Tax on ESOP Buyback in India — What Employees Actually Pay

# Tax on ESOP Buyback in India — What Employees Actually Pay

ESOP buybacks — where an unlisted company buys back shares from employees — are one of the few liquidity events available to private-company employees before an IPO. They're also one of the most tax-misunderstood events in Indian personal finance.

Most employees know there's "some tax" involved. Very few understand there are two separate tax events — and that failing to plan for both can result in an unexpectedly large bill.

Disclaimer: This article describes general principles. ESOP tax treatment is highly fact-specific and has been subject to legislative changes. Consult a CA before making any decisions around your ESOPs.

The Two Tax Events

### Event 1: Perquisite Tax at Exercise

When you exercise your ESOPs (convert options into actual shares), the Income Tax Act treats the benefit you received as a perquisite — essentially additional salary.

Perquisite value = FMV per share at exercise − Exercise price paid

This entire perquisite value is added to your salary income for the year and taxed at your income tax slab rate (which may be as high as 30% + surcharge + cess = ~43% for high earners).

**Your employer deducts TDS on this amount** and reports it in your Form 16.

For unlisted companies, FMV must be certified by a SEBI-registered Category I Merchant Banker. This valuation determines your perquisite tax and also becomes your cost of acquisition for capital gains purposes.

### Event 2: Capital Gains Tax at Sale (Buyback)

When the company buys back your shares (or when you sell on a platform like Polemarch), the second tax event occurs.

Capital gain = Buyback price per share − FMV at exercise (your cost of acquisition)

The nature of the gain (short-term or long-term) depends on how long you held the shares after exercise — not how long you held the options.

• Held ≤ 24 months after exercise → **STCG at slab rate**
• Held > 24 months after exercise → **LTCG at 20% (with indexation if applicable)**

A Worked Example

| Event | Amount | |---|---| | Exercise price (paid by employee) | ₹10/share | | FMV at exercise (certified) | ₹200/share | | Perquisite at exercise | ₹190/share → taxed as salary | | Buyback price (3 years later) | ₹450/share | | Cost of acquisition | ₹200/share (FMV at exercise) | | LTCG | ₹450 − ₹200 = ₹250/share (held >24 months) |

For 1,000 shares:

• Perquisite: 1,000 × ₹190 = ₹1,90,000 → taxed at slab (say 30%) = ₹57,000 TDS by employer
• LTCG: 1,000 × ₹250 = ₹2,50,000 → taxed at ~20% = ₹50,000

Total tax on the entire gain (₹440/share): ₹57,000 + ₹50,000 = ₹1,07,000 on ₹4,40,000 of economic gain.

Note: ₹2,000 exercise price already paid, not counted in tax.

The Surprise Tax Bill Problem

Many employees forget the perquisite tax at exercise because their employer handles it. The problem arises when:

1. 1You exercise and are immediately cash-poor (no buyback yet)
2. 2Your employer deducts large TDS, affecting your take-home for the year
3. 3You file ITR and discover additional advance tax was due

Best practice: When you exercise ESOPs in an unlisted company, immediately ask HR for:

• The certified FMV used for perquisite calculation
• The TDS amount to be deducted
• The Form 12BA that your employer will issue

Use this to plan your advance tax payments for that financial year.

Startup-Specific Rule: Section 80-IAC Tax Deferral

Employees of DPIIT-recognised startups can defer the perquisite tax at ESOP exercise. Instead of paying in the year of exercise, they pay in the earlier of:

• 5 years from exercise date
• Date of sale of shares
• Date of leaving the company

This is a significant benefit — it allows you to defer the perquisite tax until you actually receive cash from a sale. Verify with your HR team whether your company is DPIIT-recognised.

What Happens in a Secondary Sale (Not a Buyback)

If you sell your ESOP-exercised shares on Polemarch (to another investor, not back to the company), the capital gains tax applies the same way — the cost of acquisition is the FMV at exercise. No perquisite event occurs at secondary sale (that already happened at exercise).

Key Documents to Keep

• ESOP grant letter (shows exercise price and vesting schedule)
• Form 12BA from employer (shows perquisite value)
• FMV certificate from Merchant Banker
• Exercise confirmation and demat credit statement
• Sale invoice (buyback letter or Polemarch invoice)

*Published by the Polemarch editorial team. Not tax advice — consult a chartered accountant for ESOP-specific planning.*