view of whether the information possesses the necessary quality of confidence and whether it is information that is not publicly available or public knowledge. Based upon the facts and circumstances of a case, courts have also stated in a few instances that though breach of confidentiality may be enforced against an employee, it cannot be used to seek an injunction preventing the employee from pursuing another vocation or business. On similar lines, courts have recognised the right of an employee to change employment in pursuit of better opportunities as a fundamental right and this right cannot be curtailed on grounds of mere possession of customer data which can also be procured from other sources.
To conclude, a non-compete clause in employment agreements beyond the term of the employment may only act as deterrent measure for the employees from joining competitors but the provision cannot be enforced in a court of law.
Geographical scope of enforceable non-compete
As aforementioned, the courts have consistently taken a view that a non-compete or restrictive covenant operating during the term of the employment contract is enforceable while one operating beyond the term of the employment contract is unenforceable. When it comes to any geographical limitations, non-compete covenants are permissible for the protection of goodwill of the business sold to the buyer in order to ensure that the seller can be restrained within certain reasonable territorial or geographical limits. The reasonableness of restrictions will depend upon many factors, which may include the area in which the goodwill is effectively enjoyed and the price paid for it.
A typical garden leave provision is one wherein the employer pays the employee a fixed sum of money to prevent them joining a competitor for a reasonable period of time.
The courts have ruled that while it is not possible to stop an employee from leaving, he can be restricted from joining a competitor during the term of employment. Further, the lack of enforceability of non-compete clauses has resulted in the corporate sector developing and taking recourse to a concept called garden leave, under which employees are paid their full salary during the period in which they are restrained from competing.
Non-compete of a transaction rather than a termination of employment – if the employee is a selling shareholder
As per the Contract Act, an agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void. However, the exception to this principle is when parties enter into an agreement not to carry on business of which goodwill is sold (is not void). An agreement entered into between the seller of goodwill of a business and the buyer for non-compete restraining such buyer from carrying on a similar business within specified local limits would be enforceable provided the limitations appear reasonable to the court. That said, a non-compete fee is generally paid to the promoter by the acquirers so that the promoters3 do not start a similar business and pose a threat to the acquired company.
Enforceability of non-solicitation
Non-solicitation clauses are restrictive to the extent that the employee promises not to solicit the employer's clients or employees for a given period after the expiry of the employment tenure. Employers assert that such restrictions are necessary to protect their proprietary rights and their confidential information. Given that a non-solicitation clause is also a restrictive covenant, the principles remain the same, although the chance of enforceability of non-solicitation clauses is significantly more if the facts and circumstances of the matter are favourable. However, note courts in India have consistently held that mere possession of customer database or information may not necessarily provide any advantage to an employee joining a competitor and the courts have also recognised the value of the relationship shared between the employee and the customer. The courts have typically stated that where employees have established connections and developed relationships with customers, the leveraging of such relationships by the employee upon joining a competitor cannot be prevented by an injunction. Contrarily, the courts have also upheld non-solicit clauses preventing employees who have joined competitors from approaching customers and suppliers who are in direct competition with the previous employer. The courts generally evaluate every case on the basis of individual facts and accordingly award relief, which may include damages.
Limitations on the scope of enforcing non-solicitation restrictions
The chances of enforcing a non-solicitation clause in employment contracts in comparison with non-compete is significantly more. However, it also depends on the facts and circumstances of each case, and in order to enforce non-solicitation clauses, the courts4 have clarified the following principles:
- Negative covenants tied up with positive covenants during the subsistence of a contract be it of employment, partnership, commerce, agency or the like, would not normally be regarded as being in restraint of trade, business or profession unless the same are unconscionable or wholly one-sided.
- While construing a restrictive or negative covenant and for determining whether that covenant is in restraint of trade, business or profession or not, the courts take a stricter view in employment contracts than in other contracts, such as partnership contracts, collaboration contracts, franchise contracts, agency or distributorship contracts and commercial contracts. The reason being that in all other kinds of contracts, the parties are expected to have dealt with each other on more or less an equal footing, whereas in employment contracts, the assumption is that the employer has an advantage over the employee and it is quite often the case that employees have to sign standard form contracts without any objection.
- The question of reasonableness, as with the question of whether the restraint is partial or complete, is not required to be considered at all whenever an issue arises as to whether a particular term of a contract is or is not in restraint of trade, business or profession.
iii Termination of employment
Laws affecting wrongful terminations
Termination of employment in India is regulated by the Industrial Disputes Act 1947 (the ID Act). Various states in India have also passed legislation dealing with dismissal from commercial establishments.5 The procedure for termination of employment has been separately dealt with for 'workman' and 'non-workman'. Workmen are covered under the ID Act and accordingly retrenchment has been defined as the termination by the employer of employment of a workman for any reason, other than by way of disciplinary action has to be carried out in strict adherence to the legislative requirements. As per the provisions of the ID Act, a workman is 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, whether the terms of employment be express or implied, but does not include any such person (1) who is employed mainly in a managerial or administrative capacity, or (2) who, being employed in a supervisory capacity, draws wages exceeding 10,000 rupees per mensem6 or (3) who exercises, either by the nature of the duties attached to the office or by reason of the powers vested in him or her, functions mainly of a managerial nature.
To determine if an employee is a workman or not the Supreme Court of India, the apex court of the country, has held the following:
The designation of an employee is not of much importance and what is important is the nature of duties being performed by the employee. The determinative factor is the main duties of the employee concerned and not some works incidentally done. In other words, what is, in substance, the work which employee does or what is substance he is employed to do. In order to determine the categories of service indicated by the use of different words like 'supervisory', 'managerial', 'administrative', it was necessary not to import the notions of one into the interpretation of the other. It has to be broadly interpreted from a common sense point of view where tests will be simple both in theory and in their application. The learned judge further observed that a supervisor need not be a manager or an administrator and a supervisor can be a workman so long as he did not exceed the monetary limitation indicated in the section and a supervisor irrespective of his salary is not a workman who has to discharge functions mainly of managerial nature by reasons of the duties attached to his office or of the powers vested in him.
