Employee Stock Option Plans (ESOPs) are a powerful way for startups to reward and retain talent. However, one of the biggest concerns employees face is the tax impact at the time of exercising ESOPs, often leading to a large cash outflow before any liquidity is available.
To address this issue, the Government of India introduced a tax deferral benefit for employees of eligible DPIIT-recognized startups that are certified by the Inter-Ministerial Board (IMB) under Section 80-IAC, allowing them to defer tax on Employee Stock Options (ESOPs) for their employees.
How ESOP Taxation Normally Works (With an Example)
Assume:
- You are granted 10,000 ESOPs
- Exercise price: ₹10 per share
- Fair Market Value (FMV) at exercise: ₹100 per share
Perquisite value = (₹100 – ₹10) × 10,000 = ₹9,00,000
Under normal taxation:
- This ₹9,00,000 is taxed as salary income in the year of exercise
- If you fall in the 30% tax bracket, the tax outflow could be ₹2.7–3.0 lakh (approx.)
- This tax is payable even if you have not sold the shares
This is where many employees face a cash-flow challenge.
What Changes for DPIIT-Recognized Startups?
If your employer is a DPIIT-recognized startup, the tax on the perquisite value is deferred.
Using the same example:
- You exercise your ESOPs today
- No immediate tax payment is required on the ₹9,00,000 perquisite value
- You receive the shares without an upfront tax burden
This helps employees avoid funding taxes from personal savings.
When Will the Deferred Tax Become Payable?
The deferred tax becomes payable at the earliest of:
- Sale of the shares
- Completion of the prescribed deferral period
- Exit from the company
For example:
- If you sell the shares after 3 years at ₹250 per share
- Sale value = ₹25,00,000
- You will then pay:
- Deferred perquisite tax on ₹9,00,000
- Capital gains tax on the appreciation after FMV
At this stage, you usually have actual liquidity to pay the taxes.
Why This Is a Big Relief for Employees
- No immediate cash crunch at exercise
- Better alignment of tax payment with liquidity events
- Encourages employees to exercise ESOPs with confidence
Important Points to Remember
- The benefit applies only if the company is DPIIT-recognized
- The tax deferral is not permanent, only postponed
- Capital gains tax will still apply at the time of sale
- Proper documentation and compliance are critical
Final Takeaway
ESOPs can be a meaningful wealth-creation tool—but taxation can significantly impact outcomes if not understood early.
For employees of DPIIT-recognized startups, the ESOP tax deferral benefit can make a material difference, especially when exercising large option grants. Knowing when and how tax applies allows you to plan better and avoid unpleasant surprises.
