ESOP Tax Deferral for Startup Employees Under Section 192

Short answer: Employees of eligible startups can defer the Tax Deducted at Source (TDS) on the perquisite value of their Employee Stock Options (ESOPs). Instead of paying tax at the time of exercise, the tax payment is postponed. The employer must deduct and pay the TDS within 14 days of the earliest of three events: the sale of shares, cessation of employment, or 48 months from the end of the relevant assessment year. This helps alleviate cash flow burdens for employees.

What is the normal tax treatment of ESOPs?

Normally, ESOPs are taxed at two distinct stages. The first tax event occurs when you exercise your options and shares are allotted to you. The difference between the Fair Market Value (FMV) of the share on the exercise date and the exercise price you pay is considered a perquisite, which is a component of your salary income. Your employer is obligated to deduct TDS on this perquisite amount. The second tax event happens when you sell these shares. The profit from the sale is taxed as capital gains. You can learn more in our detailed guide to ESOP taxation.

Which startups qualify for this ESOP tax deferral?

A startup must be an "eligible start-up" as defined under Section 80-IAC of the Income-tax Act, 1961 to offer this benefit. This is a crucial condition; not every company calling itself a startup qualifies. The key criteria for eligibility are:

1. DPIIT Recognition: The startup must be recognised by the Department for Promotion of Industry and Internal Trade (DPIIT). You can read about the process in our Startup India Recognition guide.
2. Incorporation Date: The company must be incorporated on or after 1st April 2016.
3. Turnover Limit: Its total turnover must not have exceeded ₹100 crore in any financial year since its incorporation.
4. Innovation Condition: It must be working towards innovation, development, or improvement of products, processes, or services, or have a scalable business model with high potential for employment generation or wealth creation.

Only if the employer company satisfies all these conditions can its employees benefit from the tax deferral under Section 192(1C).

How does the ESOP tax deferral work?

The tax deferral mechanism is a significant relaxation provided to ease the burden on startup employees who hold valuable shares on paper but lack the cash to pay the tax. Instead of deducting TDS when the perquisite arises (at exercise), the employer's obligation to deduct tax is postponed to a later date. The tax must be deducted and deposited within 14 days from the earliest of the following events:

1. Lapse of 48 months from the end of the assessment year in which the shares were allotted.
2. The date the employee sells the allotted shares.
3. The date the employee ceases to be an employee of the startup (resigns or is terminated).

The employer is responsible for tracking these trigger events and complying with the TDS provisions at the appropriate time.

How is the deferred TDS calculated?

The deferral only changes the timing of the tax payment, not the method of calculation or the amount of tax due on the perquisite. The tax is calculated on the perquisite value, which is the FMV of the shares on the date of exercise minus the exercise price paid by the employee. This amount is added to the employee's income, and tax is calculated at the slab rates applicable to the employee in the year the perquisite was originally taxed (i.e., the year of exercise).

For instance, if you exercise options in FY 2025-26, the perquisite value is determined then. When one of the trigger events occurs, say in FY 2028-29, the employer will deduct tax on that pre-determined perquisite value based on your tax slab rates.

Taxation Point	Normal ESOP Taxation	Startup Deferral Taxation (Sec 192(1C))
Grant of Options	No tax event	No tax event
Vesting of Options	No tax event	No tax event
Exercise of Options	Perquisite tax is due. TDS is deducted by the employer immediately from salary.	Perquisite tax liability is determined, but TDS payment is deferred. No immediate cash outflow for tax.
TDS Payment Due	Within the same month of exercise.	Within 14 days of the earliest of: (a) sale of shares, (b) leaving the job, or (c) 48 months after the relevant AY.
Sale of Shares	Capital gains tax is payable by the employee.	1. Deferred TDS on the perquisite becomes due and is deducted by the employer. <br> 2. Capital gains tax is payable by the employee on the sale profit.

What happens if the employee sells the shares?

Selling the shares triggers two tax obligations. First, it is a trigger event for the deferred perquisite tax. Your employer must deduct TDS on the original perquisite value within 14 days of the sale date. Second, you, the employee, are liable to pay capital gains tax on the profit from the sale. The capital gain is calculated as the Sale Price minus the FMV on the date of exercise (which becomes your cost of acquisition).

• Short-Term Capital Gain (STCG): If you sell listed shares within 12 months (or unlisted shares within 24 months), the gain is taxed at your applicable income tax slab rate.
• Long-Term Capital Gain (LTCG): If you hold the shares for longer than the periods mentioned above, the gain is taxed at a specific rate. For listed equity shares, the rate is 12.5% on gains exceeding ₹1 lakh (as of July 2024). For unlisted shares, it is 20% after indexation.

For more details, refer to our guide on tax on capital gains from shares.

Worked example

Let's consider Priya, a software developer at an eligible DPIIT-recognised startup in Bengaluru. Her annual salary is ₹25,00,000.

• Options Exercised: 2,000 options on 1st June 2025.
• Exercise Price: ₹100 per share.
• Fair Market Value (FMV) on 1st June 2025: ₹1,100 per share.
• Relevant Assessment Year (AY): 2026-27.