Given the above, if an employee is a workman and employed in the company for a continuous period of not less than one year, then the provisions of the ID Act should be adhered to while terminating the services. That said, as per the provisions of the ID Act, the procedure stated below should be followed in case of termination of service of a workman:
- the employee has to be given one month's notice in writing indicating the reasons for termination of services or the employee has been paid, in lieu of notice, wages for the period of notice;
- at the time of termination, the employee has to be paid compensation, which shall be equivalent to 15 days' average pay for every completed year of continuous service or any part thereof in excess of six months; and
- notice in the prescribed manner is served on the appropriate government.
Additionally, the ID Act requires an employer to follow the last-in-first-out sequence while terminating employment. Accordingly, the employer is to terminate the workman who was the last person to be employed in that category. Such a sequence for termination may not be followed in situations where (1) there is an agreement between the employer and the workman to the contrary, or (2) the employer can provide adequate reasons for terminating any other workman. Having covered the scope of termination of employment of a workman under the ID Act, it is pertinent to note that a non-workman would be covered exclusively by the terms of the contract entered into between himself or herself (employee) and the relevant employer. There are no specific legal requirements for the termination of a non-workman other than the terms of the specific agreement although the relevant Shops and Establishments Act (the S&E Act) of particular states provide for a minimum notice period in lieu of wages payable to such employee. Additionally, if the contract provides for more beneficial provisions, such provisions would apply over and above the requirements by the relevant S&E Act.
Payment of severance remuneration
In the event the company terminates the services of workman, a severance compensation has to be paid to the workman as stated above. Further, in the event of termination of employment of non-workmen, the non-workman shall be entitled to contractually agreed notice periods, or notice pay in lieu thereof, as per the relevant S&E Act, Industrial Employment (Standing Order) Act 1946, and in terms of the employment contracts. Further, a workman and non-workman are entitled to any encashment of unused leave, gratuity or any other contractual benefits as may be agreed upon between the employer or employees.
Consequently, if an employee (workman or otherwise) has committed an act of misconduct, the employer can terminate the services of such employee immediately without serving the required statutory notice period as long as the employer has satisfied due process under applicable law.
Terminations of employment in connection with a change in control
Where the ownership of management of an undertaking is transferred, whether by agreement or by operation of law, from the employer in relation to or that undertaking to a new employer, every workman who has been in continuous service for not less than one year in that undertaking immediately before such transfer shall be entitled to notice and compensation as stated above, as if the workman had been retrenched or terminated. However, this principle shall not be applicable to workmen in any case where there has been a change of employers by reason of the transfer, if the following three conditions are satisfied: (1) the service of the workman has not been interrupted by the transfer; (2) the terms and conditions of service applicable to the workman after the transfer are not in any way less favourable to the workman than those applicable to him or her immediately before the transfer; and (3) the new employer is, under the terms of the transfer or otherwise, legally liable to pay to the workman, in the event of his or her retrenchment, compensation on the basis that his or her service has been continuous and has not been interrupted by the transfer.
Additionally, the Supreme Court of India has held that without consent, workmen cannot be forced to work under different management and in that event, those workmen are entitled to retirement or retrenchment compensation in terms of the ID Act.
Termination of employment for good cause legislatively
In addition to what is stated above, no notice period or payment of compensation is required in the case of workmen dismissed for misconduct, provided the employer conducts an internal inquiry prior to the dismissal and the due process has satisfied principles of natural justice. In the case of all other employees, there is no prescribed notice period. However, the Indian judiciary has held that termination of employment without providing prior notice would render the contract of employment as an unconscionable bargain, thus rendering it illegal. For employees who are not workmen and do not satisfy the definition of workman under the ID Act, the applicable jurisprudence allows any conditions in relation to the notice period to be addressed in the employment contract between the employee and the employer.
IV SECURITIES LAW
i Registration of securities
In India, the issue of stock options by any company is regulated by the Companies Act, and for this purpose Section 62 of the Companies Act deals with increasing subscribed capital by issuing shares to the existent equity shareholders on a proportional basis. Also, it allows for the granting of benefits to the employees of the company via a scheme of employees' stock option (ESOP).
The issue of stock options by private companies, public companies and listed companies has been regulated separately. Accordingly, a company other than a listed company, in furtherance of issue of employee stock options have to abide by the Companies (Share Capital and Debentures) Rules 2014 (the Shares and Debentures Rules). Under the Shares and Debentures Rules, (1) the approval by the shareholders of the company is sought by the passing of a special resolution and an ordinary resolution in case of private companies,7 and (2) the company makes relevant disclosures in the explanatory statement annexed to the notice for passing of the said resolution. This includes:
- total number of stock options granted;
- identification of the classes of employees eligible for the scheme;
- vesting period, lock-in period and exercise period;
- method of valuation of the options, etc.; and
- determination of excise price in conformity with the applicable accounting policies.
The Securities and Exchange Board of India (SEBI) has formulated the SEBI (Share Based Employee Benefits) Regulations 2014, which regulates the issuances of the ESOP and Phantom Stock Options/Stock Appreciation Rights (SARs) by companies whose shares are listed on a recognised stock exchange in India or proposed to be listed. Further, for issuance of ESOP or SARs to the employee, the company should rely broadly on twin principles of complete disclosure and shareholders' approval. Accordingly, the ESOP scheme or the SARs scheme to be offered to employees have to be approved by the shareholders of the company by passing a special resolution to that effect, along with an explanatory statement being annexed to the notice of the shareholders' general meeting which would include necessary information as specified by SEBI. SARs are performance-based incentive plans that are generally right given to an employee entitling him or her to receive appreciation for a specified number of shares of the company where the settlement of such appreciation may be made by way of cash payment or shares of the company.
