Budget 2026: ESOP tax treatment cries out for certainty

Employee Stock Option Plans (ESOPs) have emerged as a critical tool for companies to attract and retain talent. Yet, despite their growing use, especially in multinational group structures, the tax treatment of ESOPs in India continues to be riddled with uncertainty, leading to disputes for both employers and employees.Two areas warrant urgent attention which Budget 2026 can address: the allowability of ESOP expenditure in the hands of companies, and the taxation challenges faced by globally mobile employees.1. Non-allowability of ESOP expenditure in the hands of the companyUnder the Income-tax Act, there is no specific provision dealing with the deductibility of ESOP-related expenditure. In practice, companies claim such costs as business expenditure under Section 37(1) of the Income-tax Act, 1961 (corresponding to Section 34(1) of the Income-tax Act, 2025). However, tax authorities have frequently disallowed these claims, arguing that ESOP costs are capital or contingent in nature.This issue becomes even more contentious in cross-border group structures, where a foreign parent issues shares to employees of its Indian subsidiary and recharges the cost to the Indian entity. Indian tax authorities have increasingly taken the position that since the shares are issued by the foreign parent, the Indian subsidiary does not incur a real expenditure and the charge is merely notional.This stance sits uneasily with commercial and accounting realities. ESOP discounts are recognised as expenses under applicable accounting standards and SEBI regulations for listed entities. Highlighting this inconsistency, Rohinton Sidhwa and Amit Bablani, partners at Deloitte India, note that Indian subsidiaries of multinational groups often face denial of deductions despite clear commercial substance. In their pre-budget recommendations, they point out that tax authorities have disallowed ESOP deductions on the grounds that “the expense relates to shares of a foreign company and not the employer, that the liability belongs to the foreign company and not the Indian company and that the payments are notional” They state that amounts paid by an Indian subsidiary to a foreign parent for stock-based compensation should be treated as bona fide revenue expenditure. This deduction should be allowed in the year in which the shares are issued to the Indian employee (when the Indian company’s liability crystallizes), or in the year of actual payment where payment falls in a subsequent year, consistent with accrual/accounting norms.Valuation norms for listed/unlisted overseas entities, including the introduction of fast-track dispute resolution for valuation-related disputes would go a long way in reducing avoidable litigation. A checklist of supporting documents (invoice, payment evidence, vesting schedule, grant letters, board/salary committee approvals, valuation report, TDS compliance proof in respect of employees) could also be set out to substantiate the claim.” 2. Challenges for individuals in case of globally mobile employeesEmployees, who work across jurisdictions face their own set of challenges. Under Section 17(2) of the Income-tax Act, ESOPs are taxed as perquisites at the time of exercise. This framework fails to address the realities of globally mobile individuals who may have rendered services both in India and overseas during the grant-to-vesting period.The absence of statutory apportionment rules has resulted in inconsistent treatment by assessing officers, frequent litigation and genuine hardship for expatriates and returning Indian employees. In many cases, the entire ESOP perquisite is sought to be taxed in India, even where a substantial portion of the underlying services were rendered abroad.Divya Baweja, partner at Deloitte India, points out that the Central Board of Direct Taxes (CBDT) should issue clear guidelines for apportioning ESOP taxation in cross-border scenarios. A standard formula or method based on the location of services rendered during the grant-to-vesting period to determine the perquisite as well as the cost of acquisition should be set out; Documentation requirements for employees to substantiate service periods and locations must be stipulated. This will ensure consistency and reduce disputes.