ESOP Taxation Explained: When and How Much Tax You Pay

Understanding ESOP taxation can be confusing at first, especially if you’re hearing these terms for the first time. If your company has offered you ESOPs (Employee Stock Ownership Plans), you’re not alone in wondering how taxes work on them. The good news is that ESOP taxation in India follows a clear structure, once you get the basics right, it becomes easier to handle.

In this guide, readers will learn about the breakdown of tax on ESOP in India, explain the key stages where taxes apply, look into ESOP tax benefits, and discuss smart ways to manage them. We’ll keep it simple, updated, and very relevant for 2025.

What are ESOPs?

Before diving into ESOP taxation, let’s understand what ESOPs actually are. An ESOP is a benefit plan where a company offers its employees the option to buy shares at a predetermined price. These are not free shares, but they’re usually offered at a discounted rate, making them very attractive for long-term wealth creation.

For example, your company might let you buy shares at ₹50 each when the current market price is ₹200. Over time, as your company grows, the value of these shares increases, and you can earn a tidy profit.

When Does ESOP Taxation Happen?

Here’s where it gets important. In India, ESOP taxation happens in two stages:

1. At the time of exercise

When you exercise the ESOP (that means you actually buy the shares at the fixed price), it’s considered a “perquisite” and taxed as part of your salary income.

• Taxable Amount = FMV (on exercise date) – Exercise Price
• This amount is added to your salary and taxed as per your slab.

This is the first level of tax on ESOP in India.

2. At the time of sale

Now, when you later sell those shares, capital gains tax applies.

• Capital Gain = Sale Price – FMV (on exercise date)
• If you sell within 12 months → Short-Term Capital Gains (STCG): 15%
• If you sell after 12 months → Long-Term Capital Gains (LTCG): 10% (above ₹1 lakh)

This is the second stage of ESOP taxation in India.

Example of ESOP Taxation in India –

Let’s make this crystal clear with a quick example:

• Exercise Price = ₹100
• FMV on Exercise Date = ₹300
• Sale Price after 1 year = ₹600

At Exercise:

• ₹300 – ₹100 = ₹200 (Taxed as salary under Section 17(2)(vi))

At Sale:

• ₹600 – ₹300 = ₹300 (LTCG if sold after a year; 10% over ₹1 lakh)

As you can see, tax on ESOP in India hits you twice, but both can be managed smartly.

ESOP Tax Benefits

Now for some good news: yes, there are ESOP tax benefits available, especially for startups and growing companies. Here’s how:

1. Tax deferral for startups

As per Section 192(1C) of the Income Tax Act, if you work in an eligible startup recognized by DPIIT, your ESOP taxation at exercise can be deferred by 5 years, or until:

• You leave the company
• Sell the shares
• Or 5 years pass from the exercise date Whichever comes earlier.

This can significantly ease the tax on ESOP in India for startup employees.

2. Capital Gains Exemptions

If you reinvest your capital gains in eligible investments (like residential property under Section 54F), you can reduce your ESOP taxation burden further.

How Is ESOP Tax Calculated?

Understanding how ESOP taxation works in India involves knowing when and how the taxes apply. The taxation happens in two main stages—when you exercise the option and when you sell the shares. Here’s a clear step-by-step explanation:

1. At the Time of Exercise

When you decide to exercise your ESOPs, you buy the shares at a pre-decided price, known as the exercise price. But for taxation, the government looks at the Fair Market Value (FMV) of those shares on the date you exercise them.

• A SEBI-registered merchant banker determines the FMV.
• The difference between the FMV and your exercise price is considered a perquisite, or part of your salary income.
• This amount is taxed as per your income tax slab.

For example, if the FMV is ₹500 per share and your exercise price is ₹200, then ₹300 per share will be added to your salary for tax purposes.

2. At the Time of Sale

Later, when you sell these shares, you may make a profit or loss. This is where capital gains tax applies.

• Capital Gain = Sale Price – FMV (on exercise date)
• If sold within 12 months, it’s Short-Term Capital Gain (STCG) taxed at 15%.
• If sold after 12 months, it’s Long-Term Capital Gain (LTCG) taxed at 10% on gains above ₹1 lakh.