A company may grant to its executives or employees sweat equity shares. Sweat equity shares are issued 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. Issuing sweat equity shares is regulated by the Companies Act, Companies (Share Capital and Debentures) Rules 2014 and listed companies have to adhere to the SEBI (Issue of Sweat Equity) Regulations 2002.
The conditions to be followed for the issue of sweat equity shares are as follows: (1) the issue is to be authorised by passing a special resolution; (2) the resolution should make certain disclosure regarding the issuance of sweat equity shares; (3) not less than one year has passed, at the date of such issue, since the date on which the company commenced business; (4) if the company is listed on recognised a stock exchange then the regulation made by the SEBI should be adhered to for issuance of sweat equity shares; and (5) if the company is not listed, then sweat equity shares will be issued as prescribed from time to time. The differences between ESOP and sweat equity shares for companies other than listed companies are as mentioned below:
|Sl. No.||Basis||Sweat equity shares||Employees' stock option (ESOP)|
|1||Definition||Sweat equity shares means equity shares as 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 nature of intellectual property rights or value additions, by whatever name they are known||ESOP means the option given to the directors, officers or employees of the company or its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or the right to purchase, or to subscribe for, the shares of the company at a future date at a predetermined price|
|2||Legislative provision||Section 54 of the Companies Act, read with Rule 8, Companies (Share Capital and Debenture) Rules 2014||Section 62(1)(b) of the Companies Act, read with Rule 12, Companies (Share Capital and Debenture) Rules 2014|
|3||Eligible category of persons||Company can issue sweat equity shares to directors, employees or an employee or director of the subsidiary, in India or outside India, or of a holding company of the company||Company can issue ESOPs to (1) employees, (2) officers of the company, and (3) directors; but cannot be issued to (1) promoters (including persons belonging to the promoter group), (2) directors or directors' relatives or the director through a body corporate holding 10 per cent or more of the outstanding equity share of the company|
|4||Lock-in period||Compulsory lock-in period of three years||Minimum period of one year between grant of option and vesting of option. Further, the company has the freedom to specify the lock-in period for the shares issued pursuant to the excise of option|
|5||Restriction on issue||Sweat equity shares cannot be issued for more than 15 per cent of the paid-up equity share capital in a year or shares of value of 50 million rupees, whichever is higher||No such restriction|
|6||Tax implications||The tax incidence is applicable from the date on which the equity shares are transferred/allotted||The incidence of tax arises only after the exercise period, and from the period of granting of the ESOPs till the completion of the vesting period, no taxes are applicable|
|7||Procedural formalities required||Company has to maintain a register of sweat equity shares in Form SH-3||Company has to maintain a Register of Employees Stock Options in Form SH-6|
ii Selling of stock options by executives
Under the Companies Act, no person, including any director or key managerial personnel of a company, can be part of any insider trading unless any communication is required in the ordinary course of business or profession or employment or under any law. Further, for companies listed on any recognised stock exchange or proposed to listed, SEBI has notified the SEBI (Prohibition of Insider Trading) Regulations 2015 (the Insider Trading Regulations), which chalk out a stricter and more focused regulatory regime. The regulations have put in place a stronger legal and enforcement framework for prevention of insider trading. In terms of the Insider Trading Regulations, insider means connected persons, persons in possession of or having access to unpublished price-sensitive information. It is intended that a connected person is one who has a connection with the company or its officers that is expected to put him or her in possession of unpublished price-sensitive information. This definition deliberately brings into its ambit persons who may not seemingly occupy any position in a company but are in regular touch with the company and its officers and are reasonably expected to have access to unpublished price-sensitive information. Further, the Insider Trading Regulations prohibit insider trading in relevance to securities, defined under the Securities Contracts (Regulation) Act 1956 and securities include shares, scrips stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate.
Given the above, no insider (includes directors, key managerial personnel or executives who have access to unpublished price sensitive information) shall trade in securities that are listed or proposed to be listed on a stock exchange when in possession of unpublished price-sensitive information. However, the exceptions to this principle are listed below:
- the transaction is an off-market inter se transfer between promoters8 who were in possession of the same unpublished price-sensitive information without being in breach of provisions of the Insider Trading Regulations and both parties had made a conscious and informed trade decision;
- in the case of non-individual insiders:
- the individuals who were in possession of such unpublished price-sensitive information were different from the individuals taking trading decisions and such decision-making individuals were not in possession of such unpublished price-sensitive information when they took the decision to trade; and
- appropriate and adequate arrangements were in place to ensure that these regulations are not violated and no unpublished price-sensitive information was communicated by the individuals possessing the information to the individuals taking trading decisions and there is no evidence of such arrangements having been breached;
- the trades were pursuant to a trading plan set up in accordance with the Insider Trading Regulations;
- when in compliance standards and requirements specified by the board of directors of the company, as it may deem necessary for the purpose of the Insider Trading Regulations. The board of directors have to formulate a code of conduct to regulate, monitor and report trading by its employees and other connected persons towards achieving compliance with these relevant regulations. The code must adopt the minimum standards set out and without diluting the provisions of these regulations.
