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Exercise and buy-back are two separate tax events. When you exercise an employee stock option (ESOP) and receive shares, the spread between the shares’ fair market value (FMV) on the exercise date and the amount you paid is generally taxed as a salary perquisite. If the company later buys those allotted shares back, that payment is taxed under the buy-back rules in force on the date the company actually acquired the shares—not the date an offer was announced.
For transactions from 1 October 2024 through 31 March 2026, the then-applicable framework treated buy-back consideration as dividend income and the extinguished shares’ acquisition cost as a capital loss. From 1 April 2026, the Income-tax Act, 2025, as amended by the Finance Act, 2026, treats buy-back consideration as capital gains, with acquisition cost allowed in the computation and special rules for statutory “promoters.”
Start with the date and the legal transaction
India has had three relevant stages: the regime before 1 October 2024, the shareholder-dividend regime from 1 October 2024 to 31 March 2026, and the capital-gains regime applying from 1 April 2026. The tax year and statutory text in force on the company’s purchase date control the result. A board announcement, tender-window opening date or payment date may not be the same as the date the company bought and cancelled the shares.
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| When the company bought the shares | How consideration was characterized | What happened to acquisition cost | Important qualification |
|---|---|---|---|
| Before 1 October 2024 | Different earlier rules applied, including a company-level buy-back-tax framework. | Must be checked under the law for that transaction date. | Do not apply the later shareholder treatment retrospectively. |
| 1 October 2024–31 March 2026 | Dividend income, taxed at the shareholder’s applicable rate. | Recognized separately as a capital loss for the extinguished shares under section 69; no deduction was allowed against the dividend itself. | This description comes from the 2026 Budget FAQ and is limited to the relevant statutory period and conditions. |
| From 1 April 2026 | Capital gains. | Acquisition cost is deducted in the capital-gains computation. | Special effective rules apply if the holder meets the statutory promoter definition. |
The governing text is the Income-tax Act, 2025, as amended by the Finance Act, 2026. Keep the company’s buy-back offer, acceptance and settlement records so the actual purchase date can be demonstrated.
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Event one: exercising the ESOP
How the salary perquisite is calculated
The Income Tax Department’s ESOP guidance states that the taxable perquisite is the FMV of the shares on the option exercise date minus the amount paid or recovered from the employee. The amount is employment income even though the shares may be illiquid and even though the employee might later sell them for less.
For an unlisted company, the FMV is determined by a merchant banker under the applicable valuation rule. The valuation report should identify the relevant exercise date and the number and class of shares. Listed-company valuation and other rule-specific details can differ, so use the method prescribed for the company’s security rather than substituting a later financing price or the eventual buy-back price. The department’s current explanation is in Taxation of Employee Stock Option Plan (ESOP).
What payroll should show
The employer normally includes the perquisite in salary reporting and may withhold tax through payroll. Compare the exercise notice, payment receipt, allotment statement, valuation material and Form 16. If the employer’s payroll figure does not match the exercise-date FMV less the amount paid, obtain a written reconciliation before filing the return; do not silently replace the employer’s figure with the later buy-back price.
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Deferral for eligible start-ups
Qualifying start-up employees may defer payment of tax on the ESOP perquisite until the earliest of the statutory trigger events described in the department’s guidance, including sale of the shares, cessation of employment and expiry of the specified statutory period. Deferral is not automatic for every young company or every option plan: confirm that the employer, employee and options satisfy the current eligibility conditions and that the deferred amount is reported correctly.
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Event two: the company buys back allotted shares
Buy-backs completed from 1 October 2024 to 31 March 2026
Under the period described in the Budget 2026 FAQs, consideration received by a shareholder on a company buy-back was treated as dividend income. The dividend was taxed at the shareholder’s applicable rate, and no expenditure or deduction was allowed against that dividend. Separately, the acquisition cost of the shares extinguished in the buy-back was recognized as a capital loss under section 69, subject to the normal rules governing use and carry-forward of capital losses.
“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’.”
Income Tax Department, Budget 2026 FAQs
The wording above described the proposed change at the time of the Budget FAQ. For a transaction completed on or after 1 April 2026, use the enacted amended Act rather than continuing to apply the dividend-and-loss treatment.
Buy-backs completed on or after 1 April 2026
The amended Act charges buy-back consideration under the head “Capital gains” and permits the acquisition cost in that computation. Your calculation therefore needs the cost basis of the shares that were actually bought back, the number of shares, the consideration and the applicable holding-period and rate provisions for the relevant tax year.
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There is no single buy-back tax rate for all employees. The applicable rate depends on the statutory year, the character and holding period of the asset, the taxpayer’s status and any special rule that applies. The Act also contains special effective treatment for a holder who meets the statutory definition of a promoter. That definition can include a promoter and, in specified circumstances, a person holding more than 10% of the company. Check the definition and rate table against the employee’s actual rights and percentage; do not label every ESOP holder a promoter or assume that a 10% test applies identically in every case.
