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Key takeaways
- Perquisite tax on ESOPs is triggered at exercise, not at grant or vesting. The taxable amount is the difference between FMV on the exercise date and the exercise price.
- For unlisted companies, FMV must be certified by a SEBI-registered Category I merchant banker. The valuation must not be older than 180 days from the exercise date.
- The employer deducts TDS on the perquisite as part of salary under Section 192 (Income Tax Act, 1961) or Section 392 (Income Tax Act, 2025).
- Employees at startups with both DPIIT recognition and an IMB Certificate under Section 80-IAC can defer perquisite tax until sale, cessation of employment, or 48 months from the end of the assessment year in which the shares were allotted, whichever occurs first.
- The Income Tax Act, 2025 renumbers the relevant provisions but does not change the substantive rules on ESOP perquisite taxation.
- Companies should audit all ESOP scheme documents, grant letters, and board resolutions for section number references before the next exercise event after 1 April 2026.
What does the perquisite tax on ESOPs mean?
When an employee exercises their stock options, they are buying company shares at the exercise price, which is typically lower than what those shares are worth on that date. The government treats that gap as income earned from your employment, similar in principle to receiving a cash bonus.
Under Section 17(2)(vi) of the Income Tax Act, 1961, the value of any specified security allotted or transferred by the employer, free of cost or at a concessional rate, is taxable as a perquisite under the head "Salary." For ESOPs, this value is the Fair Market Value (FMV) of the shares on the date the option is exercised, reduced by the amount actually paid by the employee. It is taxable in the year of exercise.
Note: Section 17(2)(vi) of the Income-tax Act, 1961 continues to govern ESOP taxation until the Income-tax Act, 2025 is brought into force, from which point corresponding provisions under the new Act will apply.
There are two points in the ESOP lifecycle that trigger tax:
At the grant stage, no tax applies. The option is merely a right to buy shares in the future. At vesting, no tax applies either. Vesting only means the option has become exercisable.
At exercise, perquisite tax is triggered. The difference between FMV and the exercise price is treated as salary income and taxed at the employee’s applicable income tax rates. At sale, capital gains tax applies on any gain from the exercise date to the sale date.
The exercise event is where most of the confusion and cash flow pressure arises.
How the perquisite value is calculated
Perquisite value = (FMV on exercise date - exercise price) x number of options exercised
What makes this operationally complex for unlisted companies is the FMV determination.
For listed companies, FMV is determined under rule 3 of the Income Tax Rules, 1962. If the shares are listed on one exchange, FMV is the average of the opening and closing price on the exercise date. If listed on multiple exchanges, the exchange with the highest trading volume on that date is used. If there is no trading on the exercise date, the closing price on the nearest preceding date is taken.
For unlisted companies, FMV must be certified by a Category I merchant banker registered with SEBI. Under rule 3 of the Income Tax Rules, 1962, this valuation must not be older than 180 days from the date of exercise.
Example:
An employee at an unlisted startup has 2,000 vested options with an exercise price of ₹50 per share. On the date of exercise, the merchant banker-certified FMV is ₹400 per share.
Perquisite value = (400 - 50) x 2,000 = ₹7,00,000
This ₹7,00,000 is added to the employee's salary income for the year and taxed at their applicable slab rate.
The employee has not sold a single share and they have not received any cash. But the tax obligation arises the moment exercise happens.
How TDS is deducted on perquisite value
Under section 192 of the Income Tax Act, 1961, any company responsible for paying salary must deduct tax at the average rate of tax applicable to the employee. Since perquisites form part of salary, ESOP perquisite income is covered within this obligation.
Note: Section 192 of the Income Tax Act, 1961 governs transactions up to 31 March 2026. The Income Tax Act, 2025 renumbers this provision as section 392(1), but the obligation itself is unchanged.
The mechanics work like this: At the time of exercise, the employer calculates the perquisite value using the formula above. That amount is added to the employee's annual salary to determine the applicable tax slab.
The timing of recovery from payroll is not prescribed by the statute. Most employers recover TDS in the month of allotment, though some spread it across instalments with the employee's consent.
The TDS deducted is reflected in the employee's form 16 and can be claimed as credit when filing the income tax return.
The deferral benefit for eligible startup employees
Employees at certain startups do not have to pay perquisite tax at the point of exercise. They can defer it. To qualify, the employer must meet two conditions simultaneously:
- Recognition from the Department for Promotion of Industry and Internal Trade (DPIIT) as a startup.
- A certificate of eligible business from the Inter-Ministerial Board of Certification (IMB Certificate), confirming it satisfies the conditions under Section 80-IAC of the Income Tax Act, 1961 (and the equivalent provision under the Income Tax Act, 2025).
If both conditions are met, the company is treated as an "eligible startup" for this purpose. All employees of that company automatically benefit, without needing to apply individually.
Under the deferral scheme, TDS is not deducted at exercise. It becomes payable at whichever of the following events occurs first:
- Expiry of 48 months from the end of the assessment year in which the shares were allotted
- Sale of the shares by the employee
- Cessation of employment
Example:
An employee at an eligible startup is allotted shares in tax year 2025-26 (i.e., financial year ending March 2026). The perquisite value is ₹90,00,000.
