ESOP in India: Direct Route vs. Trust Route (and When You Actually Need a Trust)

Most Indian startups should run their ESOP through the direct route, not a trust. Under Section 62(1)(b) of the Companies Act, 2013, the board approves a scheme and the company allots fresh shares directly to the employee when they exercise — no second legal entity, no trustee, no separate funding mechanism to administer. A trust, set up under Section 67(3)(b) and Rule 16 of the Companies (Share Capital and Debentures) Rules, 2014, only earns its added complexity once you need to warehouse unallocated shares for future hires, run a pooled buyback, or move secondary shares off-cap-table without a fresh allotment each time.

That's the one-sentence version. The two routes rest on different sections of the same Act, carry different compliance loads, and get recommended by people with different incentives — which is worth knowing before you take vendor advice at face value.

Two routes, two sections

Indian company law gives you two legally valid ways to run an ESOP, and neither is more "correct" than the other — they solve different problems.

Direct route (Section 62(1)(b)). The company itself grants options under a board-approved scheme. When an employee exercises, the company issues fresh shares straight to them and files Form PAS-3 (return of allotment) with the Registrar of Companies after that exercise event. There's no intermediary holding shares on anyone's behalf. This is the default most law firms recommend to companies that haven't identified a specific reason to do anything else.

Trust route (Section 67(3)(b) + Rule 16). The company sets up a trust under the Indian Trusts Act, 1882, and funds it to acquire shares on the company's behalf — either fresh shares or shares bought back from departing or exiting employees. Section 67 generally bans a company from financing the purchase of its own shares; Rule 16 is the specific carve-out that lets an ESOP trust do exactly that, subject to a cap on how much the company can lend the trust (5% of the aggregate of paid-up capital and free reserves, outstanding at any time). The trust then holds and allocates shares to employees as they vest and exercise, and it's the vehicle of choice for secondary-share transactions — if your company is running any kind of buyback or liquidity program, those transactions typically have to go through the trust rather than directly between the company and the employee.

Both routes need a board-approved ESOP scheme. The trust is an extra structure layered on top of that scheme, not a replacement for it — and that's where founders talking to a vendor that sells trust administration tend to get a one-sided pitch.

What actually triggers the trust decision

The honest answer is: most companies don't need one yet, and advisors who make money setting up and administering trusts aren't always the first to say so.

Pick the trust route when one of these is actually true for your company, not hypothetically true in three years:

• You're running or planning a buyback. Startups bought back close to $220 million in ESOPs in Q1 2026 alone, per Entrackr's tracking — more than all of 2024 or all of 2025 combined, as later-stage Indian startups use buybacks to give employees liquidity without waiting for an IPO or acquisition. If you're one of them, the trust is usually how the mechanics actually work, not an optional nicety.
• You want to warehouse unallocated shares. A trust can hold a pool of shares earmarked for future grants, which some companies find administratively cleaner than issuing fresh shares company-by-company as each new hire's options vest.
• You're facilitating secondary sales. If departing employees need a buyer for vested shares and you want that transacted in a structured way rather than ad hoc private transfers, the trust gives you a single counterparty to route it through.

If none of those apply — you're pre-Series A, nobody's leaving yet, and you haven't discussed a buyback — the direct route does everything you need with one fewer legal entity to maintain, one fewer trustee relationship, and one fewer thing for a future acquirer's diligence team to ask about.

Who can actually receive a grant

Rule 12 of the Share Capital Rules defines "employee" for ESOP purposes, and it's narrower than founders assume. Eligible recipients are permanent employees (working in India or abroad) and directors of the company, including whole-time directors, plus employees of subsidiary or holding companies. Two groups are carved out by name:

Independent directors are never eligible, with no exception. If you've got independent directors on your board and were planning to retain them with options, that specific mechanism isn't available under Indian company law — look at a different retention structure instead.

Promoters are excluded by default, with one carve-out. A startup that holds current DPIIT (Department for Promotion of Industry and Internal Trade) recognition can grant options to promoters and to directors who hold more than 10% of the company's equity, for up to 10 years from the date of incorporation. That's a narrow, status-dependent exception — DPIIT recognition can lapse, and when it does, so does the legal basis for those grants. Don't build a founder vesting plan around a government registration you don't control the permanence of.

The vesting floor nobody can contract around

Rule 12 sets a hard minimum: at least one year has to pass between the date options are granted and the date the first tranche vests. You can design any vesting curve you want after that — monthly over four years, a cliff followed by quarterly vesting, milestone gates tied to product or revenue targets — but nothing vests inside the first twelve months, full stop. This is a company-law floor, not a tax rule, and it applies regardless of what instrument-tracking software you use or what your grant letter says.

This is separate from — and in addition to — the tax treatment that applies once options actually vest and get exercised. India taxes the exercise spread as a salary perquisite under Section 17(2), then taxes any further gain as capital gains on sale; see ESOP tax in India for how that two-stage tax actually works and which startups qualify for the 48-month deferral under Section 80-IAC. That's a tax question. This article is a structuring question. Keep the two separate when you're explaining either one to a new hire, because conflating them is exactly how founders end up over-promising on tax treatment their company doesn't actually qualify for.

