There is a pattern that plays out repeatedly in foreign-owned Indian subsidiaries. A US or UK parent company sets up an India entity, builds out the team, and wants to offer employee stock options to retain its best engineers and product managers. The ESOP scheme is drafted, the grant letters go out, and everyone feels good about it - until the first batch of employees try to exercise their options and realize that a significant tax bill arrives before a single share has been sold.
This is the ESOP cash flow problem. It is not unique to India, but India's version of it has a specific structure, a specific set of rules that govern it, and - as of April 2026 - a materially more generous deferral window that most foreign-owned entities have not yet factored into their employee equity planning.
This blog explains how ESOP taxation works in India, what the 60-month deferral introduced under the Income Tax Act, 2025 actually means for foreign-owned Indian subsidiaries and GCCs, who qualifies for it, and what has to happen before any employee can use it.
WHAT AN ESOP SCHEME IS - AND WHY FOREIGN SUBSIDIARIES USE THEM
An ESOP - Employee Stock Option Plan - is a formal scheme under which a company grants employees the right to purchase its shares at a fixed exercise price at a future date, typically after a vesting period. In India, ESOP schemes for private limited companies are governed by Section 62(1)(b) of the Companies Act, 2013 and require board approval, a special resolution from shareholders, and a formally documented scheme before any options are granted.
For a foreign-owned Indian subsidiary, the motivation to offer an ESOP plan or share options for employees is usually one of two things: the parent company wants to grant equity in the parent entity to its India team (cross-border RSUs or stock options for employees), or the Indian subsidiary wants to offer its own equity to Indian employees directly.
Both structures are used. Both carry distinct tax consequences. And both require careful legal and compliance planning - because the Indian tax authority's treatment of employee ownership through equity is detailed, specific, and enforced.
THE TWO-STAGE TAX PROBLEM EVERY EMPLOYEE MUST UNDERSTAND
Before getting to the deferral, the foundational tax structure needs to be clear. In India, ESOP taxation hits at two separate points in time.
Stage 1 - At Exercise:
When an employee converts their vested options into shares, Indian tax law treats the difference between the Fair Market Value (FMV) of the shares on the date of exercise and the exercise price as a perquisite - a form of salary income. This is taxable in the year of exercise, at the employee's income tax slab rate, regardless of whether the employee has sold a single share.
The formula is straightforward:
Taxable Perquisite = (FMV on exercise date − Exercise price) × Number of shares exercised
For a senior engineer who exercises 5,000 options when the FMV is Rs 500 and the exercise price is Rs 50, the taxable perquisite is Rs 22.5 lakh - added to that financial year's salary income and taxed at their applicable slab, potentially 30% plus cess. That is a tax bill of approximately Rs 7 lakh on shares the employee cannot yet sell.
The employer is responsible for deducting TDS on this perquisite. If TDS is not deducted, the company faces both disallowance of the deduction and interest liability under Indian tax law.
Stage 2 - At Sale:
When the employee eventually sells the shares, the gain from the sale - calculated as (sale price minus FMV at exercise) - is taxed as capital gains. The tax rate depends on the holding period. For unlisted shares, gains are long-term if held for more than 24 months from allotment - taxed at 12.5% under the Income Tax Act, 2025. Gains on unlisted shares held for less than 24 months are short-term, taxed at the individual's income slab rate.
For employees of Indian subsidiaries receiving parent-company RSUs or stock options - where the shares are listed on a foreign stock exchange - the listed share rules apply after accounting for cross-border apportionment, which is discussed separately below.
THE 60-MONTH DEFERRAL UNDER THE INCOME TAX ACT, 2025 - WHAT CHANGED AND WHY IT MATTERS
The Income Tax Act, 1961 was replaced by the Income Tax Act, 2025 effective April 1, 2026. Most of the ESOP tax framework was carried forward unchanged - but one thing improved materially: the tax deferral window for eligible startup employees was extended from 48 months to 60 months.
