ESOP (employee stock option plan): meaning, rules and tax
An ESOP gives employees the option to buy company shares at a set price after vesting. Unlisted companies follow section 62(1)(b) and rule 12.
Short answer
An ESOP (employee stock option plan) gives employees the right, but not the obligation, to buy a company's shares at a pre-determined exercise price after a vesting period. Unlisted Indian companies grant ESOPs under section 62(1)(b) of the Companies Act, 2013 and rule 12 of the Share Capital and Debentures Rules, 2014, with a special resolution approving the scheme.
- Governed by
- Section 62(1)(b) and rule 12
- Approval
- Special resolution of shareholders
- Minimum vesting
- One year from grant
- Register
- Form SH-6
How an ESOP works
The company creates an ESOP pool by special resolution and grants options to eligible employees. Options vest over time, typically four years with a one-year cliff, though the legal minimum is one year. After vesting, the employee can exercise the option by paying the exercise price and receives shares. Unvested options generally lapse when an employee leaves. Promoters and directors holding more than 10% cannot receive ESOPs, except in DPIIT-recognised startups for ten years from incorporation.
Tax treatment
On exercise, the difference between the fair market value of the shares and the exercise price is taxed as a salary perquisite, and the employer deducts TDS. When the shares are later sold, capital gains tax applies on the gain over that fair market value. Under the 1961 Act, employees of startups eligible for the startup tax holiday could defer the perquisite tax; confirm the corresponding provision under the Income-tax Act, 2025 before relying on it. The company must also account for ESOP costs in its financial statements under the applicable accounting standards.
Why it matters for startups
ESOPs help early-stage companies hire talent they cannot pay in cash. Size the pool with your investors, ensure there is enough authorised capital, set up a clear scheme document, and communicate the tax impact to employees. Poorly explained ESOPs are a common source of disputes at exit.
Related services
Sources
- India Code: official repository of central Acts
- Ministry of Corporate Affairs (MCA) portal
- Income Tax Department: Acts, rules and circulars
Written by the Refogo Editorial Team from the official sources above and checked on 2026-10-31. Laws, rates and due dates change, and authorities often extend deadlines, so confirm your own case with a qualified professional. This is general information, not legal or tax advice. Read our editorial policy or report an error to support@refogo.com.
Common questions
Can an LLP or proprietorship issue ESOPs?
No. ESOPs are issued by companies. LLPs may use profit-sharing arrangements instead.
What is a vesting cliff?
A period, often one year, before which no options vest. After the cliff, options usually vest monthly or quarterly.
Can ESOPs be granted to consultants?
Rule 12 limits ESOPs to employees and directors as defined, so independent consultants generally cannot receive them.