Approvals: don't assume the same resolution covers everything

The ESOP scheme itself is approved under Section 62(1)(b) — for a public company, that typically means a special resolution; for a private company, a 2015 exemption notification lets many companies substitute an ordinary resolution instead, but confirm which applies to your company's specific class and articles before you schedule the vote. If you're also setting up a trust, that's a separate approval under Section 67(3)(b) and Rule 16 — funding the trust and approving the scheme aren't the same corporate action, even though they usually happen around the same time in practice.

Get this sequencing wrong and the fix isn't a quiet correction — it's re-running a shareholder resolution, with all the governance overhead that implies, on a filing a lawyer should have caught the first time.

The buyback tax picture, briefly

If a buyback or secondary liquidity program is part of why you're considering the trust route, know that the tax treatment on the employee side has moved more than once in recent years and changed again for the 2026-27 financial year. From 1 April 2026, a company buying back its own shares under Section 68 taxes the employee on capital gains again, after a period where buyback proceeds were taxed as deemed dividend income. Shares sold through the trust route or to an outside investor in a secondary transaction were already under ordinary capital-gains treatment and aren't affected by that specific change. The mechanics are detailed enough, and have shifted often enough, that this is a conversation for a tax advisor at the specific moment you're pricing a buyback — not something to lock into a policy document a year in advance.

Where Govy fits, and where it honestly doesn't

Govy's cap table tracks ESOP grants as one of several instrument types — alongside RSUs, SARs, and phantom shares — on an event-sourced, append-only ledger, so whatever vesting schedule you set (subject to that one-year floor) becomes a permanent record instead of a formula in a spreadsheet someone can quietly overwrite. The same login runs your fundraising CRM and a data room served from your own Google Drive, so the cap table, the raise, and the diligence documents a buyback or a priced round will eventually require all live in one place rather than three.

To be direct about the boundary: Govy's jurisdiction-aware legal template pack today covers Saudi Arabia, the UAE, US/Delaware, and the UK. It does not generate an Indian ESOP scheme document, a trust deed under the Indian Trusts Act, or Form PAS-3 filings — that drafting and compliance work still needs an Indian corporate lawyer and company secretary. What Govy gives you is a ledger that holds the grants accurately once your lawyer has told you which route and which schedule to use, not a replacement for the legal work that decision requires. If you're comparing India-specific platforms that do offer trust administration, Trica Equity is the one built natively for that market — worth knowing what it covers before you pick a tool based on geography alone.

If what you need is a cap table that holds your ESOP grants cleanly, tracks vesting against the one-year floor automatically, and keeps your fundraising pipeline and data room on the same login, see how it handles that at govy.tech.

FAQ

Should an early-stage Indian startup use the direct route or set up an ESOP trust?

Default to the direct route. Under Section 62(1)(b) of the Companies Act, 2013, the board approves a scheme and the company allots fresh shares straight to the employee on exercise — no second entity, no trustee, no ongoing administration. A trust under Section 67(3)(b) and Rule 16 of the Share Capital Rules only earns its complexity once you're warehousing unallocated shares for future hires, running pooled buybacks, or facilitating secondary sales — problems most seed and Series A companies don't have yet.

Can promoters or independent directors receive ESOP grants in an Indian startup?

Independent directors can't, full stop — Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 excludes them by definition. Promoters are excluded too, with one carve-out: a startup recognised by DPIIT can grant options to promoters and to directors holding more than 10% equity, for up to 10 years from incorporation. Lose DPIIT recognition and that carve-out goes with it, so don't structure founder retention around an ESOP grant that depends on a status your company might not keep.

What's the minimum vesting period for ESOPs under Indian company law?

At least one year between grant and the first vesting date — Rule 12 sets this as a floor, not a default you can waive by agreement. You can vest over any schedule you want after that first year (monthly, cliff-then-monthly, milestone-gated), but nothing can vest before the twelve-month mark. This is a company-law rule, separate from and in addition to whatever tax treatment applies at exercise.

Does setting up an ESOP trust require separate shareholder approval from the ESOP scheme itself?

Yes — they're two different approvals under two different sections. The ESOP scheme itself needs approval under Section 62(1)(b), while funding a trust to administer or warehouse those shares runs through Section 67(3)(b) and Rule 16's exception to the general ban on a company financing purchases of its own shares. A private company can often use an ordinary resolution for the scheme under a 2015 exemption notification, but confirm which applies to your company before you file — getting this wrong means re-running the shareholder vote.

Is an ESOP buyback in India taxed differently depending on how the company repurchases the shares?

Yes, and the rules shifted again in 2026. From 1 April 2026, a company's own share buyback under Section 68 is taxed as a capital gain in the employee's hands, after a period where buyback proceeds were taxed as deemed dividend. Shares sold to an ESOP trust or to an outside investor in a secondary sale were already taxed under ordinary capital-gains rules, so the route you buy back through now matters less than it did — but confirm the current position with a tax advisor before you price a buyback, since this has moved more than once.