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In India, an ESOP exercise and a company buy-back are separate tax events. When you exercise and receive shares, the taxable salary perquisite is generally the shares’ fair market value (FMV) on the exercise date minus what you paid or the company recovered from you. If the company later buys back those allotted shares, that payment is taxed under the buy-back rules in force on the date the company actually acquired the shares.
For buy-backs from 1 October 2024 to 31 March 2026, the shareholder framework treated the consideration as dividend income and the extinguished shares’ acquisition cost as a separate capital loss. For buy-backs on or after 1 April 2026, the Income-tax Act, 2025 as amended by the Finance Act, 2026 treats the consideration as capital gains and permits acquisition cost in the computation, subject to special rules for statutory promoters. A cash payment for vested but unexercised options is a different legal transaction and is not settled by the official guidance cited here.
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Start with the date and the transaction type
Do not use the date on which a buy-back was announced, an offer letter was circulated, or a tender form was signed as a substitute for the tax date. Establish the date on which the company actually bought or extinguished your shares. Then confirm whether you had exercised the option and received shares before that payment. The answer can change completely if the company bought issued shares rather than cancelling option rights.
The governing documents also matter: your grant and exercise records, the board or offer documents, the company’s buy-back notice, and the contract describing any cash settlement. A company purchase of allotted securities is a buy-back question. A payment for an option that was never exercised may be compensation or another contractual settlement; the material cited here does not establish a universal tax treatment for it.
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Tax event one: exercising the ESOP
How the salary perquisite is calculated
The Income Tax Department’s ESOP guidance states that the taxable perquisite for an employee stock option or sweat-equity share is the fair market value on the option exercise date, less the amount paid or recovered from the employee. The employer normally reports that employment income through payroll and the employee’s Form 16. Read the department’s current guidance for the valuation and reporting rules: Taxation of Employee Stock Option Plan (ESOP).
For unlisted shares, the guidance requires valuation by a merchant banker under the relevant rule. The valuation date and the prescribed method are therefore not optional details. Ask the employer for the FMV certificate or valuation basis used for the exercise date, especially when the company’s preferred-share financing, a recent funding round, or a tender offer makes the value difficult to infer from a quoted market price.
Illustrative exercise calculation
Suppose an employee exercises 100 options. If the exercise-date FMV is ₹500 per share and the employee pays ₹100 per share, the perquisite is ₹40,000: (₹500 − ₹100) × 100. This is an illustration of the statutory formula, not a statement about the FMV or tax rate in any particular company. The later buy-back does not erase this salary event, even if the company subsequently buys the shares for less than the exercise-date FMV.
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Possible start-up deferral
Eligible start-up employees may be able to defer payment of tax on the perquisite, but deferral is conditional and does not remove the underlying income. The department’s guidance identifies the earliest of specified statutory events, including sale of the shares, ceasing to be an employee, and expiry of the prescribed period. Confirm that the employer qualifies, that the grant meets the conditions, and which version of the law applies before relying on deferral.
Tax event two: the company buys back allotted shares
Why allotment is decisive
The Companies Act provision on buy-backs expressly allows a company to purchase securities issued to employees under stock-option or sweat-equity schemes. Section 68 is reproduced by the Income Tax Department at Power of company to purchase its own securities. That provision supports treating a repurchase of shares already issued to you as a company buy-back. It does not, by itself, decide how a company payment for an unexercised option should be taxed.
For capital-gains purposes, official share-sale guidance measures an ESOP holding period from the date of allotment or transfer, not from the grant date. Keep the allotment advice and demat or register entry showing that date. The department’s overview is available at Tax on Sale of Shares in India | Capital Gains.
Which buy-back regime applies?
The following timeline separates the two periods that are most often confused. The date is the company’s actual purchase or extinguishment date and the table describes the shareholder treatment identified in the official material.
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|---|---|---|---|
| 1 October 2024 through 31 March 2026 | Consideration treated as dividend income, taxable at the taxpayer’s applicable rate | No deduction against the dividend; the acquisition cost of the extinguished shares is separately recognized as a capital loss under section 69 | This was the transitional framework described in the 2026 Budget FAQ. It is not the treatment for a buy-back on or after 1 April 2026. |
| 1 April 2026 onward | Consideration chargeable under the head “Capital gains” | Acquisition cost is deducted in the capital-gains computation under the applicable rules | Special effective tax rules apply to holders who meet the statutory promoter definition; check the Act and rate table for the relevant year. |
The 1 October 2024–31 March 2026 period
The Income Tax Department’s Rationalisation of Other Direct Tax Provisions: Budget 2026 FAQs describes the then-existing shareholder treatment as dividend income on the buy-back consideration. The dividend itself did not permit a deduction for the share cost. Separately, the cost of the shares that were extinguished was recognized as a capital loss under section 69. That loss and the dividend are different tax components and should not be netted as if the buy-back were an ordinary sale.
The FAQ states: It is proposed that the consideration received by a shareholder on buy-back of shares by a company shall be chargeable to tax under the head ‘Capital gains’.
The wording described the proposed change at Budget 2026; for a completed transaction, apply the law that was enacted for its date rather than relying on the proposal’s wording alone.
