The Three Types of Indian Startup Equity
1. ESOPs (Employee Stock Option Plans)
The most common form of Indian startup equity. An ESOP gives the employee the right to buy company shares at a predetermined exercise price (set at FMV at grant date) after a vesting period.
Tax treatment: Perquisite tax at exercise on the spread between the fair market value on the exercise date and the exercise price, then capital gains tax on subsequent appreciation at sale.
Best for: Employees who believe strongly in the company's exit potential and can handle the perquisite tax cash flow at vesting.
2. SARs (Stock Appreciation Rights)
A SAR grants the employee the right to receive cash equal to the appreciation in share value over a specified period. No actual shares are issued — the employee receives a cash payment at the liquidity event (IPO, acquisition, or buyback).
Tax treatment: The cash payment is taxed as salary income (perquisite) when received. No perquisite tax at exercise because vesting is not a taxable event — the charge arises on exercise.
Best for: Startups wanting to offer equity-like upside without the complexity of share issuance; employees who prefer cash settlements; companies where actual share issuance is complex.
3. Phantom Stock
Phantom stock grants a hypothetical number of "phantom shares." At a liquidity event, the employee receives cash equal to the value of those phantom shares at the time. Like SARs, no actual shares change hands.
Tax treatment: Cash received is taxed as salary/bonus income in the year received.
Best for: Compensating senior hires who join late-stage companies where the option pool is depleted; retaining employees through a bridge to liquidity.
Comparison Table
| ESOP | SAR | Phantom Stock | |
|---|---|---|---|
| Actual shares issued | Yes, at exercise | No | No |
| Tax at vesting | Perquisite tax | No | No |
| Tax at payout | Capital gains | Salary tax | Salary tax |
| Shareholder rights | Yes, after exercise | No | No |
| 409A required (US entity) | Yes | May apply | No |
| SEBI SBEB applies | Yes | Yes | Depends |
Which Indian Statute Applies Now?
India replaced the Income-tax Act, 1961 with the Income-tax Act, 2025, effective 1 April 2026. The Income-tax Rules, 1962 were likewise replaced by the Income-tax Rules, 2026.
- Income earned from 1 April 2026 onward (Tax Year 2026–27) is governed by the Income-tax Act, 2025.
- Earlier years, and proceedings already under way, continue to be governed by the Income-tax Act, 1961.
The new Act is substantially a recodification: section numbers were reorganised throughout, but the treatment of ESOP perquisites was not rewritten in substance. Older guidance citing 1961 Act section numbers may still describe the correct position while pointing at a section number that no longer exists.
Because section mapping is still settling in practice, confirm the current section reference with your Chartered Accountant before relying on any specific number.
Sources
- Income-tax Act, 2025 — in force from 1 April 2026 (replacing the Income-tax Act, 1961)
- Income-tax Rules, 2026 — notified 20 March 2026 (replacing the Income-tax Rules, 1962)
- Income-tax Act, 1961, s.17(2)(vi) — ESOP perquisite valuation; applies to years before Tax Year 2026–27
- Foreign Exchange Management (Non-debt Instruments) Rules, 2019 — pricing guidelines for unlisted equity
- Companies Act, 2013, s.62(1)(b) and Companies (Share Capital and Debentures) Rules, 2014 — ESOP issuance by unlisted companies
General information, not tax or legal advice. Indian tax and exchange-control provisions were comprehensively renumbered with effect from 1 April 2026 — confirm current section references with a Chartered Accountant.