A founder called me in February this year - mid-Series B, decent traction, about 140 employees. They were about to run an ESOP exercise window for the first time since their 2023 fundraise. Their CFO had everything ready: board resolution, exercise notices, the works. What they did not have was a fresh FMV valuation certificate from a merchant banker.
"But we have last year's valuation report," the CFO said.
That report was 14 months old.
I explained - as gently as I could - that they were about to process exercises using a stale number, expose the company to TDS shortfall, and potentially put employees in a position where the taxman reopens the perquisite computation years later. They had to pause the window, rush a valuation, and delay exercise by three weeks. It was avoidable. Completely avoidable. And I've seen this exact scenario play out at least four or five times in the last eighteen months.
What the Law Actually Says
The Income Tax Act, 2025 - effective 1 April 2026 - renumbers the ESOP perquisite framework. What was Section 17 and Section 192 of the 1961 Act is now mapped to Section 17(1)(d), Section 17(5)(h), and Section 392 of the new Act. The substantive rule hasn't changed, but there's one important addition for eligible startups: the deferral window under Section 392(3) read with Section 289(3) is now 60 months from the end of the relevant tax year - up from 48 months under the 1961 Act, for shares allotted on or after 1 April 2026.
For most unlisted companies (the ones that aren't DPIIT-recognised startups with an IMB certificate), the regular framework applies: the employer must deduct TDS under Section 392 at the time of exercise, on the perquisite value, which is:
Perquisite = FMV on exercise date – Exercise price paid by employee
Simple enough on paper. The problems are entirely in the execution.
The key rule for FMV determination for unlisted shares is under Rule 15 of the Income Tax Rules, 2026 (earlier Rule 3(9)(ii) of the IT Rules, 1962). It is clear: FMV of the unlisted shares must be determined by a SEBI-registered Category I Merchant Banker. The valuation must not be older than 180 days from the date of exercise.
Not 181 days. 180.
Mistake 1: Using the Funding Round Valuation as a Proxy
This is by far the most common error I encounter. A startup raised a Series A round eighteen months ago. The investor deck had a pre-money valuation. The company has a valuation report prepared by the investor's team for that round. Someone in finance - often in good faith - uses the per-share price implied by that round as the FMV at exercise.
This is wrong. And under the new Act, it's even less defensible.
The funding round valuation was prepared for a different purpose (capital infusion), at a different point in time, for a different class of investor (who got liquidation preference, anti-dilution protection, and other preferences). The equity value per share for a plain-vanilla ESOP exercise is not the same number. The regulation doesn't explicitly state that funding round prices are excluded - but that's exactly the ambiguity that creates problems when an assessment officer challenges the FMV.
Merchant banker certificates are specifically required because they represent an independent, dated, purpose-specific FMV - one that can be defended in proceedings.
Mistake 2: The 180-Day Staleness Trap
Let me show you why this matters with an example.
A company has an ESOP pool. They got a merchant banker valuation done in January 2026, showing FMV of Rs 350 per share. They plan to open an exercise window in August 2026. January to August is over 200 days. That valuation cannot be used for the August exercise.
Now suppose the company raised additional capital in May 2026 at a significantly higher implied per-share value. If they try to use the January certificate anyway - because getting a fresh one feels expensive or time-consuming - they are sitting on a ticking problem. If FMV was genuinely higher at the time of exercise, the TDS deducted on Rs 350 was short, and the employer is liable for the shortfall plus interest.
Some clients ask me: what if the FMV hasn't actually changed much? Maybe the business hasn't moved significantly in eight months. That may be true. But you still need a fresh certificate to demonstrate it. The rule does not provide for a "no material change" exemption.
The practical fix is simple: build the merchant banker engagement into your ESOP calendar. If you run annual exercise windows, get the valuation done about a month before the window opens. Rs 75,000 to Rs 1,50,000 for a proper merchant banker certificate is not a meaningful cost relative to the TDS exposure it protects you from.
Mistake 3: Confusing IndAS 102 Valuation with Perquisite FMV
This one trips up CAs who handle the statutory audit side more than the tax side. IndAS 102 (Share-Based Payments) requires recognising a compensation expense over the vesting period, based on the grant date fair value of the option - typically calculated using Black-Scholes or a binomial model.
