How are ESOPs taxed in India?

1The two taxable events

ESOPs are taxed twice, at two different points, and it's crucial to keep them separate:

• At exercise — when you convert your vested options into actual shares by paying the exercise price. The 'discount' you get (FMV minus exercise price) is taxed as salary.
• At sale — when you sell those shares. Any gain over the FMV at exercise is taxed as capital gains.

2Tax at exercise (the perquisite)

When you exercise, the taxable perquisite is: (FMV on the exercise date − the exercise price you paid) × number of shares. This amount is added to your salary, taxed at your slab rate, and your employer deducts TDS on it.

For listed shares the FMV is the market price; for unlisted/startup shares it's a value certified by a merchant banker.

3Tax at sale (capital gains)

When you eventually sell the shares, your capital gain is: sale price − FMV at exercise (the FMV already taxed as perquisite, so it isn't taxed twice). The rate depends on the share type and holding period:

• Listed shares held over 12 months: 12.5% LTCG on gains above ₹1.25 lakh/year
• Listed shares held under 12 months: 20% STCG
• Unlisted shares held over 24 months: 12.5% LTCG; under 24 months, taxed at slab rate

4Relief for startup employees

Because paying perquisite tax on unlisted startup shares (that you can't sell yet) can be a real burden, the law lets employees of DPIIT-recognised eligible startups defer the perquisite tax. You pay it at the earliest of: five years from exercise, the date you sell the shares, or the date you leave the company.

5The cash-flow problem at exercise

The structural difficulty with ESOP taxation in India is that tax falls due at exercise, when no money has come in.

The perquisite value — fair market value on the exercise date less the price you paid — is added to your salary and taxed at your slab rate. Your employer must deduct TDS on it, and will usually recover that from your salary or require you to fund it.

So exercising options in an unlisted company can produce a substantial tax bill on shares you cannot sell, in a company that may not have a liquidity event for years. This is the risk people underestimate, not the rate.

6The start-up deferral, and how narrow it is

Section 192(1C) allows employees of eligible start-ups to defer the TDS on the exercise perquisite, and the concession is genuinely useful — but the eligibility is much narrower than the word 'start-up' suggests.

It applies only to a start-up holding a certificate of eligibility from the Inter-Ministerial Board under section 80-IAC. DPIIT recognition alone is not sufficient, and only a small fraction of recognised start-ups hold the 80-IAC certificate.

Where it applies, tax is deferred to the earliest of five years from the end of the year of allotment, the date you sell the shares, or the date you leave the company. It is a deferral of payment, not an exemption — the perquisite value remains fixed at exercise.

7Shares in a foreign parent

Where the shares are in an overseas parent company — common in Indian arms of multinationals — two extra obligations attach.

The shares are a foreign asset, so a resident and ordinarily resident employee must disclose them in Schedule FA whether or not they were sold, and whether or not they produced anything.

On sale, the gain is not eligible for the concessional listed-equity rates, because those apply only where securities transaction tax has been paid on an Indian exchange. Foreign shares are taxed as unlisted shares, with a 24-month holding period for long-term treatment.

8What actually happens at sale

The second taxable event is the sale, and the cost base is not what you paid.

Your cost of acquisition is the fair market value that was used to compute the perquisite at exercise — not the exercise price. That is what prevents the same gain being taxed twice: the rise up to exercise was taxed as salary, and only the rise after exercise is a capital gain.

The holding period also runs from the date of allotment, not the date of grant. For listed shares sold on an Indian exchange, 12 months makes the gain long-term; for unlisted or foreign shares it is 24 months.