An ESOP (Employee Stock Option Plan) gives employees the right, but not the obligation, to buy shares of their company at a fixed exercise price after a waiting period. The gain between that price and the share value on exercise is taxed as a perquisite in the employee’s salary, and any further rise is taxed as capital gains when the shares are sold.

The rules that govern an Indian ESOP

Unlisted companies issue options under Section 62(1)(b) of the Companies Act, 2013 and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014; listed companies follow SEBI’s 2021 share-based employee benefit regulations. What matters for HR:

• At least one year must pass between grant and vesting. The rest of the vesting schedule is the company’s choice.
• Independent directors cannot get options. Nor can promoters or directors holding over 10% of the equity, except in a DPIIT-recognised startup for up to ten years from incorporation.
• Options cannot be transferred or pledged. On death or permanent incapacity in service, all granted options vest at once; on resignation, unvested options lapse and vested ones can be exercised within the window the scheme allows.

Taxed twice: a worked example

Priya holds 2,000 vested options at an exercise price of Rs 50. She exercises when the fair market value is Rs 450. Her perquisite is (450 – 50) x 2,000 = Rs 8,00,000, added to salary and taxed through TDS on salary. At a 30% slab that is Rs 2,40,000 before cess, on top of the Rs 1,00,000 she pays the company to exercise. Thirty months later she sells the unlisted shares at Rs 700. Her cost is the Rs 450 already taxed, so the gain is Rs 5,00,000; held over 24 months it is long-term and taxed at 12.5%, or Rs 62,500 before surcharge and cess.

The charging clause is Section 17(2)(vi) of the 1961 Act for FY 2025-26 and clause (d) of Section 17(1) of the new Act from tax year 2026-27. Unlisted shares are valued by a Category I merchant banker, listed ones at the exchange price on the exercise date, as the perquisite valuation rules set out.

Frequently asked questions

Is an ESOP taxed when it is granted or when it vests?

Neither. Tax arises when the employee exercises and the shares are allotted, and again on sale.

Can a startup employee postpone the tax?

Yes, if the employer is an eligible startup with the Section 80-IAC certificate (Section 140 of the 2025 Act). TDS on the perquisite is then deferred to 14 days after the earliest of sale, leaving the company, or about five years after the end of the year of allotment (60 months from the end of the tax year in the 2025 Act; 48 months from the end of the assessment year in the 1961 Act), and the employer tracks that date under Section 192 (now Section 392(3)).

Do ESOPs appear in CTC?

Many offer letters keep them outside CTC because the value is uncertain. If you include them, state the valuation basis so nobody reads it as cash.

How is an ESOP different from an RSU?

An option needs the employee to pay an exercise price; an RSU delivers shares at vesting for no payment, so its whole value is taxable.

To see how an exercise year changes the tax bill, add the perquisite to salary in the income tax calculator.