ESOPs from the Founder's Side: Tax, TDS and Company Law Duties

The ESOP pool usually gets decided in one line of a term sheet. Ten percent, maybe fifteen, "to be created before closing". Everybody signs, and the founder assumes the hard part is choosing who gets how many options.

It is not. The hard part is everything the company has to do afterwards, for years, on behalf of people who may have left long ago.

Most ESOP content in India is written for the employee: when am I taxed, what is my cost, how do I file. That is covered in our ESOP and RSU taxation guide. This piece is the other side of the table. What you, as the founder and the person who signs the company's returns, are actually taking on.

# Company law first: the scheme has to exist properly

For an unlisted company, the power comes from Section 62(1)(b) of the Companies Act, 2013, and the conditions sit in Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. Listed companies follow SEBI's Share Based Employee Benefits and Sweat Equity Regulations instead; this article is about the unlisted startup.

The requirements that trip founders up:

• Special resolution. The scheme must be approved by shareholders by special resolution, with an explanatory statement that carries the prescribed disclosures — total options, who is eligible, vesting requirements, how the exercise price is set, lock-in, and so on. A special resolution also means an MGT-14 filing with the ROC.
• Minimum one year between grant and vesting. You cannot grant on Monday and vest on Friday, however much the new CTO wants it. The only carve-out is for options granted in substitution of options held in a merged or amalgamated entity.
• Options are not transferable. They cannot be pledged or assigned either. An employee cannot "sell" unvested options to a friend.
• Register in Form SH-6, kept at the registered office, and disclosures in the Board's report every year — options granted, vested, exercised, lapsed, money realised, and employee-wise details for key managerial personnel and anyone who received 5% or more of the options granted in a year.
• Allotment on exercise is an allotment like any other, so the return of allotment follows.

# The promoter question

Rule 12 defines who counts as an "employee" for ESOP purposes, and it excludes promoters, the promoter group, and directors who hold more than 10% of the equity, directly or indirectly.

The relaxation: for a startup company, that exclusion does not apply for ten years from incorporation or registration. So a founder-promoter of a qualifying startup can receive ESOPs during that window.

There is also a SEBI angle if you plan to list. In 2025 SEBI approved an amendment allowing founders classified as promoters at the IPO stage to keep options granted to them earlier, subject to conditions including a one-year gap before the board's IPO decision. That helps IPO-bound founders. It does not change Rule 12 for a private company today.

# Valuation: the number that drives everyone's tax

When an employee exercises, the perquisite is the fair market value of the share on the date of exercise, minus what the employee pays. Under the Income-tax Act, 2025 this sits in Section 17(1)(d) (old Section 17(2)(vi)).

For an unlisted company, the fair market value is the value determined by a Category I merchant banker registered with SEBI, as on a valuation date not more than 180 days before the date of exercise. That was Rule 3(8) and 3(9) of the Income-tax Rules, 1962. The Income-tax Rules, 2026 were notified on 20 March 2026; I have not verified which rule number now carries this provision, so treat it as the corresponding provision of the new Rules.

Three practical consequences:

1. The valuation is a recurring cost, not a one-time one. If exercises happen across the year, a stale report does not work once it is more than 180 days old.
2. It is a different valuation from the one for share issue pricing. Founders often assume the Rule 11UA-type report used for a funding round will do. The ESOP perquisite rule asks for a specific valuer and a specific date window. Use the right report for the right purpose.
3. A high valuation hurts your employees, not you. A funding round at a big number pushes up the FMV used for perquisite tax on the next exercise. Plan exercise windows with that in mind.

# TDS: the company is the one that deducts

The perquisite is salary. So the tax on it is deducted by the employer under Section 392 of the Income-tax Act, 2025 (old Section 192), in the period the shares are allotted.

Here is what that looks like with numbers. Assume an employee exercises 2,000 options at an exercise price of ₹10, and the merchant banker's FMV is ₹450.

The employee paid ₹20,000 for shares that cannot be sold, and now the company has to deduct over ₹2.7 lakh from salary. In many cases the monthly salary simply cannot absorb it. Somebody has to fund that tax — the employee in cash, or through some arrangement you design in advance. If the company ends up bearing it, that has its own tax consequences; do not decide this at the payroll cut-off.

The perquisite then appears in the employee's salary certificate. From Tax Year 2026-27 (FY 2026-27 — the return you file in 2027, earlier called AY 2027-28), Form 16 is replaced by Form 130 under the Income-tax Rules, 2026, and the quarterly salary TDS return is Form 138 in place of Form 24Q. Our Form 130 vs Form 16 guide has the detail.

