Bengaluru tribunal rules that gains from unexercised ESOP buybacks are taxable as capital gains

The Income Tax Appellate Tribunal’s decision may alter the tax treatment of ESOP buybacks in India, especially post-acquisition or restructuring, affecting startups and employees alike.

The Income Tax Appellate Tribunal in Bengaluru has ruled that gains from the repurchase of vested but unexercised employee stock options can be taxed as long-term capital gains, rather than as salary perquisites, in a decision that could affect a narrow slice of ESOP transactions in India’s startup sector.

According to Inc42, the case arose from the tax return of a Flipkart senior executive who reported income that included ₹2.33 crore from the company’s repurchase of 2,653 vested stock options. An assessing officer later sought to reclassify that payment as a salary-linked benefit under the Income Tax Act, which would have subjected it to higher tax rates. After losing an appeal before the Commissioner of Income Tax (Appeals), the executive took the matter to the tribunal, which sided with the taxpayer.

In its order, the tribunal said an unexercised stock option is still only a right to subscribe to shares at a future date and is not, by itself, a specified security for the purposes of section 17(2)(vi) of the Income Tax Act. The bench held that no value can be attached to that right until the option is exercised and the specified security comes into existence. It also said that a buyback of such options amounts to a transfer of a capital asset, which brings the proceeds within section 45 and the capital gains framework.

The ruling adds to a patchwork of earlier decisions on the tax treatment of ESOPs. Tax specialists told Inc42 that the outcome is likely to matter most where vested options are cancelled for cash, often after an acquisition or during a restructuring, rather than in routine exercise-and-sale transactions. Ajay Rotti of Tax Compaas said that when options are actually exercised, the gap between the strike price and the fair market value would still be treated as salary income. Gouri Puri of Shardul Amarchand Mangaldas & Co said the decision could create different tax outcomes for transactions that are economically similar.

There is also a wider compliance question for companies. Meyyappan Nagappan of Trilegal told Inc42 that employers often account for share buybacks linked to employees as staff-related expenses, but the tribunal’s reasoning suggests they may instead need to be treated as capital asset acquisitions, which could affect disclosures. The issue is far from settled: Inc42 noted that the Delhi, Karnataka and Madras High Courts have delivered conflicting rulings in related cases, while earlier tribunal decisions in Bengaluru and Chennai also treated certain unexercised or allotted ESOP gains as capital gains. The timing is notable as ESOPs have become more common across new-age companies, with more than 9,200 startup employees unlocking ₹1,409 crore in liquidity through ESOP buybacks in 2025, according to figures cited by Inc42.