Equity & ESOPs

Four arrangements are common. An Employee Stock Option Plan (ESOP) gives an employee the right to buy company shares at a fixed exercise price after a vesting period. A Restricted Stock Unit (RSU) is a promise to deliver shares on vesting, usually at no cost to the employee. A Stock Appreciation Right (SAR) pays the increase in share value between grant and exercise, settled in cash or shares. Phantom stock pays a cash amount linked to share value without issuing actual shares. Each carries a different tax and regulatory treatment, which we map to the plan before it is rolled out.

Equity awards are generally taxed at two points. No tax ordinarily arises when options are granted or merely vest. The first charge arises at exercise for ESOPs. For RSUs, the perquisite trigger is the allotment or transfer of shares, commonly settlement after vesting, rather than vesting by itself. The second charge arises at sale, when any further gain is treated as a capital gain. This two-stage structure can create tax before the employee sells the shares.

At exercise, the difference between the fair market value of the share on the exercise date and the exercise price paid is treated as a salary perquisite under Section 17 [ITA 2025: s. 17] and valued under Rule 3 [ITR 2026: r. 15]. The employer deducts tax at source on this amount under Section 192 [ITA 2025: s. 392(1)]. The tax applies even though no shares have been sold and no cash has been received, which is the cash-flow point employees most often miss.

For listed shares, fair market value is based on the recognised-stock-exchange price on the exercise date. For unlisted shares, Rule 3 [ITR 2026: r. 15] requires valuation by a SEBI-registered Category I merchant banker on the specified date; the report may use a date not more than 180 days earlier where the rule permits. We coordinate the valuation date and report so the perquisite computation stands up to scrutiny.

An RSU usually carries no exercise price, so on vesting the full fair market value of the shares is treated as a salary perquisite and taxed at the employee's slab rate, with tax deducted at source. The difference from an ESOP lies in the trigger and the cost. An ESOP is taxed at exercise on the value above the exercise price, while an RSU is taxed at vesting on the full value because the employee paid nothing. At sale, both are taxed on the further gain as capital gains, with the perquisite value already taxed becoming the cost of acquisition.

Both are usually cash-settled. A stock appreciation right pays the rise in share value between grant and exercise, and phantom stock pays a cash amount linked to the share value, without issuing actual shares. For an employee, the payout is treated as a salary perquisite and taxed at the slab rate when it is received, with tax deducted at source as part of salary. Because no shares are issued, there is generally no second capital gains stage, unlike ESOPs and RSUs.

Yes, in defined cases. An employee of an eligible startup can defer the salary-perquisite tax that arises at exercise under Section 17 [ITA 2025: s. 17] and Rule 3 [ITR 2026: r. 15]. The deferral under Section 192(1C) [ITA 2025: ss. 289(3), 392(3)] runs until the earliest of 48 months from the end of the relevant assessment year under the 1961 Act, or 60 months from the end of the relevant tax year under the 2025 Act, the sale of the shares, or the date the employee leaves the company. The deferral postpones payment; it does not reduce the tax, and the perquisite remains taxable and reportable in the year of allotment.

The deferral is narrow. The employer must satisfy the eligible-startup conditions tied to Section 80-IAC [ITA 2025: s. 140], including the applicable recognition and eligibility certification requirements. DPIIT recognition alone is not sufficient where the statutory certificate is required. We confirm the company's status before relying on the deferral.

At sale, the gain over the fair market value already taxed as a perquisite is a capital gain. For listed shares with Securities Transaction Tax paid, a holding period above 12 months is long-term, taxed at 12.5% on gains above Rs 1.25 lakh a year, while 12 months or less is short-term, taxed at 20%. For unlisted shares, a holding period above 24 months is long-term at 12.5% without indexation, while 24 months or less is taxed at slab rates. The relevant charge is under Section 111A [ITA 2025: s. 196], Section 112 [ITA 2025: s. 197] and Section 112A [ITA 2025: s. 198], as applicable.

The perquisite at exercise or vesting appears within salary income and in the employer's salary certificate. The gain at sale is reported under the capital gains schedule of the return. Gains on equity shares cannot be filed in ITR-1, so employees use ITR-2, or ITR-3 where business income is present. Employees using the startup deferral still disclose the perquisite in the year of allotment while showing the deferred position. We reconcile the salary certificate, the annual tax statement, and the sale records before the return is filed.

For an employee who is resident and ordinarily resident in India, the perquisite at vesting or exercise is taxable in India in the same way as a domestic grant, based on the value of the foreign shares. On sale, the gain is a capital gain, and because foreign shares are unlisted in India for this purpose, a holding period above 24 months is long-term at 12.5%, while 24 months or less is taxed at slab rates. Any foreign tax withheld at vesting or sale can usually be set off through foreign tax credit, subject to conditions.

A resident and ordinarily resident holder must disclose foreign shares and equity holdings under Schedule FA of the income tax return where the applicable return instructions require it, and non-disclosure can attract significant penalties. Foreign tax withheld can be claimed as a credit by filing Form 67 [ITR 2026: Form 44] under Rule 128 [ITR 2026: r. 76]. Relief may also be available under the applicable Double Taxation Avoidance Agreement. Holding and sale of foreign shares may also carry reporting under FEMA as overseas investment. We align the income tax and FEMA positions so the filings stay consistent.

The employer must compute the perquisite at the applicable exercise or allotment/transfer event, deduct tax under Section 192 [ITA 2025: s. 392], deposit it, and report the perquisite and tax in Form 16 [ITR 2026: Form 130]. Where shares are illiquid, employers may use sell-to-cover or recover tax from salary. FEMA reporting depends on whether an Indian company issues shares to a non-resident participant or an Indian resident holds shares of a foreign parent.

Several factors influence the eventual tax, all within the law. The timing of exercise affects the perquisite value, since a lower fair market value at exercise produces a lower perquisite. The choice between the old and new tax regimes affects the slab applied to the perquisite. The holding period after exercise determines whether the sale is taxed as short-term or long-term. For eligible startups, the deferral affects when the perquisite tax falls due. We model these factors against an employee's wider income before any exercise or sale decision.

The section and form references for equity compensation changed for income and reporting periods governed by the Income Tax Act 2025 and Income Tax Rules 2026. Salary perquisite tax deduction is under Section 192 [ITA 2025: s. 392], and the startup ESOP deferral under Section 192(1C) [ITA 2025: ss. 289(3), 392(3)]. The eligible-startup definition is under Section 80-IAC [ITA 2025: s. 140]. Capital gains charges are under Section 111A [ITA 2025: s. 196], Section 112 [ITA 2025: s. 197] and Section 112A [ITA 2025: s. 198]. Perquisite valuation is under Rule 3 [ITR 2026: r. 15], the salary certificate is Form 16 [ITR 2026: Form 130], and the foreign tax credit form is Form 67 [ITR 2026: Form 44]. We update plan documents and grant letters so they cite the provisions applicable to the relevant period, subject to savings.