iii Legal requirements for executives to hold stock
There is no legal requirement under the Companies Act for executive to hold stock of their employer and employer give stock options as an incentive to the executives. Further, in the event any of executives (includes promoters, key managerial personnel, directors or employees) of the companies listed on recognised stock exchanges or proposed to be listed hold stock in the company, they have to make certain disclosure as per the Insider Trading Regulations. The disclosures are as follows:
- initial disclosures are to be made by every promoter, key managerial person and director of every listed company on a recognised stock exchange, regarding the securities held by such person in the company on the date the Insider Trading Regulations came into effect;
- every person on appointment as a key managerial personnel or a director of the company or upon becoming a promoter shall disclose his or her holding of securities of the company as on the date of appointment or becoming a promoter to the company;
- continual disclosures are also to be made by the promoters, employees and directors to the company regarding the number of such securities acquired or disposed, if the value of such securities (whether in one transaction or in a series of transactions over a calendar quarter) aggregates to value in excess of 1 million rupees; and
- such disclosures have to be notified to the stock exchange by the company within two trading days of the disclosure.
Additionally, the definition of remuneration under the Companies Act includes any money or its equivalent given to a director (whole-time or managing) and key managerial personnel. This implies that stock or shares issued to such directors or key managerial personnel would fall within the ambit of remuneration if the same has been given in consideration for any services rendered by them. The disclosure requirements for the purpose of remuneration has been discussed in detail under Section V.
iv Short swing trading
In addition to what is stated above, Insider Trading Regulations allow insiders to formulate a trading plan and present the same to the compliance officer for approval and public disclosure, pursuant to which trades may be carried out on their behalf in accordance with the plan. The intention of granting an option to persons who are perpetually in possession of unpublished price sensitive information is to enable such persons to trade in securities in a complaint manner. The formulation of a trading plan by an insider would enable that person to plan for trades to be executed in the future and thereby will not be hit by the prohibition under the regulations. Additionally, the executives (includes promoters, key managerial personnel, directors or employees) have to adhere to certain specifications when dealing with the trading plan under the Insider Trading Regulations and they are mentioned below:
- not entail commencement of trading on behalf of the insider earlier than six months after public disclosure of the plan;
- not entail trading for the period between the 20th trading day prior to the last day of any financial period for which results are required to be announced by the issuer of the securities and the second trading day after the disclosure of such financial results;
- entail trading for a period of not less than 12 months;
- not entail overlap of any period for which another trading plan is already in existence;
- set out either the value of trades to be effected or the number of securities to be traded along with the nature of the trade and the intervals at, or dates on which such trades shall be effected; and
- not entail trading in securities for market abuse.
v Anti-hedging rules applicable to executives
The RBI allows any person who is resident in India, who has a commodity exposure and faces risks due to volatile commodity prices, has the right to enter into a contract in a commodity exchange or market located outside India to hedge price risk in commodities imported or exported, domestic transactions, freight risk, etc. Hedging can be undertaken by a person in two ways, namely authorised dealers' delegate route and reserve bank's approval route. Authorised dealer banks provide facilities for remitting foreign currency amounts towards margin requirements from time to time, subject to verification of the underlying exposure.
i Companies are subject to public disclosure requirements with respect to remuneration information
All companies are required to make disclosure requirements with respect to remuneration information with respect to directors and key managerial personnel. As per the Companies Act, a company is defined as a company incorporated under this Act or under any previous company law. Further, a company may be formed for any lawful purpose by (1) seven or more persons, where the company to be formed is to be a public company, (2) two or more persons, where the company to be formed is to be a private company, or (3) one person, where the company to be formed is to be a one-person company, that is to say, a private company.
ii Types of remuneration information to be disclosed
The disclosures that are required to be made by companies,9 which include private, public and listed companies, are as follows:
- All listed companies have to constitute a nomination and remuneration committee (NRC), and the financial statements submitted must contain the policy set out for directors' appointments and remuneration.
- Every company has to prepare an annual return containing the particulars as the company stood on the close of the financial year regarding the remuneration of directors and key managerial personnel.
- Every listed company has to disclose in the board's report the following information: (1) the ratio of the remuneration of each director to the median remuneration of the employees of the company for the financial year; (2) the percentage increase in remuneration of each director, chief financial officer, chief executive officer, company secretary or manager, if any, in the financial year; (3) the percentage increase in the median remuneration of employees in the financial year; (4) the key parameters for any variable component of remuneration availed by the directors; (5) affirmation that the remuneration is as per the remuneration policy of the company; and (6) the ratio of remuneration of each director to the median employees' remuneration. A key managerial person includes (1) the chief executive officer or the managing director or the manager; (2) the company secretary; (3) the whole-time director; (4) the chief financial officer; and (5) such other officer as may be prescribed.
- In the event any director who is in receipt of a commission from the company, and who is a managing or whole-time director of the company, is disqualified from receiving any remuneration or commission from any holding company or subsidiary company of such company, will be subject to disclosure by the company in the board's report.
iii Perquisites quantified and defined
Further, except with prior approval of the board of directors, no company shall enter into any contract or arrangement with respect to the related party's appointment to any office or place of profit in the company, its subsidiary company or associate company. The office or place of profit is held by a director if the director receives remuneration over and above the remuneration to which he or she is entitled as a director by way of salary, perquisites or rent-free accommodation. However, prior consent of the company is required only for the appointment of the director or any office or place of profit in the company its subsidiary company or associate company at a monthly remuneration exceeding 250,000 rupees.