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Buy-backs on or after 1 April 2026
The consolidated Income-tax Act, 2025, as amended by the Finance Act, 2026 provides capital-gains treatment for buy-back consideration. The applicable acquisition cost is used in the computation, so the economic result is determined through the statutory capital-gains calculation rather than by treating the entire receipt as dividend.
Do not apply one universal rate. The result can depend on the applicable tax year, the taxpayer’s residential status, the nature and period of the holding, and any rate table or special provision in force. The Act also contains special effective rules for a holder who is a statutory “promoter.” The definition can include a promoter and, in specified circumstances, a person holding more than 10% of the company. An employee should test the actual definition and threshold against the company’s shareholding records instead of assuming that an ESOP holder is or is not a promoter.
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How to analyse your own buy-back
- Identify the legal transaction. Read the company notice and settlement statement. Confirm whether the company bought shares or paid to cancel, release, or settle option rights.
- Fix the operative date. Use the date the company acquired or extinguished the shares. Record the offer announcement date separately; it does not automatically determine the tax period.
- Confirm exercise and allotment. Gather the exercise notice, payment proof, allotment letter, and demat or statutory-register entry. If no shares were allotted, flag the case as an option settlement rather than assuming buy-back treatment.
- Reconcile the perquisite. Compare the exercise-date FMV, exercise price, number of shares, and the amount shown in payroll and Form 16. For unlisted shares, obtain the merchant-banker valuation basis used by the employer.
- Determine the applicable regime. A date from 1 October 2024 to 31 March 2026 points to the dividend-plus-capital-loss framework; a date from 1 April 2026 points to capital gains under the amended Act. A different date requires checking the law for that earlier or later period.
- Establish the acquisition record. Preserve the legally relevant cost and allotment date used for the capital-gains computation. Do not assume that the amount paid for the option, the exercise-date FMV, and the cost recognized under the buy-back provision are interchangeable without checking the applicable rule.
- Check promoter status. Review direct and indirect holdings and the statutory definition, including the specified 10% test where relevant. This is a classification question, not a label supplied by the employer’s ESOP plan.
- Report each component in the right place. The exercise perquisite belongs to the employment-income reconciliation. The buy-back receipt and any dividend, capital loss, or capital gain belong to the buy-back period’s return computation. Retain the company’s tax statement and proof of withholding, if any.
Worked scenarios
Exercise followed by a 2026 buy-back
An employee exercises options, receives shares, and the employer reports a perquisite based on exercise-date FMV less the exercise amount. Months later, on 20 April 2026, the company buys those shares. The salary perquisite remains tied to the exercise date. The 20 April transaction falls in the post-1 April 2026 capital-gains regime, so the buy-back computation uses the applicable acquisition cost and the current statutory rules. A loss or gain on the buy-back does not retroactively change the payroll perquisite.
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Buy-back completed before 1 April 2026
If the company actually bought the allotted shares on 15 March 2026, the 1 October 2024–31 March 2026 framework is the relevant one even if the employee received paperwork or filed a return after 1 April. The consideration is analysed as dividend income, with no deduction against that dividend, while the share cost is considered separately as the statutory capital loss. Do not carry the post-April 2026 capital-gains treatment backward.
Vested options that were never exercised
An employee may have vested options but no allotment because the plan permits a cash-out, net settlement, or cancellation. The official material cited here does not settle whether every such payment is dividend, salary, capital gain, or another category. The contract, the company’s legal structure, and the payment documentation must be examined. Treating every vested-option payment as a share buy-back can produce the wrong tax head and the wrong reporting year.
Records to keep and common mistakes
- Using the grant date as the holding-period start: for ESOP shares, official guidance points to allotment or transfer. Keep that date, not only the grant letter.
- Calling the entire receipt a capital gain: that is not correct for the 1 October 2024–31 March 2026 period described in the Budget FAQ.
- Deducting share cost from the transitional dividend: the dividend component did not allow that deduction; the cost was dealt with separately as a capital loss.
- Ignoring the exercise perquisite: a later buy-back at a low price does not cancel salary income already triggered on exercise.
- Assuming “promoter” is only a founder: test the statutory definition and specified holding threshold, including indirect holdings where the law requires.
- Relying on the announcement date: obtain the company’s completion or settlement date and the number of shares actually acquired.
- Assuming a payroll entry proves the legal cost: reconcile payroll, Form 16, allotment records, and the buy-back statement; they serve different purposes.
When specialist advice is warranted
Obtain advice from a qualified Indian tax professional when the company is unlisted, the buy-back spans a financial year boundary, the payment is for unexercised options, you may meet the promoter definition, or your residency creates cross-border reporting questions. Give the adviser the grant and exercise terms, FMV valuation, allotment evidence, buy-back documents, payroll/Form 16 data, and the exact date of the company’s purchase. Those facts determine which statutory period and tax computation apply.
What to remember
Separate the two events: exercise can create salary income, while a later company purchase of allotted shares is taxed under the buy-back regime for the purchase date. The regime changed for transactions from 1 October 2024 and changed again from 1 April 2026. Establish allotment, transaction date, acquisition cost, and any promoter status before calculating or reporting the amount.
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