What is the difference between grant, vesting and exercise?

The grant is the promise of options, vesting is when the right to exercise them is earned, and exercise is when the employee pays the exercise price and receives the shares.

How are ESOPs taxed in India?

Broadly, the difference between fair market value and the exercise price is taxed as a perquisite through payroll at exercise, and any later gain on sale is taxed as capital gains. Some eligible start-ups may defer the tax; check the current rules.

What happens to unvested ESOPs when an employee resigns?

Unvested options usually lapse. Vested options normally have to be exercised within a window set by the scheme, after which they also lapse.

Is there a minimum vesting period for ESOPs?

Company law rules generally require a minimum gap between grant and vesting, commonly one year. Confirm the current requirement and any exceptions with your company secretary.

HR & payroll glossary

Employee stock option plan (ESOP)

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Definition

A right granted to an employee to buy company shares at a set price after a vesting period. Under Section 17(2) of the Income-tax Act, the difference between fair market value on exercise and the price paid is a perquisite taxed through payroll, and a further capital gain arises on sale.

In practice

For HR and payroll, ESOPs become real at two moments: the vesting date, which is mostly record keeping, and the exercise date, when the employee buys shares. The difference between the fair market value on exercise and the exercise price is a perquisite, so payroll must add it to taxable salary and deduct TDS in that month.

Example with illustrative figures: 1,000 options exercised at ₹10 when the fair market value is ₹110 create a perquisite of ₹1,00,000 for that month. A sudden spike like this can push monthly TDS far above the employee's net pay, so coordinate the timing and the recovery plan in advance.

The common gap is the cap table team and payroll not talking. If the exercise is not reported to payroll before the run closes, Form 16 understates income. Rules on deferral of tax for eligible startups exist but change; check the current provision before applying any deferral.

Treated in depthPerquisites

Questions that involve ESOP

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FAQs

ESOP: common questions

The grant is the promise of options, vesting is when the right to exercise them is earned, and exercise is when the employee pays the exercise price and receives the shares.
Broadly, the difference between fair market value and the exercise price is taxed as a perquisite through payroll at exercise, and any later gain on sale is taxed as capital gains. Some eligible start-ups may defer the tax; check the current rules.
Unvested options usually lapse. Vested options normally have to be exercised within a window set by the scheme, after which they also lapse.
Company law rules generally require a minimum gap between grant and vesting, commonly one year. Confirm the current requirement and any exceptions with your company secretary.

HR & Payroll Glossary

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