How to establish the acquisition cost
For an exercised ESOP, the shares’ tax cost and the salary perquisite are connected but are not the same document. Preserve the exercise price paid, the exercise-date FMV used for the perquisite, the number and date of allotment, and any amount recovered by the employer. The buy-back computation then uses the acquisition-cost rule applicable to the transaction date and the amended Act.
The department’s capital-gains guidance says the holding period for ESOP shares starts from allotment or transfer. It does not start when the option vested, when you accepted the grant or when the company announced its buy-back. This start date can affect whether the gain or loss is short- or long-term under the rules for the relevant year.
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Repair common Windows errors and clear accumulated junk for a smoother, more stable PC - no reinstall needed.Free scan · no reinstallIf shares were acquired in several exercises, match the buy-back quantity to the corresponding allotments and costs. A company statement that reports only a total number of shares may be insufficient where exercises occurred at different times or prices; request a lot-wise statement or other evidence that supports the identification.
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Can a company buy back ESOP shares?
Yes. Section 68 of the Companies Act, 2013 permits a company to purchase its own securities, and the department’s text expressly includes securities issued to employees under stock-option or sweat-equity schemes. That supports treating a repurchase of shares already allotted to an employee as a company buy-back. The company-law permission does not determine the income-tax result, and it does not turn an unexercised option into a share.
Review the offer and settlement documents for the legal steps: exercise, allotment or transfer, acceptance into the buy-back, cancellation or extinguishment, and payment. The relevant company-law provision is available at section 68 of the Companies Act, 2013.
Vested but unexercised options are a different case
A payment for vested options where no shares were allotted is not resolved by the official materials cited above. It may be a cash settlement or cancellation of an option right rather than a company purchase of shares. The plan rules, the settlement agreement, accounting treatment and the company’s legal authority determine how it should be analyzed.
Do not report such a payment automatically as a share buy-back, and do not assume that the share acquisition-cost rules apply when there was no allotment. Ask the employer to identify whether it acquired securities, cancelled options, or paid compensation. Obtain advice based on the documents and the law in force on the payment date.
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A practical decision process
- Fix the controlling date. Record the date the company actually purchased or settled the interest. Keep the announcement, acceptance, settlement and bank-credit dates separately.
- Confirm what you held. Determine whether you exercised and received shares before the company paid. Note the allotment or transfer date and the exact number of shares.
- Reconstruct the exercise event. Record the exercise price, exercise-date FMV, perquisite reported in payroll, tax withheld and any start-up deferral claimed.
- Classify the company transaction. Check whether the documents describe a statutory share buy-back, a market sale, cancellation of options or another form of cash settlement.
- Apply the period-specific law. Use the dividend-plus-capital-loss framework only for qualifying buy-backs from 1 October 2024 through 31 March 2026. Use capital-gains treatment under the amended Act from 1 April 2026 onward.
- Test promoter status. Review the statutory definition, including any specified more-than-10% holding test, rather than relying on the job title “employee” or “founder.”
- Prepare the return. Reconcile the buy-back statement with Form 16, broker or demat records, the company’s tax certificate and your capital-gains schedules. Retain the calculation showing how each share lot was matched.
Documents to collect before filing
- ESOP grant, vesting and exercise notices, including the exercise price.
- Allotment or transfer statement showing dates, quantities and security class.
- Merchant-banker or other valuation evidence supporting the exercise-date FMV where required.
- Form 16, payroll worksheets and proof of tax withheld on the perquisite.
- Buy-back offer, acceptance confirmation, settlement statement and bank or demat record showing the company’s purchase.
- Evidence of acquisition cost for each lot, including corporate-action adjustments.
- Documents showing whether the company bought shares or settled unexercised options.
- Residency, tax-status and shareholding information relevant to the applicable year and any promoter rule.
Common errors and how to correct them
Using the announcement date
An announcement date can fall in one tax period while completion occurs in another. Correct the file by documenting the company’s actual purchase and extinguishment date.
Taxing only the cash received
The exercise perquisite may already have been salary income before the buy-back. Reconcile both events instead of treating the entire cash receipt as employment income or as one undifferentiated capital gain.
Carrying forward the 2024–2026 dividend rule
The dividend characterization is not the current rule for buy-backs from 1 April 2026. Recheck the amended Act whenever the purchase date crosses that boundary.
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Rates depend on the year, taxpayer category, holding period and statutory exceptions. A promoter-specific rule can change the result, so a generic percentage is unreliable.
Confusing vesting with ownership
Vesting gives a contractual right; exercise and allotment create the shareholding used for the share buy-back and holding-period analysis. A cash payment before allotment requires separate document-based analysis.
When professional review is warranted
Have an Indian tax professional review the file when the company is unlisted, exercises occurred in multiple rounds, a start-up deferral was claimed, residency changed, shares were held through more than one account, the transaction straddles 31 March/1 April 2026, or promoter status might apply. The adviser should work from the statutory version and transaction documents, not just the amount credited to your bank account.
The essential record is a two-event timeline: first, the exercise-date salary perquisite; second, the later disposal or buy-back of allotted shares under the law applicable on the company’s purchase date. Keeping those events separate is the most reliable way to avoid using the wrong regime.
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