Under Section 392(3) read with Section 289(3) of the Income Tax Act, 2025 - which succeeds Section 192(1C) of the repealed 1961 Act - employees of qualifying entities who exercise stock options on shares allotted on or after April 1, 2026 can defer the Stage 1 perquisite tax for up to 60 months from the end of the Tax Year of allotment.
The deferred tax becomes payable at whichever of these three events occurs first:
- 60 months from the end of the Tax Year of allotment
- The date the employee sells the shares
- The date the employee ceases employment
This is a five-year window. Under the old law, it was four years. For a senior employee with significant option grants, the extra year of deferral can be the difference between being able to time a liquidity event - a secondary sale, an acquisition, an IPO - and being forced to sell earlier than planned purely to fund the tax bill.
The tax rate is locked at the rates applicable in the year of exercise, not the year the deferral ends. A change in slab rates between exercise and the trigger event does not retrospectively increase the deferred liability.
WHO QUALIFIES - AND THE MISTAKE MOST FOREIGN SUBSIDIARIES MAKE
This is the most important section of this blog, and the one most commonly misunderstood.
The 60-month deferral is not available to all Indian companies. It is not available simply because a company is a foreign-owned subsidiary. It is not available because a company has DPIIT recognition under the Startup India programme.
The deferral is available only to employees of an "eligible startup" - which requires both of the following conditions to be satisfied simultaneously:
Condition 1: DPIIT Recognition
The company must be registered and recognised by the Department for Promotion of Industry and Internal Trade (DPIIT) as a startup. This requires the company to be a Private Limited Company or LLP incorporated between April 1, 2016 and March 31, 2030, with an annual turnover below Rs 100 crore in each year since incorporation, and working toward innovation, development, deployment, or commercialisation of a new product or service.
Condition 2: IMB Certification Under Section 140 of the Income Tax Act, 2025
The company must separately hold a certification from the Inter-Ministerial Board (IMB) - now governed under Section 140 of the Income Tax Act, 2025 (successor to Section 80-IAC of the 1961 Act). This is a distinct application from DPIIT recognition and is not automatically granted.
As of April 2026, approximately 3,700 companies out of over 1.97 lakh DPIIT-recognised startups hold the IMB certification. That is fewer than 2% of all DPIIT-recognised startups.
The most common mistake made by foreign-owned Indian subsidiaries - and their HR and finance teams - is assuming that DPIIT recognition alone activates the deferral benefit. It does not. The IMB certification is a separate and additional requirement. Without it, there is no deferral. Stage 1 perquisite tax hits in the year of exercise, in full, regardless of whether the employee can sell.
For a foreign-owned GCC or Indian subsidiary of a US, UK, or Singapore company that incorporates in India and builds a genuine product or technology business - DPIIT recognition is obtainable, and IMB certification under Section 140 is achievable if the eligibility criteria are met. But both must be applied for separately and confirmed before any ESOP plan is communicated to employees as including a deferral benefit.
HOW PARENT-COMPANY ESOPS WORK FOR INDIAN SUBSIDIARY EMPLOYEES
A separate and increasingly common scenario: a US or UK parent company grants its own stock options (or RSUs) to employees of its Indian subsidiary. The shares involved are the parent company's shares, listed on NASDAQ or the London Stock Exchange - not shares of the Indian subsidiary.
Here is how Indian tax treats this
The Indian subsidiary is the employer for Indian tax purposes. When the parent's options vest and the employee receives shares, the Indian subsidiary is responsible for computing the perquisite value and deducting TDS under Section 392 of the Income Tax Act, 2025 - even though the shares are of the parent company and listed abroad.
The perquisite is computed as: (FMV of the parent's shares on the vesting date, converted to INR at the prevailing exchange rate) minus (exercise price paid, converted to INR).
