Understanding the Tax Mystery Around Voluntary ESOP Compensation in India

 Employee Stock Option Plans (ESOPs) are a popular way for companies, especially startups, to reward and retain employees. They give employees the right to buy company shares at a fixed price in the future. However, sometimes unexpected events—like a corporate restructuring—can reduce the value of these ESOPs even before employees get a chance to use them.

In such cases, companies may offer a one-time voluntary payment to compensate employees for this loss in value. But the big question is: Is this payment taxable?

 

Recently, a well-known case involving Flipkart and PhonePe brought this issue into the spotlight. When PhonePe was spun off from Flipkart, the value of unexercised ESOPs dropped. Flipkart decided to make a goodwill payment to affected employees. This was a voluntary, non-contractual payment—not linked to any actual sale or exercise of shares.

 

Tax authorities initially argued that this payment should be treated as salary income and taxed accordingly. Employees, on the other hand, claimed it was a capital receipt—meaning it shouldn’t be taxed at all.

 

Different High Courts in India have taken different views:

• The Karnataka and Delhi High Courts ruled in favor of employees, saying that since no shares were actually sold or exercised, the payment is a capital receipt and not taxable.

 

• The Madras High Court, however, said that since ESOPs are linked to employment, any payment related to them should be taxed as a perquisite.

 

This confusion means that employees and employers are often left unsure about the tax treatment of such payments. Without clear rules from the tax department (CBDT) or a final decision from the Supreme Court, the situation remains uncertain.

 

What Should You Do?

• Employees: Keep detailed records of all ESOP-related documents and payments. Consult a tax advisor before filing returns.

 

• Employers: Clearly document the reason for any voluntary compensation. Consider applying for advance tax rulings to avoid future disputes.

 

In short, while companies try to do right by their employees, the tax laws haven’t kept up. Until clearer guidelines are issued, both sides must proceed with caution.