ESOPs in India Explained: A Guide for Founders and Teams

ESOPs in India, explained simply: an ESOP gives an employee the right to buy company shares later at a fixed price set today. Options vest over time, usually four years with a one-year cliff. When the employee exercises, the gain is taxed as salary; when they sell, the further gain is taxed as capital gains. Eligible startups can let employees defer the first tax.

Who this is for: founders setting up an ESOP pool or writing ESOPs into offers, and employees trying to work out what their options are worth.

I have seen ESOPs win people over, and I have seen them cause real bitterness when nobody explained the tax bill at exercise. Most of the bitterness comes from surprises. This guide is about removing them.

The four words: pool, grant, vesting, exercise

Every ESOP plan runs on four steps.

The pool

The pool is usually created by the board and approved by shareholders under the Companies Act rules on employee stock options. Investors often ask for the pool to be set up, or topped up, before their money comes in, so the dilution falls on existing shareholders rather than them. Our term sheet guide covers how this shows up in a round.

Who can get ESOPs

Under the Companies (Share Capital and Debentures) Rules, ESOPs can go to permanent employees and directors (but not independent directors). Promoters, the promoter group and directors holding more than 10% of the company are normally excluded.

There is an exception that matters for founders: DPIIT-recognised startups can grant ESOPs to promoters and such directors for up to ten years from incorporation, as long as turnover has stayed within the limit set in the rules.

The company must also keep a register of options in Form SH-6.

Cliffs and vesting schedules

The most common Indian startup schedule is four years with a one-year cliff.

• Nothing vests in the first 12 months.
• On the first anniversary, 25% vests in one go.
• The remaining 75% vests monthly or quarterly over the next three years.

Indian company law requires at least one year between grant and first vesting, so a cliff of at least a year is built in.

Other schedules you'll see:

The exercise window: the clause people forget

The exercise window says how long someone has to exercise vested options after they leave. Many older plans give 90 days. For a junior employee, finding the money to exercise and pay tax within 90 days of leaving is often impossible, so they lose options they earned.

A longer window, say several years, or until a liquidity event, is kinder and increasingly common. Decide this when you write the plan, because changing it later needs approvals.

How ESOPs are taxed in India

ESOPs are taxed at two points. The Income-tax Act, 2025 replaced the 1961 Act from 1 April 2026 and renumbered the sections, but the way ESOPs are taxed is the same.

1. At exercise: taxed as salary

When the employee exercises, the perquisite value is added to their salary:

Perquisite value = (fair market value on the exercise date minus exercise price) × number of shares

For an unlisted company, fair market value comes from a merchant banker's valuation as of the exercise date, or a date up to 180 days before it. The employer deducts TDS on it with salary.

This is the painful part. The employee pays tax on a gain they can't spend, because the shares usually can't be sold yet.

2. At sale: taxed as capital gains

When the employee later sells the shares, the gain is the sale price minus the fair market value used at exercise. So the same rupee isn't taxed twice.

The holding period runs from allotment, not from grant.

Add cess, and surcharge where it applies.

The startup tax deferral

Employees of eligible startups can defer the tax at exercise. Eligible here means the startup qualifies for the startup tax benefit and holds that certificate. DPIIT recognition alone isn't enough.

With the deferral, the employer deducts the tax within 14 days of the earliest of:

1. 48 months from the end of the relevant year of allotment,
2. the employee leaving the company, or
3. the employee selling the shares.

It's a deferral, not an exemption. If someone leaves, the tax comes due straight away, which is another reason to think about your exercise window.

Buybacks

Some startups give employees liquidity through a buyback. The tax treatment of buyback money has changed more than once since 2024, so check the current rules with your CA before you announce one.

A worked example

Priya joins a startup and gets 1,000 options at an exercise price of ₹10, vesting over four years with a one-year cliff.

Year 4, exercise. All 1,000 have vested. The latest valuation puts the fair market value at ₹510 a share.

• She pays ₹10 × 1,000 = ₹10,000 to exercise.
• Perquisite value: (₹510 minus ₹10) × 1,000 = ₹5,00,000, added to her salary.
• If she's in the 30% slab: ₹1,50,000 tax, plus 4% cess = ₹1,56,000, deducted as TDS (or deferred, if the startup is eligible).

Year 7, sale. The company is acquired and she sells at ₹1,010 a share, more than 24 months after allotment.