Additionally, perquisite is defined under the Income Tax Act 1961 and includes:
- the value of rent-free accommodation provided to the assessee by his or her employer;
- the value of any concession in the matter of rent respecting any accommodation provided to the assessee by his or her employer;
- the value of any benefit or amenity granted or provided free of cost or at concessional rate (1) by a company to an employee who is a director thereof or (2) by a company to an employee being a person who has a substantial interest in the company;
- any sum paid by the employer in respect of any obligation that, but for such payment, would have been payable by the assessee;
- any sum payable by the employer, whether directly or through a fund, other than a recognised provident fund or an approved superannuation fund or a deposit-linked insurance fund;
- the value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer, or former employer, free of cost or at concessional rate to the assessee;
- the amount of any contribution to an approved superannuation fund by the employer in respect of the assessee, to the extent it exceeds 150,000 rupees;
- the value of any other fringe benefit or amenity as may be prescribed. Related parties include (1) a director or his or her relative; (2) a key managerial person or his or her relative; (3) a firm, in which a director, manager or his or her relative is a partner; (4) a private company in which a director or manager or his or her relative is a member or director; (5) a public company in which a director or manager is a director and holds along with his relatives, more than 2 per cent of its paid-up share capital; (6) body-corporate whose board of directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager; (7) any person on whose advice, directions or instructions a director or manager is accustomed to act; or (8) any company that is (i) a holding, subsidiary or an associate company of the company, or (ii) a subsidiary of a holding company of which it is also a subsidiary; and
- any other person as may be prescribed.
Also, every contract or arrangement entered into by the company has to be referred to in the board's report to the shareholders along with a justification for entering into such contracts or arrangements.
iv Estimated value of incentives
Further, any company whose shares are listed on a recognised stock exchange in India and has a scheme of benefits granted to employees is governed by the Securities and Exchange Board of India (Share Based Employee Benefits) Regulations 2014 (the Share Based Employee Benefits). Accordingly, the valuation of share-based employee benefits is to be carried out in accordance with the guidance note on 'Accounting for Employee Share-based Payments' issued by the Council of the Institute of Chartered Accountants of India (the Guidance Note). As per the Share Based Employee Benefits and Guidance Note, there are two methods of accounting for employee share-based payments (i.e., the fair value method and the intrinsic value method) and enterprises are permitted the to use either of the two methods for accounting for such payments. However, an enterprise using the intrinsic value method is required to make extensive fair-value disclosures. Employee share-based payments generally involve grant of shares or stock options to the employees at a concessional price or a future cash payment based on the increase in the price of the shares from a specified level. Intrinsic value, in the case of a listed company, is the amount by which the quoted market price of the underlying share exceeds the exercise price of an option. Fair value is the amount for which stock option granted or a share offered for purchase could be exchanged between knowledgeable, willing parties in an arm's-length transaction.
v Agreements be made publicly available
The agreements that are required to be made publicly available are as follows:
- The Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations 2015 state that no employee including key managerial personnel or directors or promoters of a listed entity shall enter into any agreement for himself or herself or on behalf of any other person, with any shareholder or any other third party with regard to compensation or profit sharing in connection with dealings in the securities of the listed entity, unless prior approval for the same has been obtained from the board of directors as well as public shareholders by way of an ordinary resolution. Provided that (1) any agreement, whether subsisting or expired, entered into during the preceding three years from the date of coming into force of this sub-regulation, shall be disclosed to the stock exchanges for public dissemination, (2) if the board of directors approve such agreement, the same shall be placed before the public shareholders for approval by way of an ordinary resolution in the next general meeting of the company, and (3) all interested persons involved in the transaction covered under the agreement shall abstain from voting in the general meeting.
- No company shall enter into any contract or arrangement with related party without the approval of the board of directors.
- All listed companies need to formulate a policy on the materiality of related party transactions. Such transactions would need the prior approval of the audit committee, and an omnibus approval may be granted by the audit committee subject to the satisfaction of certain conditions.
- Contracts or arrangements in companies exceeding specific thresholds regarding paid-up share capital, or specific transactions can be entered into only with the prior approval of the company by a resolution passed regarding the same. The resolution cannot be voted upon by members of the company who have entered into the relevant contract or arrangement being voted on. These contracts or arrangements include: (1) sale, purchase or supply of any goods or materials; (2) selling or otherwise disposing of, or buying, property of any kind; (3) leasing of property of any kind; (4) availing or rendering of any services; (5) appointment of any agent for purchase or sale of goods, materials, services or property; (6) such related party's appointment to any office or place of profit in the company, its subsidiary company or associate company; and (7) underwriting the subscription of any securities or derivatives thereof, of the company.
- Subject to the provisions of the Companies Act, every director of a company who is in any way, whether directly or indirectly, concerned or interested in a contract or arrangement or proposed contract or arrangement entered into or to be entered into. Every company has to maintain a register for the purpose of contracts or arrangements in which directors are interested and such registers will contain particulars of (1) companies (firms or other association of individuals) in which any director has any concern or interest, (2) contracts or arrangements with a body corporate or firm or other entity in which any director is, directly or indirectly, concerned or interested, and (3) contracts or arrangements with a related party with respect to any transactions. The said register should be kept open and accessible at every annual general meeting to any person who has the right to attend the meeting.
VI CORPORATE GOVERNANCE
i Corporate governance requirements – executive remuneration
Please refer to Section V.
ii Clawback or recoupment of paid remuneration
The specific requirements for clawback or recoupment of remuneration paid in the event of a financial restatement, misconduct, adverse change in business or other circumstance are as follows:
- The remuneration payable to directors, including managing director and whole-time director, and managers has already been discussed. However, a company, where required to and without prejudice to any liability incurred under the provisions of the Companies Act or any other law for the time being in force in India, can restate its financial statements due to fraud or non-compliance with any requirement under the Companies Act and the Rules made thereunder, the company shall recover from any past or present managing director or whole-time director or manager or chief executive officer (by whatever name called) who, during the period for which the financial statements are required to be restated, received the remuneration (including stock option) in excess of what would have been payable to him or her as per restatement of financial statements.
