Income TaxTaxation of ESOPs: Pre & Post Budget 2022-23

February 22, 20220


What is an Employee Stock Option Plan?

An Employee Stock Option Plan (“ESOP”) is a scheme under which employees of a company are offered shares of that company at a rate lower than the market value of such shares.

Through ESOPs, the company i.e. the employer offers stocks of the company, generally in the form of shares, to the employee which remains in the Employee Stock Option Trust Fund till the time of its vesting and exercise of option by an employee.

ESOP inculcates a sense of ownership and trust amongst the employees of the company. Under this scheme, the employee gets an option to hold a given share of the company at a predetermined price, which would be realised or allotted at a future date. However, complete benefit under ESOPs are accrued only after the fulfilment of certain lock-in conditions, or completion of the vest-in period.

Taxability of ESOPs

ESOPs are taxable in the hands of the employees under the head ‘Income from Salary’ and ‘Income from Capital Gains’. When the employee exercises the ESOP, it is taxable as perquisite under income from Salary; and when the shares owned by the employee under ESOP are sold by the employee, it is taxable as income from Capital Gains.

Herein below we have discussed the taxation of ESOPs prior to Budget 2022-23, and the changes brought forth by Budget 2022-23 for the taxation of ESOPs.


As discussed above, ESOPs availed by the employees are liable to income tax at two instances:

1. Income from Salary

The first instance where income tax is collected from the employee for availing ESOP, is the stage when the employee exercises his option to avail the benefit of ESOP, i.e., agrees to purchase the shares offered at the ‘Exercise Price’.

Section 17(2)(vi) of the Income Tax Act, 1961 provides for allotment or transfer of a security or sweat equity share, either directly or indirectly by a former or present employer at concessional rate to employees. Explanation (e) to the said sub-section defines “option” as a right, but not an obligation, available to an employee through which they can apply for any security or sweat equity share of the employer at a predetermined price.

Income tax is levied as perquisite on the difference between the Fair Market Value and Exercise Price of the shares allotted. This prerequisite is deducted as tax at source by the employer.

Rule 3(8) of the Income Tax Rules, 1962 states that the average of the opening price and closing price of the shares shall be taken on the date of exercise of the ESOP in case of listed shares as the Fair Market Value. On the other hand, if the shares are unlisted, the Fair Market Value determined by a merchant banker in the verification certificate shall be considered.

2. Income from Capital Gains

Upon allotment of the shares under ESOP, the employee has the right to retain the shares to maintain its ownership in the company, or sell the same to gain profits out of the transaction. Hence, when such shares are sold, they attract income tax on Capital Gains.

Income tax is levied on the differential amount between the sale consideration, and the Fair Market Value of the shares on the date of exercise.

Such gains may either be a long term or short-term gain, based on the holding period beginning from the date of allotment of shares. The income tax levied on the sale of shares also depend upon whether such shares are listed or unlisted shares.

  • Capital Gains from sale of listed shares:

When a listed share is held for a period exceeding one year, they shall become long-term gains. They are subject to income tax under Section 112A of the Income Tax Act, 1961 which imposes tax at the rate of 10% without indexation, where the capital gains exceed Rs. 1 Lakh.

Listed shares held for a period not exceeding or equal to 12 months are termed as short-term capital gains, which are taxable under Section 111A of the Income Tax Act, 1961 at a concessional rate of 15%.

  • Capital Gains from sale of unlisted shares:

For unlisted shares, a two-year holding period is needed for them to be classified as long-term gains. Income from long-term capital gains arising out of sale of unlisted shares is taxable under Section 112 of the Income Tax Act, 1961 at the rate of 20% with indexation benefits.

Unlisted shares which are held for a period less than or equal to 24 months are termed as short-term capital gains, and are subject to income tax as any other income as per the regular income tax slab rates applicable to the employee.


The income tax regime governing ESOPs provided for taxation at two stages. The changes brought forth by Budget 2022-23 concern only the taxation of ESOPs at the first instance, i.e. at the time of its exercise.

