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ESOP Distribution & Taxation: A Guide

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Created on
September 12, 2022


What’s Inside

ESOPs are the hottest trend in startup town. They’re offered by startups alongside compensation to sweeten the deal because, let's face it, free coffee and foosball tables can only go so far. Employees want a slice of the pie, and ESOPs serve up a delicious slice of the equity pie.

Plus, they're a powerful motivator. When everyone's invested in success, they work harder, think smarter, and dream bigger.

In this blog, we discuss how ESOPs work, what ESOP taxation is like and other related ESOP nuances. Let’s explore!

How ESOPs work?

In India, here's a step-by-step explanation of how ESOPs work in India:

Grant Date

The ESOP process begins with the grant date, where the employer and employee agree on the terms of the ESOP. This agreement specifies the number of shares the employee can potentially own, the vesting period, exercise price, and other conditions.

Vesting Date 

The vesting date is typically the same as the grant date in India. It's the date on which the employee becomes entitled to buy shares after meeting the conditions set in the ESOP agreement. 

Vesting Period

The vesting period is the time between the grant date and the vesting date, during which the employee must fulfill the conditions.

Exercise Period

Once the shares have vested, the employee enters the exercise period. This period allows the employee to exercise the option to buy shares. The exercise period is also agreed upon in the ESOP agreement.

Exercise Date 

The exercise date is the specific date on which the employee chooses to buy the shares. It's within the exercise period, and the employee can decide when to exercise the option based on their financial planning and market conditions.

Exercise Price

The exercise price is the price at which the employee can buy the shares as per the ESOP agreement. This price is usually set lower than the prevailing Fair Market Value (FMV) of the company's stock, making it an attractive option for employees. The difference between the exercise price and the FMV is considered a benefit to the employee and is subject to taxation. 

How are ESOPs taxed?

In India, when an employee exercises their ESOPs and buys the shares at the exercise price, they may incur taxes on the difference between the exercise price and the FMV of the stock at the time of exercise. 

Under the Income Tax Act of 1961, tax implications on ESOPs are applicable at two distinct junctures: first, upon the exercise of options, and secondly, upon the sale of shares.

1. Upon Exercise of the Options

Upon exercise of the options is the first taxable event when the shares are allotted. This tax is based on how much the shares are worth at that time compared to what the employee paid. 

We calculate this taxable amount by subtracting what the employee paid (the exercise price) from the current value of the shares (the Fair Market Value) when they were received. This taxable amount is considered a part of the employee's salary income for tax purposes.

Taxable perquisite = 

Difference between the Fair Market Value (FMV) of the shares as on the date of exercise as reduced by the price actually recovered from the employee (i.e. the exercise price)


2. Upon Sale of Shares 

If the employee sells these shares, they might have to pay a tax called capital gains tax. To figure out this tax, we look at the difference between what the employee gets when selling the shares and what they paid for them. The amount they paid is based on the Fair Market Value of the shares at the time they exercised their options, which is also used to calculate the perquisites tax, as we discussed earlier.

Whether the gains are considered "long-term" or "short-term" depends on how long the employee held the shares. We count the time from when the shares were given to the employee until the day they sell them to determine this. 

Amendment Announced in Budget 2020 

It was announced in Budget 2020 to defer tax deducted at source (TDS) or tax payment on shares allotted by the startups to their employees under ESOPs. This means that employees of start-ups who are exercising their ESOPs may have to pay tax at a later date. 

This change has been proposed to ease the cash flow problem of the employees as no cash benefit arises by buying shares and leads to additional tax payout over and above the exercise price. 

Have ESOPs issued by foreign companies?

Do you have ESOPs issued by foreign a employer? Here is how they are taxed in India: 

  • In the case of ESOPs granted by foreign companies to employees of their Indian subsidiaries, any benefits received by an employee as compensation for services provided within the country are subject to taxation, regardless of where or in what form these benefits are received. 
  • Hence, ESOPs granted by the foreign parent company to employees of its Indian subsidiary fall under the taxable category in India.
  • The responsibility for deducting tax at source on these benefits lies with the Indian entity, and they must report this while filing their quarterly TDS returns using Form 24Q. Employees can access details about the perquisite amount and the tax deducted in Form 12BA or Form 16. 


To summarise, ESOPs are an optional component in the overall design of an employee's compensation plan, somewhat akin to profit sharing. ESOP taxation in India occurs in 2 stages. They are, first, taxed as perks by the employer and then again upon the actual sale in the stock market. While certain benefits and relief have been provided to emerging companies that qualify under the criteria, it is only fair to expand and extend this umbrella to cover the larger workforce.

Frequently Asked Questions

1. Are ESOPs heavily taxed?

There are two situations in which an employee's ESOP is taxed. The first is when they are exercised, and the second is when the shares are sold. In the first case, it is considered a perk and is taxed as income under the head wages. When sold on the market, it is recognised as a capital gain.

2. Does an ESOP incur income taxes?

ESOPs are considered perquisites and part of your salary. Hence, they are liable for tax deducted at source (TDS) by the employer, as per your prevalent tax slab. Other than that, there are no unique tax rates that apply to ESOPs.

3. Do I have to claim ESOP on my taxes?

Yes, you generally have to claim Employee Stock Ownership Plan (ESOP) benefits on your taxes.The value of the ESOP shares you receive is considered taxable income.You must report this income on your tax return and pay any applicable taxes

4. How are ESOPs valued in India?

In India, Employee Stock Ownership Plans (ESOPs) are typically valued based on the fair market value of the shares on the date of exercise or vesting.The valuation may be determined using methods such as the Discounted Cash Flow (DCF) method, Comparable Company Analysis (CCA), or the Net Asset Value (NAV) method.The valuation process and methodology may vary depending on the specific regulations and guidelines set by the Securities and Exchange Board of India (SEBI) and other relevant authorities.

5. Are ESOPs good in India?

ESOPs can be beneficial in India as they provide employees with an opportunity to share in the company's growth and success.ESOPs can align employee interests with company performance, motivate employees, and help retain top talent.

6. What is tax exemption for ESOP?

ESOPs in India are subject to taxation. The difference between the fair market value and the exercise price is treated as taxable salary. However, certain eligible start-ups may offer tax deferment on ESOPs. Consult a tax professional or refer to current tax regulations for specific details.

7. Is ESOP taxed twice?

ESOPs are subject to taxation in two instances for employees. Firstly, when they are exercised, it is considered a perquisite and taxed as income under the head of salaries. Secondly, when the ESOP shares are sold in the market, any resulting gains are treated as capital gains and subject to taxation.


Investment and securities are subject to market risks. Please read all the related documents carefully before investing. The contents of this article are for informational purposes only, and not to be taken as a recommendation to buy or sell securities, mutual funds, or any other financial products.
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