ESOP Tax Deferral for Eligible Startup Employees: Section 192(1C) Explained

The Core ESOP Tax Problem

When an employee exercises ESOP options, the difference between the fair market value (FMV) of the shares on the exercise date and the price actually paid (the exercise price) is treated as a perquisite under Section 17(2)(vi) and taxed as salary income in the year of exercise. For employees of unlisted startups, this creates a cash-flow mismatch: tax is due on a notional gain even though the shares cannot be sold in the open market, since there is no liquid trading venue for unlisted shares.

Section 192(1C): A Targeted Relief for Eligible Startups

To address this, the Finance Act 2020 inserted Section 192(1C), which allows employers that qualify as an eligible start-up under Section 80-IAC to defer the TDS deduction on ESOP perquisite. Instead of deducting TDS in the year of exercise, the employer can defer the deduction until the earliest of three trigger events.

The Three Trigger Events for Deferred TDS

• Five years from the end of the relevant assessment year in which the shares were allotted, whichever comes first among the three triggers
• The date the employee sells the shares, whether in part or full, in which case TDS becomes due immediately on the portion sold
• The date the employee ceases to be an employee of the company, for example on resignation, retirement or termination

Whichever of these three events occurs first is the point at which the employer must deduct and deposit the TDS that was deferred, based on rates applicable in the year of exercise.

Eligibility Conditions for the Employer

What Exactly Gets Deferred?

It is important to understand that Section 192(1C) defers only the TDS deduction by the employer, not the taxability itself. The perquisite value is still computed and the income is still considered to have accrued in the year of exercise for the purposes of the taxable event under Section 17(2)(vi). What changes is the timing of the actual cash outflow as TDS, giving the employee breathing room of up to five years (or earlier, if they sell shares or leave the company) before the tax must actually be paid.

Worked Example

What Happens at the ITR Filing Stage

Retain the exercise/allotment record, exercise price and employee-perquisite FMV evidence. For the 1961-Act period, equity-share valuation uses Rule 3(8), not section 56(2)(viib) share-issue valuation. Under the notified 2026 Rules, equity-share FMV uses Rule 15(6), including its unlisted-share merchant-banker provision; other specified securities use Rule 15(7). The merchant banker is SEBI categoryI, and Rule 15(8)(l) defines the specified date as exercise date or an earlier date no more than 180 days before it. Listed equity uses the prescribed stock-exchange opening/closing-price method. Value the employee’s perquisite on the correct exercise-date basis even if eligible payment/withholding is deferred.

Capital Gains on Eventual Sale Remain Separate

When the shares are eventually sold, a second and entirely separate tax event arises: capital gains, computed as the difference between the sale price and the FMV on the date of exercise (which becomes the cost of acquisition for capital gains purposes, not the original exercise price paid). This capital gains tax is in addition to, and independent of, the Section 17(2)(vi) perquisite tax already accounted for at exercise.