Employee Stock Option Plans (ESOPs) have become a vital instrument for businesses, particularly multinational corporations, to secure and keep top talent. However, their tax treatment in India remains a significant source of confusion and conflict for both employers and their staff. With the upcoming Budget 2026, tax experts are highlighting two critical areas that require immediate legislative intervention to end the prevailing uncertainty.
The Corporate Deduction Dilemma: A Barrier for MNCs
A primary point of contention is the allowability of ESOP expenditure as a business deduction for companies. The current Income-tax Act lacks specific provisions for deducting ESOP-related costs. Companies typically claim these expenses under Section 37(1) of the Income-tax Act, 1961. Yet, tax authorities routinely disallow these claims, labeling the costs as capital or contingent in nature.
This problem intensifies within international group structures. A common scenario involves a foreign parent company issuing shares to employees of its Indian subsidiary and then recharging the cost to the Indian entity. The Indian tax authorities often argue that since the shares are issued by the foreign parent, the Indian subsidiary incurs no real expenditure, dismissing the recharge as a notional charge.
This stance conflicts with standard commercial and accounting practices. Under Indian accounting standards and SEBI regulations for listed companies, ESOP discounts are recognized as legitimate expenses. Rohinton Sidhwa and Amit Bablani, partners at Deloitte India, emphasize this inconsistency. They note that Indian subsidiaries of multinational groups frequently face deduction denials despite clear commercial substance.
In their pre-budget recommendations, the experts state that tax authorities disallow deductions by arguing 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 assert that payments by an Indian subsidiary to a foreign parent for stock-based compensation should be treated as bona fide revenue expenditure.
Deloitte recommends that this deduction should be permitted in the year the shares are issued to the employee (when the liability crystallizes) or in the year of actual payment, aligning with standard accrual accounting. They also suggest establishing clear valuation norms for listed and unlisted overseas entities and introducing a fast-track dispute resolution mechanism for valuation conflicts to curb unnecessary litigation. A defined checklist of supporting documents could further help companies substantiate their claims.
The Global Employee Conundrum: Unfair Tax Burden
Globally mobile employees face a separate set of challenges under India's ESOP taxation framework. As per Section 17(2) of the Income-tax Act, ESOPs are taxed as perquisites at the time of exercise. However, this rule does not account for individuals who work across different countries during the period between the grant and vesting of their options.
The lack of statutory rules for apportioning the taxable value based on services rendered in India versus abroad has led to inconsistent assessments by tax officers, frequent litigation, and genuine hardship for expatriates and returning Indian professionals. In many instances, tax authorities seek to tax the entire ESOP perquisite in India, even when a substantial portion of the service period was completed overseas.
Divya Baweja, a partner at Deloitte India, calls for the Central Board of Direct Taxes (CBDT) to issue definitive guidelines for apportioning ESOP taxation in cross-border situations. She advocates for a standard formula based on the location of services rendered during the grant-to-vesting period to determine both the taxable perquisite and the cost of acquisition.
Clear documentation requirements for employees to prove their service periods and locations are also essential. Such measures would ensure consistent application of the law and significantly reduce disputes for globally mobile employees.
The Path Forward: Clarity in Budget 2026
The growing use of ESOPs, especially in complex multinational setups, makes resolving these tax ambiguities an urgent priority. The upcoming Budget 2026 presents a crucial opportunity for the government to provide much-needed clarity. Addressing the deductibility for companies and establishing fair apportionment rules for international employees would not only reduce litigation but also enhance India's appeal as a destination for global talent and investment. Stakeholders across the corporate sector are keenly awaiting reforms that align tax law with commercial reality and global workforce mobility.