- Where any insurance is taken by a company on behalf of its managing director, whole-time director, manager, chief executive officer, chief financial officer or company secretary for indemnifying any of them against any liability in respect of any negligence, default, misfeasance, breach of duty or breach of trust for which they may be guilty in relation to the company, the premium paid on the insurance shall not be treated as part of the remuneration payable to any such personnel. However, if the person is proved to be guilty, the premium paid on the insurance shall be treated as part of the remuneration.
- The termination of any director in accordance with the Companies Act would entitle the director to compensation or damages payable to him or her in respect of the termination. The compensation or damages payable shall be in accordance with the terms of the director's appointment or any other appointment terminating with that as director.
Additionally, if employees of a company who are eligible to receive gratuity as under the Payment of Gratuity Act 1972 are terminated from the services of employment in consequence of any acts, wilful omission or negligence that causes substantial damages to the company, the employees can be required to forfeit their entitlement of gratuity to the extent of the damages or losses so caused to the company.
iii Shareholder approvals – executive remuneration arrangements
Shareholders approvals for equity-linked remuneration has been explained in Section V.
iv Board or committee approvals – executive remuneration arrangements
As per the Companies Act and Companies (Meetings of Board and its Powers) Rules 2014, the board of directors of every listed company and the following classes of companies are required to constitute an NRC of the board: (1) all public companies with a paid-up capital of 10 million rupees) or more; (2) all public companies having turnover of 100 crore rupees or more; (3) all public companies, having in aggregate, outstanding loans or borrowing or debentures or deposits exceeding 50 million rupees.
The NRC shall ensure the following:
- Identify persons who are qualified to become directors and who may be appointed in senior management in accordance with the criteria laid down, recommend to the board their appointment and removal. The NRC has been given the additional responsibility of carrying out evaluation of every director's performance.
- Formulate the criteria for determining qualifications, positive attributes and independence of a director and recommend to the board a policy, relating to the remuneration for the directors, key managerial personnel and other employees.
- While formulating the policy, the committee shall consider the following:
- the level and composition of remuneration is sufficient to attract, retain and motivate directors of the quality required to run the company successfully;
- relationship of remuneration to performance is clear and meets appropriate performance benchmarks; and
- remuneration to directors, key managerial personnel and senior management involves a balance between fixed and incentive pay reflecting short and long-term performance objectives appropriate to the working of the company and its goals.
In addition to the above, the total managerial remuneration payable by a public company, to its directors, including managing director and whole-time director, and its manager in respect of any financial year shall not exceed 11 per cent of the net profits of that company for that financial year computed in the manner as laid down in the Companies Act. Further, except with prior approval of the board:
- The remuneration payable to any one managing director or whole-time director or manager shall not exceed 5 per cent of the net profits of the company and if there is more than one such director, remuneration shall not exceed 10 per cent of the net profits to all such directors and managers taken together.
- The remuneration payable to directors who are neither managing directors nor whole-time directors shall not exceed 1 per cent of the net profits of the company, if there is a managing or whole-time director or manager; or 3 per cent of the net profits in any other case.
These percentages shall be exclusive of any fees payable to directors for remuneration received by way of fees for attending meetings of the board or committee.
v Requirements – composition of the board or remuneration committee
The NRC constituted by the board of directors of companies mentioned in Section VI.iv has to consist of three or more non-executive directors, of which no less than half shall be independent directors. The chairperson of the company (whether executive or non-executive) may be appointed as a member of the NRC but shall not chair the committee.
vi Government approval – executive remuneration arrangements
The approval of the government for executive remuneration is required under the following circumstances:
- The total managerial remuneration payable by a public company, to its directors, including managing director and whole-time director, and its manager in respect of any financial year shall not exceed 11 per cent of the net profits of that company for that financial year computed in the manner as laid down in the Companies Act. However, the company may, with the approval of the central government, authorise the payment of remuneration exceeding 11 per cent of the net profits of the company subject to other provisions under the Companies Act.
- Subject to provisions of the Companies Act, if, in any financial year, a company has no profits or its profits are inadequate, the company shall not pay to its directors, including any managing or whole-time director or manager, by way of remuneration any sum exclusive of any fees payable to directors and if it is not able to comply with such provisions as prescribed under the Companies Act and Schedule V of the Companies Act, with the previous approval of the central government.
- In cases of no profits or inadequate profits,10 any provision relating to the remuneration of any director who purports to increase or has the effect of increasing the amount thereof, whether the provision be contained in the company's memorandum or articles, or in an agreement entered into by it, or in any resolution passed by the company in general meeting or its board, shall not have any effect unless such increase is in accordance with the conditions specified in that schedule and if such conditions are not being complied, the approval of the central government had been obtained.
vii Say on pay vote by shareholders
Except with prior approval, which includes approval of the shareholders, the company cannot increase the remuneration in the circumstances as mentioned below:
- To authorise the payment of remuneration to its directors, including managing director and whole-time director (in case of a public company), exceeding 11 per cent of the net profits of the company subject to other provisions under the Companies Act.
- The remuneration payable to any one managing director or whole-time director or manager exceeds 5 per cent of the net profits of the company and if there is more than one such director, remuneration exceeds 10 per cent of the net profits to all such directors and managers taken together.
- The remuneration payable to directors who are neither managing directors nor whole-time directors exceeds 1 per cent of the net profits of the company, if there is a managing or whole-time director or manager; or 3 per cent of the net profits in any other case.
