How ESOPs and RSUs Are Taxed in India: The Two Taxable Events, Startup Deferral, and Foreign Shares

Employee stock options are the most misunderstood item on a tech-sector tax return. They are taxed at two separate moments - when you exercise (or when RSUs vest), and again when you sell - under two different heads, at two different rates, and often in two different financial years. Employees routinely exercise options in a private company, pay a large tax bill on shares they cannot sell, and then discover at sale that the gain is computed from a number they never noted down. This guide walks through both events with the FY 2026-27 rates, the special deferral for eligible startups, and what changes when the shares are in a US parent company.

The vocabulary, briefly

• Grant - the company gives you the right to buy N shares at a fixed exercise price. No tax.
• Vesting - the right becomes usable, typically over four years with a one-year cliff. For options, no tax. For RSUs (restricted stock units, where shares are simply handed over), vesting is the taxable event, since there is no exercise step.
• Exercise - you pay the exercise price and receive the shares. Taxable event 1.
• Sale - you sell the shares. Taxable event 2.
• FMV - fair market value on the exercise (or vesting) date: the closing price for listed shares, a merchant banker's valuation for unlisted ones.

Event 1 - exercise: the perquisite taxed as salary

On exercise, the difference between the FMV of the shares and what you paid for them is a perquisite under Section 17(2)(vi), added to your salary for the year and taxed at your slab rate. Your employer must deduct TDS on it, which - since no cash changes hands - usually comes out of your regular salary in the month of exercise.

Perquisite = (FMV on exercise date − exercise price) × number of shares

Example. 1,000 options at an exercise price of ₹100; FMV on the exercise date ₹900. Perquisite = (₹900 − ₹100) × 1,000 = ₹8,00,000, taxed as salary. At the 30% band that is ₹2,49,600 of tax, deducted from your payslips - on shares you may not be able to sell for years if the company is private.

This is why the timing of exercise matters. Exercising in a year when your other income is low (a sabbatical, a gap between jobs, the year you move abroad) puts the perquisite in a lower band. Exercising when the FMV is close to the exercise price - early, before the company's valuation has run up - keeps the perquisite small and shifts more of the eventual gain into the capital-gains bucket, which is taxed at 12.5% rather than 30%.

For RSUs, the same computation applies at vesting with an exercise price of zero: the full FMV of the vested shares is the perquisite. Many employers sell a portion of the vested shares ("sell to cover") to fund the TDS.

Event 2 - sale: capital gains from the FMV, not the exercise price

When you sell, the gain is sale price minus the FMV on the exercise date - because the FMV has already been taxed as salary and becomes your cost of acquisition. The holding period runs from the exercise (allotment) date, not the grant or vesting date.

Continuing the example. You sell the 1,000 shares three years after exercise for ₹1,500 each. Gain = (₹1,500 − ₹900) × 1,000 = ₹6,00,000, long-term. If the company is listed in India: 12.5% on ₹6,00,000 − ₹1,25,000 exemption = ₹59,375 plus cess. If unlisted: 12.5% on the full ₹6,00,000 = ₹75,000 plus cess.

Total tax over the life of the options: ₹2,49,600 (perquisite) + about ₹61,750 (gain) on a total profit of ₹14 lakh - roughly 22%. Had you exercised early at an FMV of ₹150 instead of ₹900, the perquisite would have been ₹50,000 (₹15,600 tax) and the LTCG ₹13.5 lakh (about ₹1.6 lakh tax) - a total under ₹1.8 lakh on the same ₹14 lakh. The split between "salary" and "capital gain" is where the real planning lies.

Eligible startups: the tax on exercise is deferred

Since FY 2020-21, employees of eligible startups - those recognised by DPIIT and holding an Inter-Ministerial Board certificate under Section 80-IAC - do not pay the perquisite tax at exercise. Under Section 192(1C) the employer deducts TDS, and the employee pays the tax, at the earliest of:

1. 48 months from the end of the assessment year in which the options were exercised (so roughly five years),
2. the date you sell the shares, or
3. the date you leave the company.

The perquisite is still valued at the FMV on the exercise date - only the payment is deferred. The relief is narrow: the startup must hold the 80-IAC certificate, which a minority of DPIIT-recognised startups do. Ask HR which category yours falls in before exercising, because the cash-flow difference is the entire tax bill.

RSUs and ESPPs from a US parent

Indian employees of multinationals typically receive RSUs in the US-listed parent. The Indian tax treatment is the same two-event structure, with extra reporting:

• At vesting, the FMV of the vested shares (converted to rupees at the SBI TT buying rate on that date) is a perquisite on your Indian salary. Your Indian employer deducts TDS, often by selling some of the shares.
• At sale, the gain in rupees (sale proceeds at that day's rate minus FMV at vesting at that day's rate) is a capital gain. Foreign shares are long-term after 24 months and taxed at 12.5% without indexation; short-term gains are at slab. Currency movements are part of the gain.
• Dividends on the foreign shares are taxed at slab in India, with credit for US withholding tax (15% under the treaty) claimed via Form 67 filed before the return.
• Schedule FA: every foreign share held at any time during the calendar year must be reported in the ITR's foreign-assets schedule, with peak and closing values - even if you sold everything. Omitting it attracts a ₹10 lakh penalty under the Black Money Act, and the department matches ITR data with US broker reports.
• ESPP (buying stock at a discount through payroll): the discount is a perquisite on the purchase date; the sale is a capital gain from the purchase-date FMV.

You will need ITR-2 (or ITR-3 if you also have business income); ITR-1 does not carry Schedule FA or capital gains.

A practical checklist

1. Record the FMV on every exercise or vesting date, in rupees, with the exchange rate used. It is your cost of acquisition years later, and brokers' statements often show the exercise price instead.
2. Check Form 16 Part B and Form 12BA for the perquisite value the employer reported; it should match your own computation.
3. Plan exercise timing: low-income years, early in the company's valuation curve, and - for startups - confirm whether 192(1C) deferral applies.
4. Hold past the long-term threshold when you can: 12 months (listed Indian) or 24 months (unlisted or foreign) from exercise, which moves the gain from slab rate to 12.5%.
5. Use the ₹1.25 lakh LTCG exemption every year on listed Indian shares by selling in tranches across financial years.
6. Pay advance tax on the capital gain in the instalment after the sale - there is no TDS on it, and the 234B/234C interest on a large gain adds up.

Frequently asked questions