No TDS is deducted at exercise. The employee must disclose the ₹90,00,000 perquisite in their income tax return for the Assessment Year 2026–27, but no tax is payable on it at that time.
If the employee continues with the company and does not sell the shares, the tax becomes payable at the end of Tax Year 2030-31, i.e., 48 months from the end of the Assessment Year 2026–27 in which the shares were allotted.
If the employee sells the shares or leaves the company before that, the tax is triggered at that earlier point.
Note: The 48-month window described above reflects the position under the Income Tax Act, 1961, which applies to shares allotted before 1 April 2026. For shares allotted on or after 1 April 2026, the Income Tax Act, 2025 updates this window to 60 months from the end of the relevant tax year under Section 392(3) read with Section 289(3). All other trigger events remain the same.
Capital gains at sale
When an employee sells shares acquired through exercise, a separate capital gains tax applies. The FMV on the exercise date becomes the cost of acquisition for capital gains purposes. The capital gain is calculated as: sale price minus FMV on the exercise date.
Whether the gain is classified as short-term or long-term depends on the holding period. For unlisted shares, holding for more than 24 months from the date of exercise qualifies the gain as long-term, taxed at 12.5% without indexation. Shares sold within 24 months are taxed as short-term capital gains at the employee's slab rate.
For listed shares, the holding period threshold is 12 months. Long-term capital gains are taxed at 12.5%, with an annual exemption threshold of ₹1,25,000. Short-term capital gains on listed shares are taxed at 20%.
For a detailed breakdown of capital gains rates, holding period classifications, and ITR reporting, see ESOP taxation in India.
What changes under the Income Tax Act, 2025
The Income Tax Act, 2025 came into effect for income earned from 1 April 2026. Returns for FY 2025-26 will still be filed under the Income Tax Act, 1961. The first return under the 2025 act will be filed in July 2027, for tax year 2026-27.
The substantive rules on ESOP perquisite taxation are unchanged. The tax trigger, the FMV formula, the TDS obligation, and the deferral mechanics remain the same. What has changed is the structural organisation of the law and the section numbers.
*Note: The sub-clause reference for the ESOP perquisite provision under the Income Tax Act, 2025 should be confirmed against the gazetted text. The provision corresponds to the former section 17(2)(vi) of the 1961 Act.
Every ESOP scheme document, grant letter, employment agreement, or board resolution that cites old section numbers carries an invalid reference for income earned from 1 April 2026 onwards. Companies that have not audited their equity documents for section references should do so before the next grant or exercise event.
Closing thoughts
Perquisite tax is the point in the ESOP lifecycle where administrative gaps become expensive. The calculation depends on a valuation that must be current, the TDS obligation sits with the employer, and the cash flow consequences fall on the employee, often without adequate warning.
Getting this right requires accurate perquisite calculation at the time of exercise, a clear TDS recovery process, and documentation that reflects the correct regulatory references. Exercise events go wrong not because the rules are unclear, but because the operational setup to handle them was not in place beforehand.
EquityList calculates the perquisite tax liability automatically at the point of exercise, so founders and finance teams do not need to compute it manually. Employees can pay the tax directly through the platform via a built-in payment gateway, removing the coordination overhead that typically sits between an exercise event and TDS settlement.
FAQs on perquisite tax on ESOPs in India
Is ESOP perquisite tax payable even if shares are not sold?
Yes. Perquisite tax is triggered at the point of exercise. The employee owes income tax on the difference between FMV and exercise price regardless of whether the shares are subsequently sold. The tax applies to the notional gain at exercise, and the employer is required to deduct TDS on this amount as part of salary.
The only exception to immediate TDS applies to employees of DPIIT-recognised startups that also hold Section 80-IAC certification, where the tax deduction is deferred until the earliest of sale, separation, or 48 months from the end of the assessment year in which the shares were allotted.
How is FMV determined for ESOP perquisite tax at unlisted companies?
FMV must be determined by a Category I merchant banker registered with SEBI. Under the Income Tax Rules, the valuation must not be older than 180 days from the exercise date. Using a valuation certificate that is older than 180 days is a compliance error that can result in reassessment by the tax authorities.
Can ESOP perquisite tax be deferred?
Yes, but only for employees at startups that qualify as "eligible startups" under the Income Tax Act. The employer must hold both DPIIT recognition and an IMB Certificate under Section 80-IAC. If both conditions are met, TDS is not deducted at exercise. The tax becomes payable at the earliest of: 48 months from the end of the assessment year in which the shares were allotted, the date the employee sells the shares, or the date the employee leaves the company.
What is the TDS rate on ESOP perquisite?
TDS is not deducted at a flat rate. The employer adds the perquisite value to the employee's total estimated salary income for the year and calculates TDS at the average rate applicable to that total income. The effective rate depends on the employee's income tax slab, surcharge, and cess.
How should ESOP perquisite be reported in ITR?
The perquisite value is included in the "Income from Salary" figure in form 16 issued by the employer. When filing the income tax return, the employee copies the salary details from form 16, and the ESOP perquisite flows through as part of salary income. If the employee has also sold shares during the year, the capital gains from that sale are reported separately under the capital gains schedule. Employees who benefit from the deferral scheme disclose the perquisite in the return for the year of exercise, but the tax is payable only in the year the deferral ends.
