Taxation on ESOPs
Taxation on Employee Stock Option Plans (ESOPs) occurs in two distinct stages: first, in the hands of the Employee, and second, in the hands of the Employer.
In the hands of Employee
For an employee, ESOPs are taxable in two specific situations:
- At the time of allotment of shares
When an employee exercises their options and shares are allotted, the difference between the Fair Market Value (FMV) of the shares on the date of exercise of ESOPs and the amount actually paid by the employee(Exercise Price) is treated as a perquisite.
This amount is considered part of the employee’s salary.
It is reflected in Form 16 and is subject to TDS (Tax Deducted at Source) by the employer
- At the time of transfer of shares
Once the shares are allotted, if the employee decides to sell or transfer them, the profit earned is taxable as Capital Gains.
The taxability (Short-Term vs. Long-Term) depends on the type of security (listed vs. unlisted) and the holding period of the shares.
Let us understand the situation in detail with the help of example
At the time of allotment of shares
| Particulars | Amount |
| Date of granting of ESOP | 01-04-2023 |
| Vesting Period | 01-04-2023 to 31-03-2025 |
| Date of Exercise of ESOP | 10-05-2025 |
| Fair Market Value as on May 10, 2025 | 6,500 |
| Number of ESOP exercised | 100 |
| Pre-determined price to be paid by the employee to the employer | 500 |
| Value of perquisite [(Rs. 6,500 – Rs. 500) * 100] | Rs.6,00,000 |
At the time of transfer of shares
Mr. X exercised his ESOP on April 1, 2023, and the shares were allotted on May 1, 2023; upon selling these shares on April 1, 2025, the tax liability is determined by two distinct rules: the Period of Holding for capital gains (Short-term vs. Long-term) is calculated from the date of allotment (May 1, 2023) to the day before the sale, while the Cost of Acquisition is legally fixed as the Fair Market Value (FMV) of the shares on the date of exercise (April 1, 2023).
This distinction ensures that the portion of the share value already taxed as a “salary perquisite” at the time of exercise is not taxed again as a capital gain, effectively treating the FMV at exercise as the employee’s “purchase price” for future tax purposes.
In the hands of Employer
Tax Treatment of ESOPs in the Hands of the Employer
Initially, the discount on the issue of shares under an Employee Stock Option Plan (ESOP) was not considered an allowable business expenditure.
Legal Framework: Section 37(1)
Section 37(1) of the Income Tax Act states:
“Any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head ‘Profits and gains of business or profession’.”
Judicial Precedents
The Karnataka High Court observed that the term “expenditure” includes “loss.” Consequently, the discount incurred—defined as the difference between the Market Price of shares at the time of exercise and the Pre-determined Price at which shares are exercised—is to be treated as a deductible Business Expenditure.
This ruling aligns with the landmark case of Biocon Ltd. In the matter of Dy. Commissioner of Income-tax (LTU), Bangalore vs. M/s Biocon Limited, the Income Tax Appellate Tribunal (ITAT) held that:
- Discounts under an ESOP constitute an employee cost.
- Such costs should be allowed as a deduction over the vesting period in the hands of the issuing company.
Tax treatment if the employer is a eligible Start-up company.
If the employer is eligible as a start-up company under section 80-IAC, the employees are eligible for deferment of TDS and tax on the perquisite value on the ESOPs.
So the employer which is meeting the definition of eligible start-up shall deduct tax from income arising in the nature of perquisites from ESOPs within 14 days from the happening of any of the following events (whichever is earlier):
- On the expiry of 48 months from the end of the assessment year in which securities are allotted under ESOPs;
- From the date the assessee ceases to be an employee of the organization; or
c) From the date of sale of securities allotted under ESOP.
The Author is Kundana is a Qualified Chartered Accountant with expertise in finance, accounting, and taxation. Passionate about writing, she simplifies complex financial and business topics into clear, engaging, and insightful content.