• Capital gain: (₹1,010 minus ₹510) × 1,000 = ₹5,00,000.
• Long-term capital gains tax at 12.5% = ₹62,500, plus 4% cess = ₹65,000.

She paid ₹10,000 to exercise and ₹2,21,000 in tax over the two events, and received ₹10,10,000 from the sale. Surcharge is ignored here for simplicity.

Sizing the pool and each grant

There's no fixed rule for pool size. Work backwards from your hiring plan instead of picking a number that sounds normal.

1. List the roles you'll hire before the next round, say the next 18 to 24 months.
2. Decide which roles get options, and roughly how much each kind of role should get. Senior hires usually get more than early-career ones.
3. Add up the grants, then add a buffer for refresh grants and roles you haven't thought of yet.
4. Check the total against what investors will accept in the round, and agree it before the term sheet is signed.

For each grant, think in value, not in a count of options. A thousand options means nothing on its own. Work out what the grant would be worth at the last round's price, compare it with the cash salary the person is giving up, and keep it consistent across people at the same level. Write your bands down, so two people doing the same job don't end up with wildly different grants because one negotiated harder.

Review the pool before every round. If most of it has been granted, a top-up will be part of the next negotiation, and it's better to raise it yourself than have it imposed.

Communicating ESOPs in an offer

Most ESOP disappointment comes from a vague offer. Put these in writing:

• Number of options and the exercise price.
• What that is as a share of the company today, in rough terms.
• Vesting schedule and cliff, with dates.
• Exercise window after leaving, and what happens on resignation, termination or acquisition.
• Tax, in one paragraph: tax at exercise, tax at sale, and whether the deferral applies.
• An honest note on value. Show what the options would be worth at the last round's price, and say clearly that this isn't a promise.

Never add ESOPs to CTC. They aren't cash, they cost money to exercise, and they may end up worth nothing. Keep them on a separate page. Our CTC vs in-hand salary guide covers the cash side of the offer.

A one-page explainer helps

Attach a one-page explainer to every offer: the four words, the vesting picture and the tax at each step. The give-away below is a template you can adapt.

Running the plan once it exists

• Board minutes for every grant.
• Grant letters signed by both sides.
• An up-to-date register (Form SH-6) and cap table.
• A yearly valuation, so exercise-day fair market value can be worked out.
• Leavers handled promptly. Unvested options lapse back to the pool; vested ones follow the exercise window. See our full and final settlement checklist.

Common mistakes

• Promising a percentage you can't track. Grant a number of options and keep the cap table current.
• A 90-day exercise window by default. It quietly takes options away from people who earned them.
• Not explaining the tax at exercise. It's the single biggest source of ESOP anger.
• Assuming DPIIT recognition gives the tax deferral. It needs the separate startup tax certificate.
• Granting before the plan is approved by the board and shareholders.
• Adding ESOP value to CTC. It inflates the offer and erodes trust later.

Questions people ask

How are ESOPs taxed in India?

ESOPs are taxed twice. When you exercise, the difference between the share's fair market value and your exercise price is taxed as salary, and the employer deducts TDS. When you later sell, the gain over that fair market value is taxed as capital gains, short or long term depending on how long you held the shares.

What is a one-year cliff in ESOPs?

A cliff is the minimum time before any options vest. With a one-year cliff, nothing vests in the first year; on the first anniversary, a year's worth vests at once, and the rest vests monthly or quarterly after that. Indian company law requires at least one year between grant and first vesting.

Can startup employees defer tax on ESOPs?

Yes, if the company is an eligible startup with the tax benefit certificate, not only DPIIT recognition. The tax at exercise is then deferred until the earliest of 48 months after the relevant year ends, the employee leaving, or the employee selling the shares. It is a deferral, not an exemption.

Should ESOPs be included in CTC?

No. ESOPs are not cash, their value depends on the company's future, and the employee usually has to pay to exercise them. Show them separately in the offer, with the number of options, exercise price, vesting schedule and what happens if the person leaves.

Sources

• Income Tax Department: Taxation of Employee Stock Option Plans (opens in a new tab)
• King Stubb & Kasiva: ESOP taxation in India and the startup deferral (opens in a new tab)
• EquityList: ESOPs under the Companies Act (opens in a new tab)
• Tax2win: Income tax changes from April 2026 (opens in a new tab)

This is general information, not legal or tax advice. Check with your CA or lawyer for your company's situation.