The Indian subsidiary must charge back this perquisite cost to the parent company - this is a transfer pricing transaction. Without a properly documented intercompany recharge agreement, the subsidiary has a deductible expense with no corresponding income, which creates transfer pricing exposure and potential tax adjustments.
For employees who relocated from India to the US or UK during the vesting period and then back to India before exercise - or vice versa - India taxes only the portion of the perquisite attributable to services rendered in India. Determining this apportionment requires tracking vesting periods against work location, which most global mobility programmes do not do precisely enough.
The 60-month deferral is not available for parent-company ESOP grants to Indian subsidiary employees, unless the Indian subsidiary itself qualifies as an eligible startup with IMB certification. The deferral applies to options in the issuing entity - not the employer entity.
THE ESOP POOL: HOW MUCH EQUITY SHOULD A FOREIGN SUBSIDIARY RESERVE
For a foreign-owned Indian subsidiary planning its own ESOP scheme - issuing subsidiary shares rather than parent shares - the question of pool size is a board-level decision that intersects with the parent's cap table.
Standard practice for Indian technology startups is to reserve 10% to 15% of the fully diluted equity for the ESOP pool. For a wholly owned subsidiary, the parent company holds 100% of the equity - so any ESOP issued from the subsidiary pool directly dilutes the parent's holding.
This has FEMA implications. When Indian subsidiary shares are allotted to Indian employees through an ESOP exercise, those shares are issued at FMV. But if the subsidiary's valuation has grown significantly since incorporation, the FMV-based issuance to Indian employees may trigger a reporting requirement under FEMA - since the parent's percentage holding in the subsidiary decreases when new shares are allotted.
Additionally, if the subsidiary ever plans to have foreign employees exercise options or receive shares, cross-border share issuance adds a further layer of FEMA compliance around the mode of remittance and the applicable FDI sectoral limits.
WHAT THE SECTION NUMBERS CHANGING MEANS FOR YOUR ESOP DOCUMENTATION
One operationally important consequence of the Income Tax Act, 2025 replacing the 1961 Act from April 1, 2026: the section numbers have changed. Section 192(1C) - which provided the ESOP deferral under the old law - is now Section 392(3) read with Section 289(3). Section 80-IAC - the tax holiday and eligibility provision - is now Section 140.
Any ESOP plan document, grant letter, board resolution, or employee communication that references the old section numbers should be updated before the next exercise event occurring after April 1, 2026. References to outdated provisions in grant documentation can create ambiguity in disputes and tax assessments.
Similarly, Form 16 - now called Form 130 under the new Act - must reflect the deferred perquisite correctly when the deferral is applicable. Employers that do not update their TDS and payroll systems to the new form references will face compliance gaps in TDS returns.
HOW ACCORP PARTNERS HELPS FOREIGN SUBSIDIARIES STRUCTURE ESOP COMPLIANCE
For foreign-owned Indian subsidiaries, ESOP is not just an HR decision. It involves India company law, FEMA, income tax, TDS compliance, transfer pricing, and for qualifying entities, the IMB certification process. Getting any one of these wrong creates either a penalty for the company or an unexpected tax bill for the employee - both of which undermine the retention objective the ESOP was designed to serve.
Accorp Partners works with foreign-owned Indian subsidiaries and GCCs on the full compliance stack - including ESOP plan structuring aligned with Indian company law, DPIIT recognition and IMB certification for qualifying entities, transfer pricing documentation for intercompany ESOP recharge arrangements, and the ongoing TDS compliance that ESOP exercises trigger each year.
The author is a cross-border corporate advisor specialising in India entry for NRI and foreign founders, covering SPICe+ incorporation, FEMA compliance, ODI/ODI reporting, and post-incorporation secretarial support. The author is associated with Accorp Partners, a CPA (USA), ICAEW, and CA-led firm providing end-to-end India incorporation and compliance services for companies across the US, UK, Singapore, and UAE. For queries, write to accorppartners.com.
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