ESOPs are becoming increasingly common in India, especially with the rise of startups and global companies offering them to their employees here.

An ESOP (Employee Stock Option Plan) is a benefit where a company gives its employees the option to own shares in the business. It works somewhat like a profit-sharing plan. The company offers these shares at little or no cost to the employee.

The shares are kept in an ESOP trust until the vesting period ends. Once this period is over, employees can choose to exercise their options, usually when they leave the company or retire.

Important Terms to Know About ESOPs and RSUs

Before diving into how ESOPs and RSUs are taxed, it’s helpful to understand a few key terms commonly used:

• ESOP (Employee Stock Option Plan): This allows employees to buy shares of the company they work for, usually over a set period. The terms are defined in an agreement between the employer and the employee.

• ESPP (Employee Stock Purchase Plan): Under this plan, employees can buy company shares at a discounted price. The payment is made directly from their bank account or deducted from their salary every month.

• RSU (Restricted Stock Units): Commonly offered by foreign-listed companies, RSUs are granted as a reward for meeting certain goals or milestones. Unlike ESOPs, employees don’t have to pay anything to receive these shares.

• Grant Date: The date when the company agrees to offer shares to the employee in the future.

• Vesting Date: The date when the employee becomes eligible to buy or receive the shares, after fulfilling specific conditions.

• Vesting Period: The time between the grant date and the vesting date.

• Exercise Period: The time during which an employee can choose to buy the shares after they’ve vested.

• Exercise Date: The actual date when the employee decides to purchase the shares.

• Exercise Price: The price at which the employee can buy the shares. This is usually lower than the market price and is fixed when the ESOP terms are agreed upon.

Once the employee meets the required conditions or the vesting period ends, the stock options become active. At this stage, the employee can choose to exercise the option and buy the shares at the agreed price. If they choose not to buy, no tax is applicable.

How ESOPs Are Taxed

There are two stages when ESOPs are taxed:

1. When You Exercise the Option – Taxed as a Perquisite

When you decide to buy the shares (exercise your ESOP), the difference between the Fair Market Value (FMV) of the share on that date and the exercise price is considered a perquisite. This amount is treated as part of your salary income.

• Your employer will deduct TDS on this amount.

• It will appear in your Form 16 and must be included when you file your income tax return.

For Eligible Start-Ups (From FY 2020–21):
If you work for a recognized start-up and receive ESOPs, you don’t have to pay tax right away. Tax payment is deferred until the earliest of the following events:

• 5 years from the end of the financial year in which ESOPs were allotted

• The date you sell the shares

• The date you leave the company

2. When You Sell the Shares – Taxed as Capital Gains

After you’ve bought the shares, you may choose to sell them later. When you do, the difference between the sale price and the FMV on the exercise date is taxed as capital gains.

The tax rate depends on how long you hold the shares before selling—short-term or long-term capital gains rules will apply.

Capital Gains Calculation on ESOPs

When an employee sells ESOP shares after exercising them, capital gains are calculated as:

Example:

Mr. Z works at ABC Ltd. He was granted 2,000 ESOP shares at an exercise price of ₹80 per share on 1st April 2021.
He exercised his options on 1st January 2023, when the Fair Market Value (FMV) of each share was ₹150.

So, the cost of acquisition is:

• 2,000 shares × ₹150 = ₹3,00,000

First Sale:

• Mr. Z sold a portion of the shares on 1st October 2023

• Let’s say he sold 1,000 shares at ₹180 per share

• Sale value = 1,000 × ₹180 = ₹1,80,000

• Cost = 1,000 × ₹150 = ₹1,50,000

• Capital Gain = ₹1,80,000 – ₹1,50,000 = ₹30,000
  (Since held for less than 12 months, this will be short-term capital gain)

Second Sale:

• He sold the remaining 1,000 shares on 3rd March 2025 at ₹220 per share

• Sale value = 1,000 × ₹220 = ₹2,20,000

• Cost = 1,000 × ₹150 = ₹1,50,000

• Capital Gain = ₹2,20,000 – ₹1,50,000 = ₹70,000
  (Since held for more than 24 months, this will be long-term capital gain)

How to Calculate Fair Market Value (FMV)

The Fair Market Value (FMV) is the market price of the stock on the date you exercise your ESOP. This value becomes important because it is treated as the cost of acquisition when you later sell the shares.

For example, if you exercise your ESOP at ₹80 per share when the FMV is ₹150, then ₹150 per share will be used to calculate capital gains when you sell the shares in the future.