Step 1: Calculate Perquisite Value

• Perquisite per share = ₹1,100 (FMV) - ₹100 (Exercise Price) = ₹1,000
• Total Perquisite Value = 2,000 shares * ₹1,000 = ₹20,00,000

Step 2: Apply Deferral

• Normally, Priya's employer would deduct TDS on this ₹20,00,000 in June 2025, causing a huge tax outgo without any cash inflow. Her taxable income for FY 2025-26 would be ₹25,00,000 (salary) + ₹20,00,000 (perquisite) = ₹45,00,000.
• Under Section 192(1C), her employer defers this TDS. Priya has no immediate tax liability on the perquisite.

Step 3: Trigger Event Occurs Priya decides to sell all 2,000 shares on 10th August 2027, for ₹2,500 per share.

• Event: Sale of shares.
• TDS Due Date: Within 14 days, i.e., by 24th August 2027.
• Action by Employer: The employer must now deduct TDS on the original perquisite value of ₹20,00,000 at Priya's applicable slab rates.

Step 4: Calculate Capital Gains for Priya

• Sale Consideration: 2,000 shares * ₹2,500 = ₹50,00,000
• Cost of Acquisition (FMV at exercise): 2,000 shares * ₹1,100 = ₹22,00,000
• Holding Period: 1st June 2025 to 10th August 2027. Assuming the shares are unlisted, this is over 24 months, making it a long-term capital gain.
• Long-Term Capital Gain (LTCG): ₹50,00,000 - ₹22,00,000 = ₹28,00,000 (Indexation benefit would also apply, which we are ignoring for simplicity).
• Tax on LTCG: Priya is liable to pay tax at 20% on this gain when she files her income tax return for AY 2028-29.

This deferral allowed Priya to hold her shares without a tax burden until she monetized them, perfectly aligning the tax payment with the cash inflow.

Common mistakes

1. Assuming All Startups are Eligible: Many employees mistakenly believe this benefit applies to any startup. It is strictly limited to those recognised under Section 80-IAC.
2. Forgetting Tax is Deferred, Not Waived: The tax liability does not disappear. Employees must plan for this future outgo, which can be substantial.
3. Miscalculating the 48-Month Period: The clock starts from the end of the assessment year in which shares are allotted, not from the date of allotment itself. For an allotment in FY 2025-26, the AY is 2026-27, which ends on 31 March 2027. The 48-month period ends on 31 March 2031.
4. Ignoring the Employer's Role: This is not a benefit an employee can claim directly in their ITR. The employer must be an eligible startup and must correctly implement the deferral in their TDS process.
5. Failing to Plan for a Liquidity Crunch: If the trigger event is leaving the company or the expiry of 48 months, the employee will have to pay tax without having sold the shares. It is crucial to have funds ready for this eventuality.

How SP & SC helps

Navigating ESOP taxation, especially with special provisions like deferral, requires careful planning and compliance. SP & SC Legal and Taxation Services provides end-to-end assistance for both startups and their employees. We help startups structure compliant ESOP schemes, ensure correct TDS compliance, and advise employees on managing their tax liabilities effectively. Our team can review your ESOP documents, calculate tax implications, and help you plan for maximum benefit. For more detailed, personalised advice, explore our tax consultation services.

Frequently asked questions

H3: What if the startup loses its 'eligible' status after I receive the shares?

The benefit of deferral is determined at the time of exercising the options. If the startup was eligible under Section 80-IAC when the shares were allotted to you, the deferred tax treatment should continue to apply as per the conditions laid down.

H3: Does this tax deferral apply to consultants or only employees?

Section 192 specifically deals with TDS on 'Salary'. As perquisites under Section 17(2) are part of salary, this benefit is available only to individuals who are employees of the eligible startup. It does not apply to consultants or independent contractors.

H3: Is this benefit available under the old tax regime?

Yes. The provisions of Section 192(1C) are independent of the tax regime chosen by the employee. An employee of an eligible startup can avail this benefit whether they are in the old or new tax regime.

H3: What happens if the share value drops after I exercise?

The perquisite tax is calculated based on the FMV on the date of exercise. A subsequent drop in the share's value does not reduce the deferred tax liability. This is a risk employees must be aware of; you could end up owing a significant amount of tax on a perquisite value that is higher than the current market value of the shares.

H3: Can I choose not to take the deferral?

The deferral is an obligation placed on the employer ('shall deduct...'). However, in practice, an employee who wishes to pay the tax immediately to avoid a large future liability could coordinate with their employer. The default process for an eligible startup, however, is to defer the tax.

Get a fixed-fee quote

Understanding your ESOPs and their tax impact is crucial for wealth creation. If you are a startup founder designing an ESOP plan or an employee trying to understand your tax obligations, let us help. Share your documents with us for a confidential review, and we will provide a written fixed-fee quote for our services. We handle all aspects of tax planning and compliance end-to-end. You can Contact SP & SC or WhatsApp us at +91 90356 74566 to get started.