ESOP Taxation for Employees of Indian Startups: Exercise, Deferral and Sale

ESOPs are a big part of startup pay, but many employees don't realise tax can arise before they ever sell a share. This guide explains how ESOPs are taxed in India under the rules applicable through FY 2025-26; the Income-tax Act, 2025 continues the same approach from tax year 2026-27.

At Grant and Vesting

No tax arises when options are granted or vest.

At Exercise

When you exercise, the difference between the fair market value of the shares on the exercise date and the exercise price is taxed as salary (a perquisite). For unlisted shares, the fair market value comes from a merchant banker's valuation. The employer deducts TDS.

Deferral for Eligible Startups

Employees of eligible startups — broadly, DPIIT-recognised startups certified for the startup tax benefit — can defer the tax on exercise. The tax becomes payable within 14 days of the earliest of: 48 months from the end of the relevant assessment year, the sale of the shares, or leaving the company.

At Sale

The gain on sale is the sale price minus the fair market value on exercise. The holding period runs from allotment. Unlisted shares held more than 24 months are long-term, taxed at 12.5% since July 2024; shorter holdings are taxed at slab rates.

Buybacks

Since 1 October 2024, amounts received on a share buyback are taxed as dividends in the shareholder's hands, and the cost of the shares becomes a capital loss. This affects ESOP liquidity programmes structured as buybacks, so check the structure.

Planning Points

• Plan cash for tax on exercise, especially without deferral.
• Consider timing exercise when valuations are lower.
• Keep valuation reports and allotment records.
• Understand the company's exit and liquidity plans.

Getting Help

Think Filing advises employees and startups on ESOP taxation and planning.