ESOP and RSU Taxation

A note on the law: section numbers here are from the Income tax Act, 1961, the operative law for the current filing cycle. TDS on ESOP perquisites moves from Section 192 to Section 392 under the Income tax Act, 2025, for exercises from 1 April 2026 onward, the substantive rules stay the same. This article is for general information and does not constitute tax advice.

ESOPs: taxed as salary before any capital gain

When an employer allots shares under an Employee Stock Option scheme, the gap between fair market value on the exercise date and whatever the employee paid to exercise is taxed as a salary perquisite under Section 17(2)(vi), in the year of exercise, whether or not the employee has actually sold anything or received any cash. This is separate from, and happens before, whatever capital gain arises later at actual sale.

The employer deducts TDS on this perquisite as part of salary, and it appears in Form 16 and Form 12BA with the FMV, exercise price, and number of shares broken out. The genuine cash-flow problem shows up when the perquisite value dwarfs the employee’s monthly cash salary, the employer cannot recover the full TDS from a normal month’s pay alone, and the employee typically ends up paying the shortfall directly or selling enough shares to cover it, sometimes called a sell-to-cover.

Where employer TDS falls short, advance tax exposure follows. A large ESOP exercise or RSU vesting late in the financial year is a common trigger for a genuine 234B and 234C interest problem: the employer withholds against the perquisite through payroll, but if that withholding, spread across the year, still leaves a shortfall against total tax liability, the difference is the employee’s to cover through their own advance tax instalments. Waiting until the return is filed to settle the balance means interest has already been accruing since the missed instalment date. Anyone with a significant exercise or vesting event should re-run their advance tax estimate for that quarter rather than assume payroll TDS has fully covered it.

The startup deferral, and the misconception around it

Employees of eligible startups can defer paying this TDS, but qualifying is narrower than most people assume. DPIIT recognition under Startup India is not enough on its own. The employer also needs a separate Section 80-IAC exemption certificate from the Inter-Ministerial Board, and only a small fraction of DPIIT-recognised startups actually hold one. Ask which certificate your employer has before assuming this deferral applies to you.

Where it does apply, TDS on the perquisite is deferred until the earliest of three triggers:

• 48 months from the end of the assessment year in which the shares were allotted
• The date the employee sells the shares
• The date the employee ceases employment with the startup

This is a deferral, not an exemption. The employer must deduct the deferred TDS within 14 days of whichever trigger occurs first, and the tax is computed at the rates that applied in the year of allotment, not the year the trigger actually happens. An employee who neither sells nor leaves still hits the 48-month wall automatically, worth tracking that date directly rather than waiting for a reminder.

RSUs: the same idea, minus the exercise price

Restricted Stock Units follow the same Section 17(2)(vi) framework, with one structural difference: there is usually no exercise price to pay, the units simply vest. The full fair market value on the vesting date becomes the perquisite, taxed as salary in that year, and the employer withholds TDS the same way. The startup deferral above applies to RSUs too, if the same 80-IAC certification exists.

RSUs from a foreign parent company carry extra reporting. Beyond the perquisite itself, holding shares of a foreign company at all triggers Schedule FA (Foreign Assets) disclosure in the ITR, and rules out ITR-1 and ITR-4 for the year, regardless of whether any shares were actually sold. The holding period for the eventual capital gain runs from the vesting date, and whether listed or unlisted treatment applies depends on whether the parent trades on an Indian exchange, foreign-listed shares follow unlisted rules.

What this means for the eventual sale

The cost of acquisition for the eventual capital gain is the fair market value already taxed as a perquisite, not what you originally paid to exercise. For ESOPs, that means the exercise price itself drops out of the calculation entirely once the shares are sold, replaced by the FMV on the exercise date. For RSUs, since there was no exercise price at all, the cost of acquisition is simply the FMV on the vesting date. This is what stops the same value being taxed twice, once as salary and again as a capital gain: the capital gain on sale is measured only on the movement in price after the perquisite was already taxed, not on the whole sale value. Getting this wrong, and using the exercise price as cost of acquisition for ESOPs, overstates the capital gain and means paying tax on value that was already taxed as salary.

The holding period for determining short-term or long-term treatment on that eventual sale runs from the exercise date for ESOPs and the vesting date for RSUs, not from the date the option was originally granted. Keeping the Form 12BA or payslip that recorded the perquisite value is the practical way to have that FMV figure on hand when the shares are eventually sold, sometimes years later.