At the stage of exercising ESOP, there is merely a paper conversion of the options into shares and there may not be any avenue to sell the shares at that time, especially in the case of unlisted firms and start-ups. Taxes at the first stage, i.e. at the time of exercise of options, have caused enhanced tax burden for employees.

Due to the high chances of a start-up failing to sustain the competition or develop a market in its stages of inception, tax paid on the exercise of ESOP by an employee may turn out to be a dead cost as the start-up may cease to exist at a later stage, forcing the employee to sell his share.

Secondly, during the initial stages of development and establishment of a start-up, its valuation constantly fluctuates, which also affects the returns that an employee gets by retaining the share with himself or selling it in the market. Such situations create unfavourable tax burden of ESOP on the employees.

The above reasons compelled the Central Government to revisit the taxation scheme for start-ups and resultantly, the Government deferred the tax deducted at source on perquisite income (first instance of taxation) on ESOP through Finance Act, 2020.

Start-ups have been granted the option to deduct perquisite tax on income on exercise of ESOP within 14 days of:

  • Expiry of 48 months from the end of the relevant assessment year; or
  • Date of sale of shares by employee; or
  • Date from which the taxpayer ceases to be an eligible member of start-up.

Thus, Budget 2022-23 has sought to defer the tax deducted at source liability, subject to the fulfilment of criteria laid down by Section 80 IAC of the Income Tax Act, 1961.

As per the said Section, the start-up must be incorporated between 01.04.2016 to 31.03.2022 and its turnover shall not be more than Rs. 100 crores in the previous financial years for which a deduction is claimed.

Additionally, the start-up must be engaged in activities of innovation, improvement or development of products, services or process; and provide a high opportunity of employment and/or wealth creation.


ESOPs are a novel step taken by employers to intrinsically inculcate employees within the company, enabling them to directly monetize the growth and profits of the company. As ESOPs provide additional income to employees, they are subject to income tax as salary, at the time of its exercise, or as capital gains when the shares allotted are sold.

With the implementation of the Start-up India scheme in India, the Government has taken various steps to create a robust ecosystem for nurturing innovation and start-ups in the country. Such start-ups, in order to attract and retain talented workforce offer ESOPs to their employees.

However, start-ups and their employees face various adversities during the course of their inception, which were further heightened by the additional tax burden of ESOP.

Thus, the proposed amendment in the Budget 2022-23 deferring the tax deducted at the stage of exercise is a step forward in the right direction to reduce additional tax burden of start-ups which affect their limited cash flows.

Team AMLEGALS, assisted by Ms. Mehar Kaur Arora (Intern)

For any query or feedback, please feel free to get in touch with or

Leave a Reply

Your email address will not be published. Required fields are marked *

Current day month ye@r *

© 2020-21 AMLEGALS Law Firm in Ahmedabad, Mumbai, Kolkata, New Delhi, Bengaluru for IBC, GST, Arbitration, Contract, Due Diligence, Corporate Laws, IPR, White Collar Crime, Litigation & Startup Advisory, Legal Advisory.


Disclaimer & Confirmation As per the rules of the Bar Council of India, law firms are not permitted to solicit work and advertise. By clicking on the “I AGREE” button below, user acknowledges the following:
    • there has been no advertisements, personal communication, solicitation, invitation or inducement of any sort whatsoever from us or any of our members to solicit any work through this website;
    • user wishes to gain more information about AMLEGALS and its attorneys for his/her own information and use;
  • the information about us is provided to the user on his/her specific request and any information obtained or materials downloaded from this website is completely at their own volition and any transmission, receipt or use of this site does not create any lawyer-client relationship; and that
  • We are not responsible for any reliance that a user places on such information and shall not be liable for any loss or damage caused due to any inaccuracy in or exclusion of any information, or its interpretation thereof.
However, the user is advised to confirm the veracity of the same from independent and expert sources.