The Income Tax Appellate Tribunal (ITAT) has ruled that gains arising from the repurchase of vested, unexercised employee stock options (ESOPs) are taxable under the long-term capital gains (LTCG) bracket rather than salary perquisites. 

Gains taxed under the LTCG regime generally attract a lower tax rate than income taxed as salary perquisites, potentially reducing the tax liability for employees. In India, LTCG are generally taxed at a flat rate of 12.5% without indexation for most assets.

The Bengaluru bench of the appellate tribunal held that stock options remain a right to subscribe to shares at a future date, and hence cannot be treated by itself as “specified securities” for the purposes of Section 17(2)(vi) of the Income Tax Act, 1961. 

“We are of the considered view that till a ‘specified security’ comes into existence upon exercise of the stock option by the employee, no value can be assigned to it. Accordingly, in such a scenario, the question of taxability under the head ‘salaries’ does not arise,” the ITAT stated in its order. 

It further noted that repurchase of unexercised options constitutes a transfer of capital assets, making any resulting gains eligible for taxation under Section 45 of the Act. 

The ruling, which came in last week, was related to a case involving a Flipkart senior executive. As per their income tax return, the executive reported a gross salary of ₹1.90 Cr along with LTCG of ₹2.45 Cr, including ₹2.33 Cr received after Flipkart repurchased 2,653 vested stock options.

However, the assessing officer sought to reclassify the proceeds of the buyback as a salary perquisite under Section 17(2) of the Income Tax Act, subjecting it to higher income tax rates applicable to salary slabs. 

Following an unsuccessful appeal with the Commissioner of Income Tax (Appeals), the executive had approached the ITAT for relief. 

What Does The Ruling Entail?

The ruling, while impactful, applies only to a narrow range of situations where ESOPs have not been exercised but have been vested and cancelled for a payment, said boutique tax consulting organisation Tax Compaas’ CEO Ajay Rotti.

“I have mainly seen this happen in the past where a startup is acquired by a large company and the acquirer does not want to continue the ESOPs, or wants to replace them with their own options. In a small percentage of cases, the company may say I will cancel these options and I’ll give you money,” said Rotti. 

In situations where ESOPs are exercised, the difference between the strike price of the option and the fair market value would continue to be taxed as salary, he added. 

Shardul Amarchand Mangaldas & Co’ partner (tax practice) Gouri Puri believes that the ruling could create a distortion in the tax treatment of two economically equivalent transactions . 

She compared two situations where an employee granted ESOPs by their company had two options of exercising their options and selling the shares versus cancelling the options and receiving a payment in compensation. While the proceeds in the former scenario would be treated as a salary perquisite, in the latter scenario, they would attract taxation at the lower LTCG rate. 

However, Rotti noted that, doing so, was effectively giving up the commercial upside of ESOPs in order to bring down one’s tax burden. “As an employee, if I know that the company is going to do well and the share prices are going to go up, I will say I don’t care about the additional tax. I would want to hold the shares for more time,” he said. 

However, the ruling raises another question, according to Meyyappan Nagappan, partner at Trilegal. 

While companies typically report share buybacks as employee related expenses for tax purposes, the ruling implies that it should instead be treated as an acquisition of a capital asset. 

“There might be a mismatch in how the company treats its expenses versus how the employee is taxed. The categorisation treatment has an implication on the various disclosures,” he added. 

In the bigger picture, while ESOPs are often a key means for startups and new-age companies to acquire and retain talent, how the ruling fits into the existing tax framework remains unclear. 

Notably, the Delhi, Karnataka, and Madras High Courts have all delivered conflicting rulings in other cases on similar questions of whether payouts for unexercised ESOPs should be taxed as perquisite. 

The recurrence of such cases only seems likely to increase as ESOP schemes are becoming all the more common. In 2025, over 9,200 startup employees unlocked a cumulative ₹1,409 Cr in liquidity through ESOP buybacks. 

Ultimately, these questions could remain a matter of contention unless policymakers or administrative authorities explicitly clear the air in the future. 

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