In India’s fast-growing startup ecosystem, Employee Stock Option Plans (ESOPs) have become a popular way to attract and retain top talent. For employees working in unlisted Indian startups backed by foreign parent companies, the excitement of owning a piece of the company is often followed by confusion around how these stock options are taxed.

This article provides a comprehensive overview of how ESOPs are taxed for such employees and the nuances you should be aware of when the issuing entity is a foreign parent company.

What is an ESOP?

An Employee Stock Option Plan (ESOP) is an agreement where a company offers employees the right to purchase its shares at a predetermined price (known as the exercise price) after a specific vesting period. ESOPs are often issued as part of compensation packages, especially in startups where cash is limited, but growth potential is high.

Two Levels of Taxation on ESOPs in India

There are two stages at which ESOPs are taxed for employees in India:

1. At the Time of Exercise – Perquisite Tax (as Salary Income)

When an employee exercises their ESOP, the difference between the Fair Market Value (FMV) of the share and the exercise price is taxed as a perquisite under Section 17(2)(vi) of the Income Tax Act.

• Taxable Value = FMV on exercise date – Exercise price

• Tax Head: Income from Salary

• Tax Paid By: Employer is required to deduct TDS on this perquisite value even if the company is unlisted or foreign.

2. At the Time of Sale – Capital Gains Tax

When the employee sells the shares, capital gains tax is applicable.

• Capital Gains = Sale Price – FMV at time of exercise

• If held for >24 months, it's Long-Term Capital Gains (LTCG) (20% with indexation).

• If held for ≤24 months, it's Short-Term Capital Gains (STCG) (taxed at slab rate).

🔹 Special Scenario: ESOPs from Foreign Parent Companies

When ESOPs are issued by a foreign parent company (e.g., a US-based holding company of an Indian startup), Indian employees still face taxation in India. Here’s how:

✅ At Exercise:

• The employer may not deduct TDS as they're not registered in India.

• However, you, the employee, are liable to self-declare and pay advance tax on the perquisite amount.

• FMV must be determined by a Category I Merchant Banker registered with SEBI in INR.

✅ At Sale:

• If shares are sold on a foreign exchange, capital gains are computed in INR.

• The gain is taxable in India even if proceeds are received in foreign currency.

• Double Taxation Avoidance Agreements (DTAA) may help mitigate foreign tax liability, but correct filing is crucial.

Compliance Requirements for Employees

• Include perquisite income in salary while filing ITR (generally ITR-2 or ITR-3).

• Pay advance tax on the perquisite value during the year of exercise.

• Report foreign assets (shares) under Schedule FA in the Income Tax Return (if applicable).

• If you own more than 50% of the shares or are a beneficial owner, additional disclosure under Schedule AL is required.

Tips for Tax Planning on ESOPs

• Plan liquidity before exercising options; since tax is due at exercise even if you don’t sell the shares.

• Consider selling some shares to cover tax obligations if there's no lock-in.

• Use DTAA benefits to reduce double taxation, especially if you’re taxed abroad on sale.

• Work with a tax advisor who understands cross-border taxation.

Key Challenges in Foreign ESOP Taxation

• Lack of clarity on FMV in the absence of listed price

• No withholding by foreign employer, leaving tax compliance to employee

• Complex reporting for foreign shares and sale proceeds

• Potential mismatch in taxing year between India and foreign jurisdiction

Conclusion

While ESOPs offer a fantastic opportunity to participate in a startup’s growth, employees in Indian startups with foreign parents must be proactive in handling the tax implications. Taxation kicks in even before you make money from selling your shares, so plan ahead, stay compliant, and seek professional advice to avoid surprises later.