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An Indian employee usually faces two separate tax events: first, salary-perquisite tax when an ESOP is exercised and shares are allotted; second, tax when the company later buys those shares back. For a company buy-back completed on or after 1 April 2026, the consideration is generally computed under the capital-gains provisions of the Income-tax Act, 2025 as amended by the Finance Act, 2026, with the acquisition cost taken into account. Buy-backs completed from 1 October 2024 through 31 March 2026 followed the then-applicable dividend-income and capital-loss treatment. The exact result depends on the completion date, whether shares were actually allotted, your records and residency, and whether a promoter-specific rule applies.
The short answer: exercise and buy-back are different tax events
Exercising an employee stock option does not normally make the later company buy-back tax-free. The Income Tax Department treats the discount on exercise as a taxable salary perquisite. The taxable amount is the fair market value (FMV) of the shares on the exercise date minus the amount you paid or that was recovered from you. This rule is explained in the department’s 2026 ESOP guidance.
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When the company subsequently purchases those allotted shares, that is a second transaction. You must determine the buy-back’s completion date and apply the law in force for that period. The tax paid as a salary perquisite on exercise and the later buy-back computation are related through your records, but they are not the same income event.
First establish which law applies
Use the date on which the company actually bought or extinguished the shares, not simply the date on which a buy-back offer was announced or opened. The statutory treatment changed during the period covered by the current rules.
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| When the company completed the buy-back | Shareholder-level treatment described by official material | What to verify |
|---|---|---|
| 1 October 2024 to 31 March 2026 | Consideration treated as dividend income at the shareholder’s applicable rate; no deduction against that dividend. The acquisition cost of the extinguished shares is separately recognized as a capital loss. | Confirm the completion date, the number of shares extinguished and the acquisition-cost records. This period is described in the Income Tax Department’s Budget 2026 FAQ. |
| On or after 1 April 2026 | Buy-back consideration is charged under capital gains and acquisition cost is used in the computation. Special rules can apply to a statutory promoter. | Read the applicable provisions and rate table in the Income-tax Act, 2025 as amended by the Finance Act, 2026. |
The older law before 1 October 2024 is not interchangeable with either row. If your company completed an earlier transaction, identify the relevant assessment year and consult the law applicable then rather than carrying forward one of these treatments.
What happens when you exercise an ESOP
Listed-company shares
For listed shares, the exercise-date FMV is determined under the applicable income-tax valuation rules. Your employer generally reports the resulting perquisite through payroll and includes it in Form 16, subject to the facts of your plan and the applicable year.
Unlisted-company shares
For unlisted shares, the department’s guidance requires valuation by a merchant banker under the relevant rule. The valuation date, report and prescribed method matter. Keep the merchant-banker valuation or the employer’s supporting document with your exercise confirmation; an internal estimate is not a substitute when the rule requires a prescribed valuation.
Illustrative exercise calculation
Suppose you exercise 1,000 options when the required FMV is ₹240 per share and pay ₹40 per share. The illustrative perquisite is (₹240 − ₹40) × 1,000 = ₹2,00,000. That ₹2,00,000 is salary income for the exercise event. It is not the tax on a later buy-back, and it does not automatically equal the amount you will receive from the company.
Some eligible start-ups can defer payment of tax on the ESOP perquisite until the earliest of specified statutory events, including sale of the shares, cessation of employment or expiry of the prescribed period. Eligibility, the exact trigger and the current statutory wording must be checked before relying on deferral; it is not a general exemption.
How the buy-back is taxed from 1 April 2026
For a buy-back completed on or after 1 April 2026, the amended Income-tax Act, 2025 provides capital-gains treatment. In broad terms, the consideration received for the shares is compared with the acquisition cost under the applicable computation provisions. The resulting gain or loss is then classified and reported according to the holding period, asset classification and other rules in force for your assessment year.
The law also has special effective-tax rules for a holder who meets the statutory definition of “promoter.” That definition can include a promoter and, in specified circumstances, a person holding more than 10% of the company. Do not assume that every employee is outside the definition or that every employee is inside it. Check the actual definition, your voting or ownership percentage and the rate table for the relevant year.
The official Budget 2026 FAQ records the policy statement: “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’.” For a transaction completed after the amendment took effect, use the enacted, consolidated Act rather than relying on the earlier proposal wording.
How buy-backs completed from 1 October 2024 to 31 March 2026 were treated
For this earlier window, the Budget 2026 FAQ describes the shareholder treatment as dividend income on the consideration received. The dividend is taxed at your applicable rate, and no deduction is allowed against that dividend itself. Separately, the acquisition cost of the shares that were extinguished is recognized as a capital loss under section 69, subject to the normal rules on classification, set-off and carry-forward for that assessment year.
This can produce an apparently counter-intuitive result: the dividend amount is not reduced by your share cost, while the cost appears in a separate capital-loss computation. Do not net the two figures together in the dividend schedule, and do not report the dividend treatment for a buy-back completed on or after 1 April 2026.
When an ESOP share is eligible for buy-back
Section 68 of the Companies Act, 2013 permits a company to buy back securities, including securities issued to employees under stock-option or sweat-equity schemes. The department’s section 68 text is available at Power of company to purchase its own securities. This supports applying buy-back analysis when you exercised, received shares and the company purchased those shares.