In addition to the above, the remuneration payable to the directors of a company, including any managing or whole-time director or manager, shall be determined, in accordance with and subject to the provisions of the Companies Act, either by the articles of the company, or by a resolution or, if the articles so require, by a special resolution, passed by the company in general meeting and the remuneration payable to a director determined aforesaid shall be inclusive of the remuneration payable to him or her for the services rendered by him or her in any other capacity. However, any remuneration for services rendered by any such director in other capacity shall not be so included if (1) the services rendered are of a professional nature, and (2) in the opinion of the NRC, if the company is a listed company and such class of company as prescribed, or the board of directors in other cases, the director possesses the requisite qualification for the practice of the profession.
viii Proxy advisory firms
Proxy advisory firms have been regulated by the Securities and Exchange Board of India. Proxy advisory firms provide advice to institutional investors or shareholders of a company with respect to the exercising of the rights in the company, which includes independent opinion, research and data on corporate governance issues, as well as voting recommendations on shareholder resolutions. Further, given that shareholders' approval is required (1) to authorise the payment of remuneration to its directors, including managing director and whole-time director (in case of a public company), exceeding 11 per cent of the net profits of the company subject to other provisions under the Companies Act, (2) for remuneration payable to any one managing director, whole-time director or manager that exceeds 5 per cent of the net profits of the company and if there is more than one such director remuneration exceeding 10 per cent of the net profits to all such directors and manager taken together, (3) for remuneration payable to directors who are neither managing directors nor whole-time directors that exceeds: (i) 1 per cent of the net profits of the company, if there is a managing or whole-time director or manager; or (ii) 3 per cent of the net profits in any other case, proxy advisory firm may provide their recommendation to the shareholders before they give their approval to increase executive remuneration.
VII SPECIALISED REGULATORY REGIMES
i Executive remuneration – related to specific industries or companies
Executive remuneration with respect to banks in India has been regulated by the RBI under Banking Regulation Act 1949 (the Banking Act) to ensure complete transparency and accountability. In 2012, the RBI issued the Guidelines on Compensation of Whole Time Directors/Chief Executive Officers/Other Risk Takers (Guidelines – Whole Time Directors, Chief Executive Officers/Other Risk Takers) and in 2015 issued the Guidelines on Compensation of Non-executive Directors of Private Sector Banks (Guidelines – Private Sector Banks) (together, the Guidelines).
As per the Guidelines – Private Sector Banks:
- private sector banks should formulate and adopt a comprehensive compensation policy covering all their employees and conduct annual review;
- the board of directors of banks should constitute a remuneration committee of the board to oversee the framing, review and implementation of compensation policy of the bank on behalf of the board;
- banks should ensure that, in relation to compensation, for full-time directors or chief executive officers: (1) compensation is adjusted for all types of risk; (2) compensation outcomes are symmetric with risk outcomes; (3) compensation payouts are sensitive to the time horizon of the risk; and (4) the mix of cash, equity and other forms of compensation must be consistent with risk alignment;
- banks are required to ensure that the fixed portion of compensation is reasonable, taking into account all relevant factors, including the industry practice;
- while designing the compensation arrangements, it should be ensured that there is a proper balance between fixed pay and variable pay; however, variable pay should not exceed 70 per cent of the fixed pay in a year. Within this ceiling, at higher levels of responsibility the proportion of variable pay should be higher. The variable pay could be in cash, or stock linked instruments or mix of both;
- in the event of negative contributions of the bank or the relevant line of business in any year, the deferred compensation should be subjected to malus/clawback arrangements;
- guaranteed bonuses are not consistent with sound risk management or the pay-for-performance principles and should not be part of the compensation plan;
- banks should not provide any facility or funds or permit employees to insure or hedge their compensation structure to offset the risk alignment effects embedded in their compensation arrangement; and
- members of staff engaged in financial and risk control should be compensated in a manner that is independent of the business areas they oversee and commensurate with their key role in the bank.
Further, no amendment of any provision relating to remuneration of a chairman, a managing director or any other director, full-time or otherwise or manager or chief executive officer, whether that provision be contained in the company's memorandum or articles of association, agreement entered into by it, or in any resolution passed by the company shall have effect unless approved by the RBI; and any provision conferring any benefit or providing any amenity or perquisite, whether during or after the termination of the term of office of the chairman or the manager or the chief executive officer called or the managing director, or any other director, full-time or otherwise, shall be deemed to be a provision relating to his or her remuneration.
ii Industries and employees covered
The RBI has the authority to issue rules specific to executive remuneration of banking companies covered under the Banking Act. Further, the Guidelines issued by the RBI are different for private sector banks, foreign banks and primary (urban) cooperative banks. Banking company under the Banking Act is defined as any company that transacts the business of banking in India. Any company that is engaged in the manufacture of goods or carries on any trade and that accepts deposits of money from the public merely for the purpose of financing its business as such manufacturer or trader shall not be deemed to carry out the business of banking within the meaning of this clause.
Additionally, the employees covered under the said rules are the chairman, managing director, any other director, full-time director, manager or a chief executive officer.
iii Additional disclosure requirements
As per the guidelines issued by the RBI, the key disclosures that are required to be made by private sector bank and foreign banks with respect to remuneration are as mentioned below. Further, the disclosures are divided into qualitative and quantitative categories for private sector banks; however, the quantitative disclosures should only cover whole-time directors, chief executive officers and other risk-takers.
Private sector banks
- Banks are required to make disclosure on remuneration on an annual basis in their annual financial statements.
- Qualitative disclosures include: (1) information relating to the composition and mandate of the remuneration committee; (2) information relating to the design and structure of remuneration processes and the key features and objectives of the remuneration policy; (3) description of the ways in which the bank seeks to link performance during a performance measurement period with levels of remuneration; (4) description of the ways in which current and future risks are taken into account in the remuneration processes; (5) a discussion of the bank's policy on deferral and vesting of variable remuneration and a discussion of the bank's policy and criteria for adjusting deferred remuneration before vesting and after vesting; the (6) description and rationale of the different forms of variable remuneration (i.e., cash, shares, ESOPs and other forms) that the bank utilises.
