ESOPs (Employee Stock Options) are a cornerstone of startup compensation in India. But they come with complex tax implications. There are two taxable events: at the time of exercising the option (treated as salary/perquisite income) and at the time of selling the shares (treated as capital gains). Here's everything you need to know about ESOP taxation for FY 2025–26.
How ESOP Taxation Works — Two Taxable Events
| Event | When It Happens | Tax Treatment | TDS |
|---|---|---|---|
| Grant | Company offers ESOPs to employee | No tax | No TDS |
| Vesting | ESOPs become exercisable | No tax on vesting | No TDS |
| Exercise | Employee pays exercise price to get shares | Perquisite = FMV at exercise − exercise price (taxed as salary at slab rates) | TDS by employer (if listed) or deferred (if startup) |
| Sale | Employee sells shares in market/off-market | Capital gains (LTCG/STCG based on holding period from exercise date) | No TDS for listed shares |
ESOP Perquisite Tax at Exercise
When you exercise your ESOPs (pay the exercise price to get shares), the difference between Fair Market Value (FMV) on the exercise date and the exercise price you paid is treated as a perquisite — part of your salary income. Example: ESOP exercise price ₹10 per share. FMV on exercise date ₹500 per share. Perquisite = (₹500 − ₹10) × 1,000 shares = ₹4,90,000. This ₹4.9 lakh is added to your salary and taxed at your slab rate. Your employer deducts TDS on this.
Tax Deferral for DPIIT-Recognised Startup Employees
For employees of DPIIT-recognised startups (Section 192 amendment): TDS on ESOP perquisite is NOT deducted at exercise. Instead, it's deferred — tax is collected 14 days after: (a) 5 years from exercise date, OR (b) date of sale, OR (c) date of ceasing employment — whichever is earlier. This deferral helps employees avoid a large upfront tax burden when they don't have cash to pay tax at exercise.
Capital Gains Tax on ESOP Sale
| Type | Listed Company Shares | Unlisted Company Shares |
|---|---|---|
| Holding period for LTCG | 12 months from exercise | 24 months from exercise |
| STCG rate | 20% (Sec 111A, if on exchange) | Slab rate |
| LTCG rate | 12.5% above ₹1.25L (Sec 112A) | 12.5% without indexation |
| Cost of acquisition | FMV at exercise (already taxed as perquisite) | FMV at exercise (already taxed as perquisite) |
How to Report ESOP in ITR
- Perquisite income: Already included in your Form 16 Part B (salary income) by employer
- Check AIS/Form 26AS for perquisite value reported by employer
- Use ITR-2 (not ITR-1) — ESOP sale generates capital gains
- Under 'Schedule Capital Gains': add ESOP sale — cost = FMV at exercise, sale price = actual sale price
- For unlisted shares: submit share transfer documents, valuation certificate
- For DPIIT startup employees with deferred tax: employer will handle via Form 26QC/TDS at the deferral trigger event