So, ESOP taxation in India involves both salary tax and capital gains tax. To avoid paying more than necessary, it’s important to plan when you exercise and when you sell. Both stages impact your final tax outflow, so understanding them clearly can help you make better financial decisions.

ESOP Taxation for NRIs

If you’re a Non-Resident Indian (NRI), the rules are similar with a few extras:

• TDS may be deducted on the perquisite value at exercise
• Capital gains are taxable in India (check your Double Taxation Avoidance Agreement – DTAA)
• ESOP tax benefits may vary based on your country of residence

NRIs must be careful about tax on ESOP in India, as they may be paying taxes in two countries without careful planning.

Things to Keep in Mind

• Plan your exercise timing: If you exercise and sell soon, you’ll pay both salary tax and STCG (double hit).
• Watch out for AMT (Alternative Minimum Tax) if you’re a high-income individual.
• ESOPs from foreign companies may have different tax rules.

Being aware of these helps manage your ESOP taxation better and helps you enjoy the ESOP tax benefits fully.

Common Mistakes in ESOP Taxation

1. Exercising Without Liquidity

One of the most common mistakes in ESOP taxation is exercising your options without having the funds to pay the tax. You might owe income tax at the time of exercise, even if you haven’t sold the shares and made no actual profit.

2. Not Planning Sale Timing

Selling your ESOP shares too soon after exercising can lead to short-term capital gains (STCG), which are taxed at a higher rate than long-term capital gains (LTCG). Timing your sale wisely helps reduce tax outflow.

Also read: Short-Term vs. Long-Term Capital Gains

3. Ignoring FMV Documentation

Accurate and certified Fair Market Value (FMV) reports are crucial. Without them, your ESOP taxation in India may be calculated incorrectly, possibly leading to penalties or audits.

4. Missing Foreign Disclosures

If your ESOPs come from a foreign parent company, they must be reported under Schedule FA in your income tax return. Missing this can invite scrutiny from tax authorities.

Updated ESOP Taxation Rules – June 2025

As of June 2025, no major changes have been made to the basic tax on ESOP in India, but here are a few key updates:

• Startup tax deferral still applies for eligible DPIIT-registered startups.
• FMV must be certified within 180 days of the exercise date by a SEBI-registered merchant banker.
• TDS (Tax Deducted at Source) is now mandatory at the time of exercise, even if tax is deferred.

These updates ensure ESOP taxation in India remains fair but also tightens compliance.

How to Save on ESOP Taxation

While taxes are unavoidable, smart planning can help reduce your burden:

• Sell after 12 months to enjoy LTCG (10%) instead of STCG (15%)
• Use exemptions like Section 54F if reinvesting
• For startup employees, leverage deferral under Section 192(1C)
• Always consult a tax advisor for high-value transactions

If you follow these tips, you can enjoy most ESOP tax benefits and keep more of your gains.

Conclusion

To sum it up, ESOP taxation involves two phases: when you exercise and when you sell. Understanding ESOP taxation in India helps you avoid surprise tax bills and allows you to plan your financial future better.

Whether you’re working for a startup or a large corporation, knowing the tax on ESOP in India will help you unlock the real value of your stock options. From tax planning to compliance, ESOPs need careful attention, but the rewards can be massive.

For personalized support, tax filing, and expert investment advice, platforms like SMC Global Securities can help you stay compliant and confident. Their team can assist you with filing returns, reporting ESOP income, and exploring ESOP tax benefits that suit your financial goals.

Frequently Asked Questions – FAQs

1. What is ESOP taxation in India?

ESOPs are taxed twice, first as a perquisite at the time of exercise and second as capital gains at the time of sale.

2. When is tax paid on ESOPs?

You pay tax when you exercise the ESOP (as part of your salary) and again when you sell the shares (as capital gains).

3. How is the perquisite tax calculated on ESOPs?

It’s calculated as the difference between the fair market value (FMV) on the exercise date and the exercise price.

4. What are the capital gains tax rates on ESOPs?

If shares are sold after 24 months, you pay 20% long-term capital gains tax (with indexation); else, short-term capital gains apply.

5. Can ESOP taxation be deferred for startup employees?

Yes, for eligible startups, tax on ESOP exercise can be deferred for up to 5 years or until shares are sold, whichever is earlier.

Author: All Content is verified by SMC Global Securities.