ESOPs at Concessional Price: Experts Clarifies Taxability Under Income-tax Act
Employees Must Pay Tax on ESOP Benefits as Salary Income
Employers Obliged to Deduct TDS on Perquisite Value
By Our Legal Correspondent
New Delhi: December 12, 2025:
Employee Stock Option Plans (ESOPs) have become a popular tool for rewarding and retaining talent in India’s corporate sector. From startups to listed conglomerates, ESOPs are used to align employee interests with long-term company growth. However, ESOPs also raise important tax questions. One of the most debated issues is whether the discounted value of shares allotted under ESOPs is taxable, and if so, how employers should handle tax deduction at source (TDS).
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Recent clarifications by the Income-tax Department and judicial pronouncements have settled the matter: ESOPs allotted at a concessional price are taxable as salary income, and employers must deduct TDS on the perquisite value
What the Law Says
- Section 17(2)(vi) of the Income-tax Act, 1961: Includes within “perquisites” the value of any specified security or sweat equity shares allotted by an employer at a concessional rate.
- Computation of Perquisite:
[ \text {Taxable Perquisite} = \text {FMV on exercise date} - \text {Exercise Price} ] - Rule 3(8) of the Income-tax Rules, 1962: For listed companies, FMV is the average of the opening and closing price on the recognized stock exchange on the date of exercise.
In the example provided:
- FMV = ₹1,200
- Exercise Price = ₹500
- Taxable Perquisite = ₹700 per share
This ₹700 is treated as salary income in the year of exercise.
Employer’s Responsibility
Once the perquisite is taxable, the employer must:
- Include the perquisite value in the employee’s salary.
- Compute tax liability under Section 192.
- Deduct TDS at the time of allotment or transfer of shares.
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Failure to deduct TDS makes the employer an “assessee-in-default” under Section 201, attracting recovery proceedings, interest, and penalties.
Two Stages of Taxation
Experts highlight that ESOPs are taxed at two stages:
- At Exercise: As a perquisite under Section 17(2)(vi).
- At Sale: As capital gains, when the employee sells the shares.
- Cost of acquisition = FMV considered at the time of exercise.
- Gains = Sale price – FMV.
This dual taxation ensures both the benefit at exercise and subsequent appreciation are taxed appropriately.
Special Provisions for Startups
Recognizing the importance of ESOPs in startups, the government introduced Section 80-IAC and related rules allowing deferral of tax liability for employees of eligible startups. In such cases:
- Tax on ESOP perquisites can be deferred up to 5 years, or until the employee leaves the company, or sells the shares—whichever is earliest.
- This provides relief to employees who may otherwise face liquidity issues.
Why This Matters
- For Employees: ESOPs are not “free money.” The concessional benefit is taxable as salary.
- For Employers: Compliance with TDS obligations is critical to avoid penalties.
- For Startups: Tax deferral provisions make ESOPs more attractive as a compensation tool.
Expert Views
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Tax professionals note that ESOP taxation is often misunderstood. Many employees assume tax applies only at sale, but the law clearly taxes the benefit at exercise. Employers must educate staff and ensure proper compliance.
Conclusion
The taxability of ESOPs allotted at concessional prices is firmly established under Indian law. Employees must pay tax on the perquisite value as salary income, and employers must deduct TDS under Section 192. The FMV must be computed strictly as per Rule 3(8).
This clarity strengthens India’s equity compensation framework, balancing employee rewards with tax compliance. For startups, deferred taxation provisions provide additional flexibility, ensuring ESOPs remain a powerful tool for talent retention.
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Also Read: ESOPs at Concessional Price: Experts Clarifies Taxability Under Income-tax Act