That grant date fair value is an option value. It accounts for time value, expected volatility, expected dividends, risk-free rate. It is not the same as the FMV of the underlying share at exercise.
So you can have a situation where:
- Grant date (say, April 2023): Black-Scholes option value = Rs 120 per option → IndAS 102 expense spread over 3-year vesting
- Exercise date (April 2026): FMV of share = Rs 400 per share, Exercise price = Rs 50 → Perquisite = Rs 350 per share
These are different numbers, different computations, different purposes. The IndAS 102 number goes into P&L. The Rs 350 figure goes into the employee's Form 16 and the employer's TDS workings.
I've seen cases where the CFO presented the grant date Black-Scholes value to the tax team as "the valuation," and the tax team used it for perquisite computation. Both teams thought they were doing the right thing. The audit trail looked clean. But the perquisite was completely misstated.
A Quick Calculation to Illustrate
Say a Series B company, unlisted private limited, gets a fresh merchant banker certificate in June 2026 valuing each equity share at Rs 500. An employee exercises 1,500 vested options at an exercise price of Rs 40 per share.
Perquisite value = (Rs 500 – Rs 40) × 1,500 = Rs 6,90,000
This amount is treated as salary income in the employee's hands for FY 2026-27. TDS under Section 392 must be deducted by the employer at applicable slab rates. If the employee is in the 30% bracket: TDS ≈ Rs 2,07,000 on this perquisite alone (excluding surcharge and cess).
Now imagine the same calculation done with a stale valuation showing FMV of Rs 350:
Perquisite = Rs 4,65,000 → TDS ≈ Rs 1,39,500 → Shortfall: Rs 67,500 - per employee
Scale this across 50 employees exercising in the same window, and you're looking at a material employer liability that sits on the books unnoticed until a scrutiny assessment.
The Startup Deferral: Genuine Relief, But With Strings
For DPIIT-recognised startups that also hold an Inter-Ministerial Board (IMB) certificate under Section 140 of the IT Act 2025 (the successor to Section 80-IAC of the 1961 Act), there is meaningful relief. Under Section 392(3), for shares allotted on or after 1 April 2026, employees can defer payment of this perquisite tax for up to 60 months from the end of the tax year in which the shares are allotted - or until they sell the shares or leave the company, whichever is earlier.
This is a genuine improvement over the previous 48-month window and reduces the cash-flow burden on employees who cannot immediately liquidate their shares.
But - and this is a point many founders miss - the deferral does not eliminate the employer's obligation to track and certify this liability. The TDS still has to be computed. The deferral is for the employee's cash payment, not for the employer's reporting obligation. Get this wrong and the employer's TDS proceedings can still be opened.
What I'd Tell Any CA Handling an ESOP Audit
If you're signing off on a company's financial statements and they've had an ESOP exercise window during the year, check these three things specifically.
First, was the FMV certificate used for each exercise window dated within 180 days of that window's opening date? Not the certificate date versus year end - the certificate date versus exercise date.
Second, was the valuation done by an entity that actually holds a SEBI Category I Merchant Banker registration? Some companies outsource this to boutique advisory firms that issue certificates but don't have the formal registration. Those certificates don't meet the legal requirement.
Third, is the IndAS 102 expense amount reconciled separately from the perquisite workings? Both should be in the file, and they should be clearly different numbers.
These aren't exotic compliance checks. They're basic - but they get missed more often than they should.
At the end of the day, ESOP is a retention tool. Done well, it aligns employee and company incentives beautifully. Done sloppily - with outdated valuations, wrong FMV proxies, or confused accounting treatment - it creates litigation risk for the company and tax grief for the employees you were trying to reward. If your clients are in this space and you're not sure whether their ESOP records hold up, it's worth a conversation before the assessment officer comes asking.
The author is a Director at FinVal Research & Consultancy, an IBBI Registered Valuer firm based in New Delhi. FinVal specialises in business valuation, ESOP advisory, and transaction advisory. finvalresearch.in
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