How is income taxed when a startup buys back ESOP shares from an employee

Question

My startup employer offered to buy back my vested ESOP shares before any public listing, and I want to know how this buyback amount will be taxed. I have been reading conflicting things online and I would like to understand what Indian law actually says about this, which Act and Section applies, what the realistic timelines and costs are, and what I should be doing right now to protect my position. If the matter can be resolved without litigation I would prefer that route, but I want to know what my rights are before I agree to anything or sign any document.

MyVakeel Legal Desk · Accepted Answer

How is income taxed when a startup buys back ESOP shares from an employee is governed in India primarily by Income-tax Act, 1961, Section 17(2), Income-tax Act, 1961, Section 45 and Income-tax Act, 2025. The short answer is set out below, followed by the practical steps most people in this situation need to take. Read it alongside the specific provisions named, because the exact relief available to you turns on the facts you can prove on paper.

When ESOP options are exercised and shares are allotted, the difference between the fair market value on the date of exercise and the exercise price paid by the employee is taxed as a perquisite under Section 17(2) and forms part of salary income at that stage, regardless of any later buyback.

When the employer later buys back these already-allotted shares from the employee, the transaction is treated as a transfer of a capital asset, and any gain over the fair market value already taxed as perquisite is taxed as capital gains under Section 45, classified as short-term or long-term based on the holding period from the date of allotment.

For unlisted startup shares, the holding period must exceed twenty-four months to qualify as a long-term capital asset eligible for the lower long-term capital gains rate; a shorter holding period results in short-term capital gains taxed at the employee's applicable slab rate.

Eligible startups recognised by the Department for Promotion of Industry and Internal Trade can, subject to conditions, allow employees to defer payment of tax on the ESOP perquisite to a later trigger event such as sale of shares, completion of five years from allotment, or cessation of employment, under a special deferral provision, but this defers the salary-stage tax and does not eliminate the separate capital gains tax on buyback.

The employer buying back shares from an Indian resident employee is generally not required to deduct TDS on the capital gains component, since TDS obligations for share buybacks by unlisted companies fall on the buyback distribution tax framework applicable to the company rather than as a deduction from the employee's payment in most such structured deals; sellers should independently pay advance tax on the resulting capital gains.

What to do next: 1) Confirm the perquisite value already taxed at the time of ESOP exercise; 2) Compute capital gains on buyback using the exercise-date fair market value as cost of acquisition; 3) Determine holding period from allotment date to classify gains as short-term or long-term; 4) Pay advance tax on the capital gains arising from the buyback if TDS is not deducted.

If the other side has already issued a notice, filed a case or set a deadline, treat the matter as time-sensitive — most remedies under Income-tax Act, 1961, Section 17(2) carry limitation periods, and a delay you cannot explain weakens an otherwise strong case. You can post the details on the MyVakeel forum for a practising advocate to review, or book a paid consultation with a Bar Council verified lawyer in this practice area.