The Central Board of Direct Taxes (CBDT) has recently issued a much-awaited clarification regarding the tax treatment of ESOP (Employee Stock Option Plan) buybacks, particularly under Section 115QA of the Income Tax Act, 1961. This clarification aims to remove ambiguity, promote compliance, and provide a boost to India's startup ecosystem.
Employee Stock Option Plans (ESOPs) are a powerful tool used by startups and companies to attract and retain talent, offering employees ownership in the company.
Sometimes, instead of the company going public or employees selling shares in the open market, the company offers to buy back these shares from employees—this is known as an ESOP Buyback.
The CBDT, through a circular issued in July 2025, clarified the following key points:
Section 115QA, which imposes a 20% tax on distributed income from share buybacks by unlisted companies, does not apply to employee-related ESOP buybacks.
The rationale: ESOP buybacks are not considered a distribution of profits to shareholders but are individual transactions between the company and its employees.
🧠 Why This Matters: Employees will not be taxed under the punitive buyback tax regime, making their earnings more equitable and reducing double taxation.
As per the CBDT's clarification, ESOP buyback gains will be treated under the Capital Gains regime. Here's how it breaks down:
Short-Term Capital Gain (STCG):
If the shares are held for less than 24 months before buyback – taxed as per slab rate.
Long-Term Capital Gain (LTCG):
If held for more than 24 months – taxed at 20% with indexation benefits.
Cost of Acquisition = Price paid by the employee to exercise the ESOP.
Capital Gains = Buyback price – Cost of acquisition.
This capital gain is then taxed based on the holding period and applicable rates.
This clarification is a major win for:
Startup employees – more clarity and less tax burden.
Companies – simplified compliance and better retention incentives.
Investors – more certainty and trust in India's startup ecosystem.
In recent years, ESOPs have become an essential component of startup compensation. However, concerns around excessive taxation discouraged many employees from exercising their options or participating in buybacks.
With this move, the government shows it is:
✔️ Encouraging wealth creation for employees
✔️ Supporting Make in India and Startup India missions
✔️ Enhancing the ease of doing business
The CBDT’s clarification removes a long-standing cloud over ESOP taxation, especially during buyback events. It ensures fairness, simplicity, and consistency in tax treatment.
📣 As India’s innovation economy grows, such progressive tax reforms are not just welcome—they’re essential.