Understand the complete taxation structure of ESOPs (Employee Stock Option Plans) in India. Learn about tax implications at allotment, sale, and strategies for saving taxes on ESOPs in 2025.
Introduction
Employee Stock Option Plans (ESOPs) have emerged as a powerful tool for startups and corporations to attract and retain top talent. By offering employees a chance to own equity in the company, ESOPs align individual performance with company growth. But with ownership comes tax obligations. Understanding taxation on ESOPs in India is crucial for effective financial planning.
This article breaks down everything you need to know about ESOP taxation — from when you are taxed to how much and what you can do to reduce your liabilities.
What Are ESOPs?
Employee Stock Option Plans (ESOPs) are a form of employee compensation where employees are granted the right to purchase a specific number of company shares at a pre-determined price (exercise price) after a certain period (vesting period).
Key Terms You Should Know
| Term | Meaning |
|---|---|
| Grant Date | Date when the company offers ESOPs to the employee |
| Vesting Period | Time the employee must wait before exercising the option |
| Exercise Price | Price at which the employee can buy the shares |
| Exercise Date | Date on which employee actually buys shares |
| Fair Market Value (FMV) | Market value of shares on the exercise date |
| Sale Date | Date on which employee sells the shares |
Stages of Taxation on ESOPs in India
Tax on ESOPs is levied at two stages:
- At the time of Exercise – Taxed as perquisites under the head “Income from Salary”
- At the time of Sale – Taxed as capital gains (short-term or long-term depending on holding period)
1. Taxation at the Time of Exercise
When you exercise your ESOPs, the difference between the Fair Market Value (FMV) on the exercise date and the exercise price is considered a perquisite and taxed under the head “Income from Salary.”
Formula:
Perquisite Value = (FMV on exercise date – Exercise Price) × Number of shares
This amount is added to your total salary income and taxed as per the applicable income tax slab.
Example:
| Particulars | Amount (INR) |
|---|---|
| Number of shares exercised | 1,000 |
| Exercise Price | ₹100 |
| FMV on exercise date | ₹300 |
| Perquisite value | (300 – 100) × 1,000 = ₹2,00,000 |
Taxable Salary = ₹2,00,000 (plus your existing salary)
Note: The employer is responsible for deducting TDS on this amount.
2. Taxation at the Time of Sale
When the employee eventually sells the shares, capital gains tax is applicable. The purchase cost is taken as the FMV on the date of exercise (not the original exercise price).
Capital Gain = Sale Price – FMV on Exercise Date
| Holding Period | Type of Gain | Tax Rate |
|---|---|---|
| Less than 12 months | Short-Term Capital Gain (STCG) | 15% (if listed) |
| More than 12 months | Long-Term Capital Gain (LTCG) | 10% (on gains exceeding ₹1 lakh) |
| For unlisted shares | STCG at slab rate, LTCG at 20% with indexation |
Example:
| Particulars | Amount (INR) |
|---|---|
| FMV on Exercise | ₹300 |
| Sale Price | ₹500 |
| Holding Period | 14 months |
| Capital Gain | ₹200 per share |
| Tax | LTCG @10% if listed, else 20% with indexation if unlisted |
Special Case: ESOPs in Startups (Eligible Startups under Section 80-IAC)
The Finance Act, 2020 provided a relief for employees of eligible startups. In such cases, the perquisite tax (which is normally payable at the time of exercise) is deferred to the earlier of the following:
- 5 years from the year of allotment
- Date of sale of shares
- Date the employee leaves the company
Who Qualifies?
Only recognised startups registered under the DPIIT and eligible under Section 80-IAC of the Income Tax Act qualify for this relief.
Tax Planning Strategies for ESOPs
Here’s how you can optimize your ESOP tax liability:
1. Plan Exercise Timing
Exercise your ESOPs when your total taxable income is low to reduce tax on perquisites.
2. Sell After One Year (If Listed)
To take advantage of LTCG tax benefits, wait for at least 12 months after exercising before selling.
3. Utilize Capital Losses
Offset your capital gains by booking capital losses in other investments to lower your tax liability.
4. Defer Exercise (If Possible)
If your company allows it, delay exercising ESOPs until close to a liquidity event (IPO or acquisition) to manage cash flow for paying tax.
5. Understand Your Company’s ESOP Tax Policy
Some companies offer gross-up on tax, i.e., they bear the TDS on your behalf. Check your employment offer.
Sample Tax Calculation for Listed Company
| Details | Amount |
|---|---|
| No. of shares | 500 |
| Exercise Price | ₹50 |
| FMV on Exercise Date | ₹200 |
| Sale Price | ₹350 |
| Holding Period | 15 months |
Step 1 – Tax on Exercise:
Perquisite = (₹200 – ₹50) × 500 = ₹75,000 → Taxed as Salary
Step 2 – Tax on Sale:
Capital Gain = (₹350 – ₹200) × 500 = ₹75,000 → LTCG @10% = ₹7,500
Table: Tax Rates on ESOPs in India
| Event | Type of Income | Taxable Amount | Tax Rate |
|---|---|---|---|
| Exercise of ESOP | Salary | FMV – Exercise Price | As per slab |
| Sale (Listed) – <12 months | Capital Gains | Sale Price – FMV | 15% |
| Sale (Listed) – >12 months | Capital Gains | Sale Price – FMV | 10% above ₹1 lakh |
| Sale (Unlisted) – <24 months | Capital Gains | Sale Price – FMV | As per slab |
| Sale (Unlisted) – >24 months | Capital Gains | Sale Price – FMV | 20% with indexation |
Compliance and Filing Requirements
- Form 16: Check for ESOP-related perquisites in Part B.
- ITR-2 or ITR-3: Use these ITR forms if you’ve sold ESOP shares.
- Form 26AS & AIS: Match TDS deducted with your perquisite income.
- Capital Gains Report: Maintain sale invoices and contract notes from brokers.
Common Mistakes to Avoid
- Ignoring tax at the time of exercise
- Not accounting for capital gains separately
- Assuming only sale is taxable
- Selling unlisted shares without understanding holding period tax rates
- Not reporting ESOP transactions in ITR
ESOP Taxation in Foreign Companies
If you’re receiving ESOPs from a foreign parent company, the same tax treatment applies at the time of exercise. Additionally, you must comply with foreign asset reporting under Schedule FA in your income tax return.
Also, for foreign shares sold, currency conversion rules and Double Taxation Avoidance Agreements (DTAA) may come into play.
Conclusion
Understanding taxation on ESOPs in India is essential to maximize the financial benefits they offer. Whether you’re a startup employee or a part of a large listed company, tax planning around ESOPs can significantly improve your post-tax returns.
Consult with a tax advisor or CA, especially if your ESOPs involve foreign holdings or if you’re part of an eligible startup with deferred taxation benefits.
FAQs
Q1. Are ESOPs taxed twice?
Yes, once as perquisites during exercise and again as capital gains upon sale.
Q2. Do I need to pay tax if I don’t sell my ESOPs?
Yes, if you have exercised them, the perquisite is taxable regardless of whether you sell or not.
Q3. Can I claim any deductions on ESOPs?
No specific deductions, but you can use capital loss offsetting and optimize timing to reduce overall tax.
Q4. What if I leave the company before vesting?
You will not be able to exercise unvested ESOPs, and no tax will be applicable on them.