# The eligible start-up deferral — and what it really requires

The deferral exists to solve exactly the problem in the table above. For an eligible start-up, tax on the ESOP perquisite need not be deducted at exercise.

Under Section 392(3) of the Income-tax Act, 2025 (old Section 192(1C)), an eligible start-up deducts or pays the tax on the basis of the rates in force for the tax year in which the shares were allotted, within the time given by Section 289(3). That section says the tax is payable within fourteen days after the earliest of:

• the expiry of sixty months from the end of the relevant tax year;
• the date the employee sells the shares; or
• the date the employee ceases to be an employee of the employer that allotted them.

# Is 60 months an extension?

Some articles this year describe the deferral as "extended from 48 to 60 months". Read the two texts side by side. The old Act counted 48 months from the end of the relevant assessment year. The new Act counts 60 months from the end of the relevant tax year. An assessment year ended one year after the financial year it related to. So both formulas land on the same 31 March.

For shares allotted in Tax Year 2026-27, the tax year ends on 31 March 2027. Sixty months from then is 31 March 2032, and the fourteen days run to 14 April 2032 — assuming no sale and no exit before that.

# Who is an eligible start-up

This is not every DPIIT-recognised startup. Section 392(3) refers to the eligible start-up in Section 140 of the Income-tax Act, 2025 (old Section 80-IAC). That means:

• a company or LLP,
• incorporated on or after 1 April 2016 but before 1 April 2030,
• with total turnover not exceeding ₹100 crore for the relevant year, and
• holding a certificate of eligible business from the Inter-Ministerial Board of Certification.

Note the ₹100 crore figure in the tax provision. DPIIT's own recognition threshold moved to ₹200 crore in February 2026, but the tax section still says ₹100 crore. A company can be a recognised startup and still fall outside this definition. Recognition alone does not get your employees the deferral — the IMB certificate is what counts.

# What to set up on day one

• A register of every exercise under the deferral: date of allotment, perquisite value, rate applicable for that tax year.
• An exit checklist item: "deferred ESOP tax — compute and recover before F&F".
• A notice clause in the ESOP plan requiring employees to inform the company before selling shares in any secondary transaction.

# Accounting: an expense that never shows up in cash

Granting options is a cost to the company even though no cash leaves. How it is measured depends on which framework you follow.

• Ind AS companies apply Ind AS 102, Share-based Payment. Equity-settled options are measured at grant-date fair value and expensed over the vesting period.
• Companies following Accounting Standards apply the ICAI Guidance Note on Accounting for Share-based Payments issued in 2020, which replaced the 2005 version and requires fair-value measurement.

The part founders rarely anticipate is the shape of the expense when vesting is graded. Assume 4,000 options with a grant-date fair value of ₹300 each, vesting 25% at the end of each of the next four years. Treat each tranche as a separate award, and assume nobody leaves:

A straight-line spread would have been ₹3,00,000 a year. Under a tranche-by-tranche approach, more than half the total cost lands in the first year. If your investors track EBITDA closely, show them this before the grant, not after the audit.

# Does the company get a tax deduction?

This is where I would be careful. The Karnataka High Court in CIT v. Biocon Ltd (2020), affirming a Special Bench of the Bangalore Tribunal, held that the discount on ESOPs is an allowable business expenditure, spread over the vesting period and adjusted when options lapse or are exercised. The Delhi High Court has taken a similar view, and commentators report that the Revenue's appeal in at least one such case has gone to the Supreme Court.

So the claim is supportable, but it is not settled beyond argument. If you claim it, document the computation tranche by tranche, reverse it properly for forfeitures, and expect to defend it.

# Liquidity events: where the triggers go off

Three events come up in almost every startup's life.

Secondary sale to an investor. If an employee sells shares that were allotted under the deferral, the sale itself is a trigger. The company's fourteen days start running from the sale date — even though the company is not a party to the sale. This is why the notice clause above matters.

Company buyback. From 1 October 2024 the amount a shareholder receives on a buyback is taxed as dividend in the shareholder's hands, not as capital gains, which changes the economics for employees tendering shares. Our share buyback taxation guide walks through it. The company should also plan for its own withholding and Companies Act buyback compliances.

