Will Budget 2025 Finally Bring Startup ESOP Tax Relief?

Will Budget 2025 Finally Bring Startup ESOP Tax Relief?

SUMMARY

While the ESOPs are beneficial for the employees, the benefits are yet to come on par with the conventional capital gains from the market

When employees of startups or unlisted companies receive shares via ESOPs, they have to pay taxes on two occasions: once when they exercise the option (i.e buy the shares) and when they sell them

The key demand from industry is that tax on ESOPs should be deferred until employees sell their shares, rather than being levied at the time of exercise

In November 2024, foodtech major Swiggy went public with an INR 11,327 Cr IPO. This was one of the largest IPOs in the startup ecosystem of India recently, with many of the Swiggy employees getting a chance to make generational wealth by selling their shares they received via employee stock option plan or ESOPs. 

ESOPs have become a key talent retention and wealth creation strategy for many startups in India, especially as the ecosystem has matured and the surge in the number of public listings. 

However, while the ESOPs are beneficial for the employees, the benefits are yet to come on par with the conventional capital gains from the market. 

How ESOP Taxation Currently Works

Essentially, when employees of startups or unlisted companies receive shares via ESOPs, they have to pay taxes on two occasions: once when they exercise the option (i.e buy the shares) and when they sell them. There is no tax on granting of ESOPs or their vesting period. 

For most employees, the tax is triggered as soon as they are allotted the shares. The taxable income is calculated as the difference between the fair market value (FMV) of each share on the exercise date and the price employees paid to buy each share. This amount is considered as income and taxed according to their regular income tax slab.

However, employees of eligible startups recognised by the Department for Promotion of Industry and Internal Trade (DPIIT) do get a tax deferral benefit. 

This DPIIT exemption is for eligible startups — not older than 10 years old, incorporated as a private limited or partnership and annual turnover of less than Rs 100 Cr.

These employees don’t have to pay tax immediately but can delay it until the earliest of these three events:

  1. Five years after the financial year in which they exercised their ESOPs
  2. When they sell the shares
  3. When they leave the company

However, no such benefit is available for non-startup companies or startups that don’t come into the eligibility criteria. 

As of January 2025, there are about 1.5 Lakh DPIIT recognised startups in India, and there are more than 26 Lakh registered companies in India as of the financial year ending March 2024 (FY24). 

This means that employees of about 5.8% companies or less in India, only receive tax deferral benefits as of now. 

Further, when the employees sell their ESOP shares, they may make a profit (capital gain) or a loss. The taxable capital gain is the selling price minus the FMV that was already taxed when they exercised their ESOPs.

If they sell the shares within 24 months of exercising them, it is treated as a short-term capital gain, and they pay tax based on their income tax slab. 

However, if they hold the shares for more than 24 months, it is a long-term capital gain, taxed at 12.5% plus applicable surcharges.

ESOP Changes Proposed By Startup Ecosystem Stakeholders 

For years, the startup ecosystem has advocated for a more employee-friendly ESOP taxation framework. The key demand is that tax on ESOPs should be deferred until employees sell their shares, rather than being levied at the time of exercise. 

A similar provision already exists for capital assets converted into stock-in-trade, where capital gains tax is only payable upon sale.

Additionally, ESOP gains are currently taxed as salary income, often pushing employees into higher tax brackets. In contrast, capital gains from stock sales enjoy lower tax rates. Industry leaders have argued that ESOP taxation should align with capital gains taxation to ensure fair treatment.

“In the upcoming budget, I anticipate tax reforms to tackle these hurdles – simplifying ESOP taxation, streamlining capital gains tax structure across asset classes or introducing tax exemptions for angel investors and aligning them with global standards to encourage greater inflows of private capital into the startup ecosystem,” said Ashwani Singh, Managing Director of 35 North Ventures.

Another critical demand is revising the turnover threshold for startups eligible for tax benefits. Currently, only startups with an annual turnover of less than INR 100 Cr qualify for a tax holiday. 

Raising this limit would allow more startups to access tax relief, fostering a more supportive environment for innovation and talent retention.

Param Patel, general partner of Volt VC, believes that expanding tax deferment benefits to all DPIIT-registered startups would make ESOPs a more effective incentive. 

Patel further said that “when employees sell their ESOP shares, taxes should apply only to the capital gains—calculated as the sale price minus the previously taxed FMV at the time of exercise—rather than being subjected to double taxation.” 

Globally, countries like Denmark, Japan and the US have similar adjustments to provide employees relief by taxing only capital gains when stock is sold. 

“Startup ecosystem in the last few years has contributed towards India’s growing economic boom, yet ESOPs are still not considered a part of public market investments,” said Mayank Kumar, cofounder of UpGrad.

“Incentivising ESOPs with simpler and appropriate tax structures like shares would make it an attractive wealth creation opportunity and would also help startups attract and retain their talent,” he further explained. 

After taking Angel Tax off the table last year, will Nirmala Sitharaman bring more ‘tax relief’ for Indian startups with simpler ESOP taxation at the Union Budget tomorrow?

[Edited by Nikhil Subramaniam]