Rule 16 explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Rule 16 lets a company fund a trust that buys the company's own shares (or its holding company's shares) for the benefit of employees, but only if four conditions are met. It also adds extra disclosures to the notice, bars certain people from being trustee and requires a Board's report disclosure when employees do not vote directly. This article states the rule as amended up to G.S.R. 43(E) dated 21 January 2023 per the MCA e-book; check for later amendments before relying on it.
A company must not provide money for the purchase of, or subscription for, shares of itself or its holding company by trustees holding them for employees unless the scheme is approved by a special resolution, the purchase is made through a recognised stock exchange (if listed), a registered valuer values unlisted shares, and the total stays within five per cent of paid-up capital plus distributable reserves (the Act's defined term). Directors, key managerial personnel, promoters and ten per cent holders cannot be trustees. Section 67 sets the statutory restriction; see our post on section 67.
What rule 16 covers
Sub-rule (1) opens with a prohibition. The company shall not make a provision of money for the purchase of, or subscription for, shares in the company or its holding company, if the purchase or subscription by trustees is for shares to be held by or for the benefit of the employees of the company, unless it complies with the conditions in clauses (a) to (d). The rule sits beside the employee schemes in rule 12 on stock option schemes and the sweat equity rule, but it is a different route: the company hands money to a trust and the trust buys the shares. A company that plans such a scheme may also want to review its ESOP structure at the same time.
The four conditions in sub-rule (1)
| Clause | Condition |
|---|---|
| (a) | The scheme of provision of money for purchase or subscription is approved by the members by a special resolution in a general meeting. |
| (b) | Where the company's shares are listed, the purchase is made only through a recognised stock exchange and not by private offers or arrangements. |
| (c) | Where the shares are not listed on a recognised stock exchange, the valuation at which they are to be purchased is made by a registered valuer. |
| (d) | The value of shares purchased or subscribed, together with the money provided by the company, does not exceed five per cent of the aggregate of paid-up capital and distributable reserves (the Act's defined term; the rule uses that defined term). |
Clause (d) adds the company's money and the share value together against the five per cent ceiling. The rule does not say how the aggregate is to be measured by date; read the clause as printed and take the figures from the company's accounts with your auditor.
The explanatory statement
Sub-rule (2) says the explanatory statement annexed to the general meeting notice under section 102 must, in addition to the particulars mentioned in sub-rule (1) of rule 18, contain these particulars:
- the class of employees for whose benefit the scheme is implemented and money is provided;
- the particulars of the trustee or employees in whose favour the shares are to be registered;
- the particulars of the trust, and the name, address, occupation and nationality of the trustees and their relationship, if any, with promoters, directors or key managerial personnel;
- any interest of key managerial personnel, directors or promoters in the scheme or trust, and its effect;
- the detailed particulars of the benefits that will accrue to the employees from the scheme;
- who would exercise the voting rights on the shares to be purchased or subscribed, and how.
The printed cross-reference is to "sub-rule (1) of rule 18" of this same set. In the e-book, rule 18 is the debenture rule, and rule 17 is the buy-back rule whose sub-rule (1) lists explanatory statement items; read the reference as printed and confirm with the official text which list the drafters meant.
Who cannot be a trustee
Sub-rule (3) says a person shall not be appointed as trustee to hold the shares if he:
- is a director, key managerial personnel or promoter of the company or of its holding, subsidiary or associate company, or any relative of such a director, key managerial personnel or promoter; or
- beneficially holds ten per cent or more of the paid-up share capital of the company.
So the trustee must be an outsider to management and promoters, and not a significant shareholder. A professional trustee company with no such links, or a group of independent individuals, fits the rule's wording; always check each trustee against both limbs before the appointment.
Voting by the trust and the Board's report
The explanatory statement must say who will vote and how. Sub-rule (4) then adds an annual disclosure: where the voting rights are not exercised directly by the employees on shares to which the scheme relates, the Board of Directors shall, among other things, disclose in the Board's report for the relevant financial year:
- the names of the employees who have not exercised their voting rights directly;
- the reasons for not voting directly;
- the name of the person exercising those voting rights;
- the number of shares held by or in favour of such employees, and their percentage of the total paid-up share capital;
- the date of the general meeting in which the voting power was exercised;
- the resolutions on which votes were cast by persons holding such voting power;
- the percentage of that voting power to the total voting power on each resolution; and
- whether the votes were cast in favour of or against the resolution.
The words "inter alia" in the rule mean the list is a minimum, not a ceiling.
Example
Orchid Components Limited, an unlisted public company, proposes to provide money to the Orchid Employee Welfare Trust to buy its shares for factory staff. Its general meeting passes a special resolution. The shares are valued by a registered valuer because they are unlisted. The company's finance head tests the proposal against the five per cent ceiling using the aggregate of paid-up capital and distributable reserves (the Act's defined term). The two trustees are an independent chartered accountant and a retired bank manager, neither a promoter, KMP or ten per cent holder. If the employees do not vote directly, the next Board's report names each such employee, the reason, the person who votes for the trust and the resolutions voted on.
Need help with an employee share scheme?
If your company is setting up a trust-based scheme, the special resolution, explanatory statement, valuation and trustee appointment all have to line up. We help prepare and review them as part of our employee stock option work.
Key takeaways
- Rule 16 bars a company from funding a trust to buy its or its holding company's shares for employees unless clauses (a) to (d) are met.
- A special resolution is needed; listed shares must be bought through a recognised stock exchange; unlisted shares need a registered valuer.
- The shares plus the company's money must not exceed five per cent of paid-up capital and distributable reserves (the Act's defined term).
- Directors, KMP, promoters, their relatives and ten per cent holders cannot be trustees.
- The Board's report must carry the voting disclosures where employees do not vote directly.
Read next
- Rule 12 of the Share Capital Rules: employee stock option schemes
- Rule 17 of the Share Capital Rules: buy-back of shares
- Section 67: restrictions on purchase of own shares or giving loans
- ESOP eligibility under rule 12
Disclaimer: Based on the Companies Act, 2013 rules named above as consolidated in the MCA e-book (consulted on 3 October 2026), with the later notifications the article names. Later amendments, fees, forms and the Companies Act, 2013 provisions referred to should be checked. This article is general information, not legal advice; check the official text before acting.