- Quantitative disclosures include: (1) number of meetings held by the NRC during the financial year and the remuneration paid to its members; (2) number of employees who received variable remuneration award during the financial year; (3) total amount of deferred remuneration paid, number and total amount of sign-on awards made during the financial year, details of guaranteed bonus, if any, paid as joining or sign-on bonus, details of severance pay, in addition to accrued benefits, if any; (4) total amount of outstanding deferred remuneration, split into cash, shares and share-linked instruments and other forms, total amount of deferred remuneration paid out in the financial year; (5) breakdown of amount of remuneration awards for the financial year to show fixed and variable, deferred and non-deferred; and (6) the total amount of outstanding deferred remuneration and retained remuneration exposed to ex post explicit or implicit adjustments, total amount of reductions during the financial year due to ex post explicit adjustments, and total amount of reductions during the financial year owing to ex post implicit adjustments.
Foreign banks operating in India will be required to submit a declaration to the RBI annually from their head offices to the effect that their compensation structure in India, including that of their chief executive officer, is in conformity with the finance stability board (FSB) principles and standards.
iv Rules with respect to institution based in the jurisdiction or simply operating a foreign subsidiary or branch
Foreign banks are operating in India through branch mode of presence and the compensation policy of these banks is governed by their respective head office policies. Therefore, the RBI expected these head offices to adopt the FSB principles. Further, the compensation proposals for chief executive officers and other staff of foreign banks operating in India that have not adopted the FSB principles in their home country have to implement the compensation guidelines as prescribed for private sector banks in India, to the extent applicable to them. Further, the RBI is in charge of implementing and overseeing these rules.
VIII DEVELOPMENTS AND CONCLUSIONS
When dealing with executive remuneration or compensation, the trend in today's growing market is to find a fine balance between the act of rewarding executives and the growth and progress of the company. Several instances can be pointed out where shareholders have openly communicated their reservations against the ad hoc changes in the structure of the compensation or remuneration payable to senior executives. It is also interesting to note that, in certain instances, the backlash has been from the founders of the companies.
Corporate governance in India can be said to be proactive by already having provided the shareholders' say on pay vote. The concept has increasingly found its place in corporate governance in India. Influence and bias are concepts that cannot be disregarded and their involvement can be detrimental to the interests of the company. The involvement of shareholders in the determination of remuneration of executives who must exercise their duties in a fiduciary manner is a step forward in maintaining the prudent financial and operational structure of companies. It is our opinion that all companies must realise that good governance practices at every level go a long way in helping the performance of the company, and awarding employees adequately, ensures the necessary and permanent growth of the company in the long run, as it serves as an incentive to further common objectives.
1 Avik Biswas and Namita Viswanath are partners and Jaya Shruthi is an associate at IndusLaw. The information in this chapter was accurate as at August 2018.
2 Asiatic Oxygen Ltd (1994) 49 ITD 355 (Cal.)
3 For the purpose of clarification, a promoter includes (1) a person who has been named as such in a prospectus or is identified by the company in the annual return, (2) a person who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise, and (3) persons in accordance with whose advice, directions or instructions the board of directors of the company is accustomed to act. However, nothing in clause (3) shall apply to a person who is acting merely in a professional capacity.
4 Wipro v. Beckman Coulter International SA 2006(3) ArbLR118 (Delhi).
5 The Constitution guarantees certain fundamental rights, such as equality before the law and prohibition of discrimination in education and employment on the basis of religion, sect, gender and caste. Further, the Constitution envisages certain directive principles to guide the legislature towards social and economic goals. In an operational sense, the Constitution provides for a division of legislative powers between the Parliament (federal legislature) and State Assemblies (state legislatures). Labour and employment laws are listed under the Concurrent List, which means that the parliament and state legislatures have co-equal powers to enact laws relating to all labour and employment laws in India.
6 The financial benchmark that has been set would not be relevant in certain circumstances. The classification of workman is generally based mostly on the role and responsibilities of the workman in the company rather than the wages he or she is drawing.
7 Subject to the provision of the Companies Act, a resolution shall be an ordinary resolution if it is required to be passed by the votes cast, whether on a show of hands, or electronically or on a poll, as the case may be, in favour of the resolution, including the casting vote, if any, of the chairman, by members who, being entitled so to do, vote in person, or where proxies are allowed, by proxy or by postal ballot, exceed the votes, if any, cast against the resolution by members, so entitled and voting. A resolution shall be a special resolution when the votes cast in favour of the resolution, whether on a show of hands, or electronically or on a poll, as the case may be, by members who, being entitled so to do, vote in person or by proxy or by postal ballot, are required to be not less than three times the number of the votes, if any, cast against the resolution by members so entitled and voting.
8 Promoter includes (1) a person who has been named as such in a prospectus or is identified by the company in the annual return, (2) a person who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise, and (3) persons in accordance with whose advice, directions or instructions the board of directors of the company is accustomed to act. However, nothing in clause (3) shall apply to a person who is acting merely in a professional capacity.
9 Private company means a company that by its articles restricts the right to transfer its shares, consequently a public company includes any company that is not a private company. Public companies can further be classified into listed and unlisted companies. Listed companies are public companies that have their securities listed on any recognised stock exchange in India.
10 Schedule V annexed to the Companies Act 2013 deals with the conditions to be fulfilled for the appointment of a managing or whole-time director or a manager without the approval of the central government. Additionally, it also lists the amount of remuneration payable by companies having no profit or inadequate profit with the central government's approval.