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Outbyte PC Repair FREERepair Windows errors before they cause bigger problemsFix Now →Outbyte Driver Updater FREEScan for outdated or missing drivers - takes under a minuteDriver Scan →It does not decide the tax treatment of a cash payment for vested options that were never exercised. An unexercised option is a contractual right, not an allotted share. The official material considered here does not settle whether a particular cash-out, cancellation or net settlement should be treated as a share buy-back. The plan rules, transaction documents and legal structure must be examined before choosing a tax schedule.
Holding period and acquisition cost for ESOP shares
For ESOP shares, official capital-gains guidance measures the holding period from the date of allotment or transfer, not from the grant date or vesting date. The department’s general explanation is at Tax on Sale of Shares in India | Capital Gains. Record the allotment or transfer date for each tranche, because an employee may exercise options in several lots.
For the acquisition-cost figure, preserve the exercise price and the number of shares allotted. Your exercise-date FMV is used to calculate the salary perquisite; the buy-back computation then follows the acquisition-cost rule applicable to the relevant statutory period and transaction type. Because the Act’s treatment changed, do not assume that the amount shown in payroll is automatically the only figure needed for the buy-back schedule.
Illustrative post-2026 calculation
Assume 1,000 shares were allotted on exercise at ₹40 each, and the company completed a buy-back on 20 May 2026 for ₹300 per share. The gross consideration is ₹3,00,000. The capital-gains computation must use the acquisition-cost and other statutory adjustments prescribed for the applicable assessment year. The earlier ₹2,00,000 salary perquisite (if the exercise FMV was ₹240) remains a separate salary event; it is not deducted again merely because it was used to value the exercise benefit.
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Unexercised, vested options: why the answer is not automatic
A vested option can be handled in several ways: you may exercise and receive shares before a buy-back; the company may cancel the option for cash; or a transaction may provide a net settlement without any share allotment. These structures are legally different.
- Exercise followed by share purchase: analyze the salary perquisite on exercise and the subsequent buy-back under the date-based rules above.
- Cash cancellation before exercise: there is no allotted share on the facts described. The reviewed official guidance does not provide a settled, universal buy-back answer for this payment. Read the plan, board and offer documents and obtain advice for the specific structure.
- Net settlement or automatic exercise: verify whether shares were legally allotted, the allotment date and whether the company acquired securities or only settled an option obligation.
Do not label every payment to an option holder a “buy-back” without checking the documents.
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.A practical record-checking procedure
Use this sequence before preparing your return or asking payroll to correct a report:
- Identify the completion date. Find the date the company acquired or extinguished the shares. Keep the tender acceptance, settlement statement, registrar advice or board notice that proves it.
- Confirm allotment. For every lot, record whether you exercised, the allotment or transfer date, the number of shares and the exercise price.
- Reconcile the exercise perquisite. Compare the exercise-date FMV and amount paid with payroll records, Form 16 and any tax withheld. For unlisted shares, obtain the required valuation report.
- Classify the company transaction. Determine whether it was a statutory purchase of shares, a cancellation of options, a merger-related cash-out or another arrangement.
- Apply the date-specific rule. Use the dividend-plus-capital-loss framework only for the 1 October 2024–31 March 2026 window. Use capital gains for transactions from 1 April 2026, subject to promoter provisions and the current Act.
- Check promoter status. Review direct and indirect holdings, voting rights and the statutory 10% test where relevant. Obtain the applicable rate from the Act for the assessment year; do not use a generic buy-back percentage.
- Prepare the return schedules. Report salary perquisite, dividend or capital gains/loss in the schedules that correspond to the year and transaction. A loss may be subject to set-off and carry-forward restrictions, so preserve the computation and filing acknowledgement.
Documents to keep
- ESOP grant, vesting and exercise notices.
- Exercise confirmation showing price, quantity and allotment date.
- Exercise-date FMV evidence, including a merchant-banker report where required.
- Payroll statements, Form 16 and tax-withholding details for the perquisite.
- Buy-back offer, acceptance and settlement statements showing the actual completion date and consideration.
- Demat statements or the company’s register extract proving allotment and extinguishment.
- Shareholding records needed to test any promoter definition.
- Working papers that separate the salary event from the buy-back event.
Common mistakes and how to avoid them
Using the announcement date
An announcement or tender-opening date may precede settlement. Tax the transaction under the law applicable when the company actually bought or extinguished the shares.
Treating vesting as allotment
Vesting gives a contractual right. The ESOP holding period starts at allotment or transfer, so grant and vesting dates cannot replace the allotment date.
Deducting acquisition cost from dividend
For the 1 October 2024–31 March 2026 regime, the dividend itself had no deduction. The acquisition cost was a separate capital-loss item.
Assuming one rate applies to everyone
Rates depend on the assessment year, taxpayer status, holding period and, under the post-1 April 2026 law, possible promoter treatment. Use the statutory rate table for your facts.
Ignoring residency and payroll mismatches
Residency can affect the tax computation and reporting. Reconcile employer withholding with your return and obtain professional advice if the company’s statement, Form 16 and settlement document do not agree.
When professional advice is warranted
Get advice from a qualified Indian tax professional when the company paid you before allotting shares, the transaction involved a merger or overseas entity, you crossed a promoter-related ownership threshold, shares came from several exercise dates, or the buy-back spans a financial-year boundary. Provide the adviser with the completion date and documents, not just the offer announcement and a net cash figure.
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