Employee Stock Option Plans (ESOPs) have become an integral component of compensation structures, especially in startups, technology companies, and multinational organisations. By allowing employees to acquire shares at a predetermined price, ESOPs aim to align employee performance with long-term company growth. However, while ESOPs offer wealth-creation opportunities, their taxation under the Income-tax Act, 1961 remains complex.
The challenges are more for expatriates and returning Indians, for whom the absence of clear legislative guidance results in uncertainty, double taxation and prolonged disputes.
Two different stages
ESOPs are taxed at two different stages. The first taxable event occurs at the time of exercise of the stock option. The difference between the fair market value of the shares on the exercise date and the price paid by the employee is treated as a perquisite under the head ‘Income from Salary’.
The second stage of taxation arises when the employee sells the shares. At that point, the difference between the sale consideration and the fair market value considered at the time of exercise is taxed as capital gains.
Multiple countries
The principal difficulty arises when an employee works in multiple countries during the period between grant and vesting of ESOPs. Although Section 9(1)(ii) provides that salary income is deemed to accrue in India to the extent services are rendered in India, the law does not prescribe a clear mechanism for apportioning ESOP income between Indian and overseas service periods. As a result, assessing officers often adopt inconsistent approaches, sometimes taxing the entire perquisite value in India merely because the exercise of options occurs while the individual is a resident in India.
This issue particularly affects expatriates and returning Indians. Employees who worked abroad during the vesting period but exercise their options after relocating to India may face taxation in India on the full ESOP value, even if a substantial portion of services were rendered overseas. In many cases, the same income may have been taxed in a foreign jurisdiction, leading to genuine instances of double taxation. While Double Taxation Avoidance Agreements and foreign tax credit provisions exist, their practical application becomes difficult in the absence of clear domestic rules on income attribution.
Against this backdrop, Budget 2026 presents an opportunity for reform. Introducing statutory clarity on ESOP taxation for globally mobile employees would significantly reduce disputes. Explicit provisions prescribing service-based apportionment, along with standardised formulas and documentation requirements, would ensure uniform treatment across cases. Such measures would protect employees from unintended tax exposure and also provide certainty to employers in meeting their withholding obligations.