Advisory Shares in Indian Startups: Legal & Tax-Compliant Equity Alternatives for C-Level Consultants

Contributed by:
Athira Ramesh
athira@simplybiz.in

A significant challenge for startup founders in India is aligning the interests of crucial external talent, such as C-level consultants and expert advisors, with the long-term success of the company. Since standard employee equity compensation instruments are not available to non-employees, founders must navigate a complex landscape of Indian corporate and income tax laws to grant what are commonly termed “Advisory Shares.”

This article provides a framework for legally issuing equity to your non-employee C-level consultants, with a specific focus on cost-effectiveness and mitigating the high-tax liability that arises when a company’s Fair Market Value (FMV) has significantly outpaced its Book Value.

1. The Need for Alternatives and Statutory Compliance

External consultants and advisors, being independent contractors, do not qualify for standard employee-centric equity plans under the Companies Act, 2013. The equity grant must therefore be structured through one of the following permissible routes, ensuring compliance with:

• Companies Act, 2013: Governs the issuance of securities (Private Placement, rights issues, allotment for consideration other than cash).
• Income Tax Act, 1961 (Section 56(2)(x)): The key provision that taxes the recipient if shares are received from the company at a price less than their Fair Market Value (FMV).

Option A (Recommended): Founder’s Share Transfer

For large grants (2–5% equity) where the startup has a high FMV, but you wish to avoid a massive up-front tax burden for the advisor, the transfer of shares from an existing shareholder (typically a founder) is often the cleanest and most cost-effective path.

The Mechanism

Instead of the company issuing new shares (which would trigger the FMV-based tax hurdle), an existing founder transfers a portion of their personal shareholding to the advisor via a Share Purchase Agreement (SPA). The terms of this transfer are purely between the founder and the advisor.

Key Advantage: Pricing and Tax Efficiency

This approach neatly sidesteps the restrictive FMV pricing rule for new issuances from the company.

This is the most practical way to fulfil a promise of substantial equity (2-5%) without forcing the advisor to incur an immediate, non-cash tax liability based on the company’s high Fair Market Value.

Private Sale is Legally Valid

Option B: Direct Company Allotment for Services

This is the formal, standard route for issuing shares in exchange for non-cash services, but it comes with significant compliance and tax overheads.

The Mechanism

The company issues new shares directly to the advisor in exchange for professional services rendered. This is treated as an allotment of shares for consideration other than cash.

1. Service Invoice: The advisor raises an invoice for the value of their C-level consulting services.
2. Corporate Approvals: The company passes a Board Resolution and a Special Resolution from shareholders (for private placement) to approve the allotment.
3. Allotment: Shares are allotted against the value of the invoice.

The Tax and Valuation Hurdle

This option creates two layers of tax liability for the advisor:

1. Advisor’s Immediate Income Tax: The full value of the services (the invoice amount) is treated as Professional Income in the hands of the advisor in the year of allotment. This amount is taxed at the advisor’s peak applicable slab rate. The company is liable to deduct TDS on the value of the services paid in the form of shares.
2. Mandatory FMV Compliance: The company must ensure the issue price is at or above the Fair Market Value (FMV), as determined by a Registered Valuer. Issuing shares below the FMV will cause the difference to be taxed as ‘income from other sources’ for the advisor, compounding their immediate tax burden.

This option is cumbersome because it triggers the high-valuation tax liability and administrative requirements for the advisor, which is contrary to the goal of a cost-effective grant.

It is legally valid (Allotment for Non-Cash Consideration)

Option C: Non-Equity Incentives (Stock Appreciation Rights)

If the main goal is a performance-linked incentive tied to value appreciation without immediate dilution or granting voting rights, non-equity instruments are a flexible alternative.

Stock Appreciation Rights (SARs)

A SAR is a contractual right that gives the holder a payment (in cash or shares) equal to the appreciation in the company’s value over a specified period.

• No Ownership: SARs are purely contractual and do not confer share ownership, meaning they don’t involve the complexities of share issuance or voting rights.
• Payout: Upon vesting/exercise, the appreciation amount is paid out.
• Tax Implication: The payout, whether in cash or shares, is taxed entirely as professional income at the advisor’s applicable slab rate. This avoids the upfront tax on the grant date, but the entire gain is taxed as income, not as capital gains.

Action Plan and Mandatory Compliance Checklist

A grant of 2–5% equity is a major corporate decision. For any of the above modes, ensure meticulous compliance:

1. Draft a Robust Advisor Agreement: This legal document must clearly define the advisor’s role, the specific number of shares/options, the Vesting Schedule (e.g., 1-year cliff, 3-year monthly vesting), and clauses on Intellectual Property Rights (IPR) and confidentiality.
2. Board Approval: The Board of Directors must formally approve the grant and the terms of the advisor equity in a duly convened Board Meeting.
3. Valuation (Mandatory for Option B): Appoint an IBBI Registered Valuer to certify the Fair Market Value (FMV) of the shares to comply with Income Tax laws for new issuances.
4. TDS and GST: For any share-for-service exchange (Option B), ensure the company correctly deducts and remits TDS on the value of the services, and that the advisor’s invoice addresses GST applicability (if required).

Final Word: Aligning Incentives with Tax Strategy

Navigating the grant of Advisory Shares in Indian startups requires a strategic approach that prioritizes tax efficiency and legal compliance. Ultimately, founders must select the path that best aligns the advisor’s incentives with minimal personal financial friction, always ensuring that the grant is meticulously documented in a robust Advisor Agreement and approved by the Board to maintain corporate hygiene.

If you are looking for professional assistance in share issuance, share transfers, stamp duty payments, fundraising transactions or end-to-end compliance management for your company, SimplyBiz offers comprehensive solutions covering all stages of the entity life cycle. To know more or to outsource your compliance requirements, please write to Shilpa Agarwal at shilpa@simplybiz.in.