Advance Tax on Capital Gains

As per the Income Tax Act, if your total tax liability for the year is ₹10,000 or more, you’re required to pay advance tax in four installments:

• 15th June – 15% of total tax liability

• 15th September – 45% of total tax liability

• 15th December – 75% of total tax liability

• 15th March – 100% of total tax liability

When you exercise your ESOPs, TDS is deducted on the perquisite value. However, if you sell the shares later and make capital gains, you may also need to pay advance tax on those gains.

What If You Miss Advance Tax Due to Capital Gains?

It’s often difficult to predict capital gains in advance. The tax law allows some flexibility in such cases:

• If your advance tax installment is short due to unexpected capital gains, no interest is charged under sections 234B or 234C.

• But once you make the sale and realize the gain, make sure to include the capital gains tax in the next installment.

Other Considerations While Calculating Tax on ESOPs

While calculating tax on the sale of ESOPs, there are a few additional points to keep in mind.

1. Sell-to-Cover Transactions

When ESOPs or RSUs are exercised after the vesting period, they are treated as a perquisite under the head “Income from Salary.” The employer must deduct TDS under Section 192 on the Fair Market Value (FMV) of the shares allotted.

Since these are non-cash benefits, the question arises—how does the employer collect TDS?

There are usually two ways:

• Bank Transfer: The employee transfers the TDS amount directly to the company.

• Sell-to-Cover: This is the more common method. The employer sells a portion of the shares on your behalf to cover the tax due.

Example: Sell-to-Cover (for US-listed RSUs)

Since a part of your shares is sold to cover taxes, this sale transaction may lead to notional capital gain or loss, which must be reported in your income tax return. You don’t need to worry about tax when the sell-to-cover happens, as the employer handles that part. But when you later sell the remaining shares, capital gains tax applies, and that’s when you need to calculate and report it properly.

2. Capital Gains or Losses

The tax you pay on capital gains from selling ESOP shares depends on how long you held the shares after exercising the option. This period is counted from the exercise date to the date of sale.

• Listed Shares: If the shares are listed on a recognized stock exchange and STT (Securities Transaction Tax) is paid on sale, they are:

  • Short-term if sold within 12 months. Taxed at 20% from 23rd July 2024 (earlier 15%).

  • Long-term if held for more than 12 months. Taxed at 12.5% (earlier 10%) without indexation on LTCG above ₹1.25 lakh.

• Other Financial & Non-Financial Assets:

  • Short-term gains are taxed as per your income tax slab.

  • Holding periods are simplified now—only two categories:

    • 12 months for listed securities.

    • 24 months for unlisted or other assets. (The earlier 36-month rule has been removed from Budget 2024–25.)

If you incur a capital loss, you can carry it forward and adjust it against future gains. Short-term losses can be set off against both short- and long-term gains.

3. Listed vs Unlisted Shares

There is a difference in tax treatment between listed and unlisted shares.

• Unlisted shares in India or shares listed abroad (like U.S. stocks) are treated as unlisted under Indian tax rules.

• For such shares:

  • Short-term: If sold within 24 months of exercise.

  • Long-term: If sold after 24 months of exercise.

  • Short-term gains are taxed at your regular slab rates.

  • Long-term gains are taxed at 20% with indexation benefit.

The holding period always starts from the date you exercised the option and ends on the date of sale.

4. Buyback of Stock Options
Sometimes, companies—especially startups—offer to buy back stock options from employees before they are converted into equity shares. This usually happens when the shares are not liquid and there’s no easy way to sell them, such as in the case of unlisted companies. The company buys back these options to give employees some cash benefit.

Such income is treated as salary and taxed accordingly. The employer deducts TDS under Section 192, and the income will be included in your Form 16. You don’t need to show it separately in your income tax return.

5. Residential Status
Your tax liability in India depends on your residential status.

• If you are a resident, your global income is taxed in India.

• If you are a non-resident or resident but not ordinarily resident, and the ESOPs or shares are exercised or sold outside India, then this income may not be taxable in India.

So, determining your residential status correctly is very important for tax purposes.

6. Disclosures in ITR
If you hold ESOPs or RSUs of a foreign company and you are a resident taxpayer, you must report them under Schedule FA (Foreign Assets) in your income tax return. The government has increased reporting requirements for overseas holdings, so ensure accurate and complete disclosure to avoid penalties.

7. When Options Are Not Exercised
When ESOPs vest, you get the right to buy shares, but you are not required to do so. If you choose not to exercise your stock options, there are no tax implications. You are not liable to pay any tax just because the options vested.

Disclaimer: The content on this website is for informational purposes only and does not constitute legal, financial, or professional advice. Please consult qualified experts before acting on any information. K M GATECHA & CO LLP accepts no liability for errors, omissions, or outcomes from the use of this content. This site is not an advertisement or solicitation.