Acquisition. Vested options may be cashed out, rolled into the acquirer's plan, or accelerated. Each route has a different tax outcome for the employee and a different deduction or reporting consequence for the company. The ESOP plan document should say what happens — decide it when drafting, not while the share purchase agreement is being negotiated.

# A founder's checklist

Before the pool is created:

1. Special resolution with the full explanatory statement; MGT-14 filed.
2. Plan document covering vesting (minimum one year), exercise window, what happens on exit, on a sale, and on an acquisition.
3. Decide whether any promoter will receive options, and confirm that the startup relaxation actually applies to your company today.

Every time someone exercises:

1. A merchant banker valuation dated not more than 180 days before the exercise date.
2. Perquisite computed, and TDS deducted — or, for an eligible start-up, the deferral register updated.
3. Allotment compliance done; SH-6 register updated.

Every year:

1. Share-based payment expense booked under Ind AS 102 or the ICAI Guidance Note.
2. Board's report disclosures.
3. Deferral register checked against exits and secondary sales in the year.
4. A view taken, with documentation, on claiming the ESOP expense for tax.

If you have not yet worked out whether your company qualifies as an eligible start-up, that question comes first. Everything about the employee's cash flow depends on it.

Get founder-grade answers before the grant letters go out. VittSphere ONE's ARTHA chat answers ESOP, TDS and startup tax questions in plain English or Hinglish with the section cited, and every feature is free until 31 March 2027. Start free →

# Related reading

1. ESOP and RSU taxation in India — the employee's side
2. India's startup definition changed in February 2026
3. Form 130 vs Form 16 — the new salary TDS certificate
4. Share buyback taxation after October 2024
5. ROC annual compliance calendar

# References (verified 23 September 2026)

• Income Tax Department — Section 392, Income-tax Act, 2025: https://www.incometaxindia.gov.in/w/section-392-6
• Indian Kanoon — Section 289, Income-tax Act, 2025: https://indiankanoon.org/doc/156679841/
• Income Tax Department — Section 140, Income-tax Act, 2025: https://www.incometaxindia.gov.in/w/section-140-87
• Income Tax Department — Section 192, Income-tax Act, 1961: https://www.incometaxindia.gov.in/w/section-192-65
• Income Tax Department — Taxation of Employee Stock Option Plan (ESOP): https://www.incometaxindia.gov.in/w/taxation-of-employee-stock-option-plan-esop-
• Indian Kanoon — Rule 12(1), Companies (Share Capital and Debentures) Rules, 2014: https://indiankanoon.org/doc/177317418/
• CAIRR — Rule 12, Companies (Share Capital and Debentures) Rules, 2014 (full text reproduction): https://ca2013.com/rule-12-companies-share-capital-and-debentures-rules-2014/
• Vinod Kothari Consultants — ESOPs for founders, SEBI amendment (June 2025): https://vinodkothari.com/2025/06/esops-for-founders-well-intended-relief-garbled-by-language/
• TaxGuru — CBDT notifies Income-tax Rules, 2026 (G.S.R. 198(E), 20 March 2026): https://taxguru.in/income-tax/cbdt-notifies-income-tax-rules-2026-income-tax-forms.html
• SCC Online — Form 16 and Form 130 comparison: https://www.scconline.com/blog/post/2026/06/15/overview-comparison-of-form-16-and-form-130-tds-certificate/
• StudyCafe — ICAI Guidance Note on Accounting for Share-based Payments: https://studycafe.in/icai-release-guidance-note-on-accounting-for-share-based-payments-92536.html
• Cyril Amarchand Mangaldas Tax Blog — Karnataka HC on ESOP discount deductibility (Biocon): https://tax.cyrilamarchandblogs.com/2020/12/karnataka-hc-affirms-discount-on-issue-of-esops-is-a-tax-deductible-business-expenditure/

Disclaimer: This article is educational and general in nature and is not legal, tax or accounting advice for any specific company. ESOP schemes depend on the company's articles, investor agreements, the exact text of the Companies Act rules and the Income-tax Act, 2025 as amended, and the company's accounting framework; the worked figures above are illustrative and do not represent any client's data. Have your plan, valuation and payroll treatment reviewed by a qualified Chartered Accountant and Company Secretary before acting. VittSphere ONE does not provide valuation, legal or secretarial services. Data verified 23 September 2026.

Written by

Prabhakar Kumar

Chartered Accountant (ICAI, Nov 2019)

Chartered Accountant (FCA, ICAI) and founder of VittSphere Technologies. Writes on Indian taxation, capital gains, GST and personal finance.