Budget 2026: ESOP taxation gaps trigger disputes for expatriates, returning Indians; what lies ahead

Budget expectations: Employee Stock Option Plans (ESOPs), a core element of compensation for senior professionals and leadership talent, are facing increased scrutiny in India as existing tax rules struggle to keep pace with an increasingly mobile global workforce. While the current framework works reasonably well for employees who render services entirely in India, it has exposed significant gaps for expatriates, returning Indians, and global executives who work across multiple jurisdictions during the grant-to-vesting period.

Under Indian tax law, ESOPs are taxed as salary perquisites at the time of exercise, based on the difference between the fair market value of shares on the exercise date and the exercise price. However, the absence of clear rules on how to allocate ESOP income across countries has resulted in uncertainty, inconsistent assessments, and rising litigation.

Current tax framework

ESOPs are taxed under Section 17(2)(vi) of the Income-tax Act, 1961, read with Rule 3(8) of the Income-tax Rules, 1962. Tax expert CA Suresh Surana explained that the framework functions well in a purely domestic setting. “ESOPs are taxed as salary perquisites at the time of exercise, and the taxable value is computed as the difference between the fair market value on the exercise date and the exercise price paid by the employee. This framework functions effectively in a purely domestic context where services are rendered entirely in India during the grant-to-vesting period,” Surana told the Economic Times.

However, once employees render services across borders, the law offers little guidance on how to split the ESOP benefit.

Cross-border employment

The challenge becomes pronounced for expatriates, returning professionals, and employees holding global leadership roles. Anuj Mundhra, Founder and CMD of Nandani Creation Limited, said the ambiguity around ESOP taxation defeats the long-term incentive structure of such plans.

“The plight occurs where employees have been working across various countries during the vesting period. In such cases, the entire ESOP tax is likely to be levied in India simply because the options are exercised here, even though the value was created across multiple jurisdictions,” Mundhra said.

He added that this uncertainty affects how equity compensation is structured and perceived by globally operating Indian companies. “The very objective of ESOPs -- compensating long-term value creation—is defeated by such ambiguity,” he said.

Double taxation and risks

Experts warn that the lack of sourcing rules can expose employees to double taxation. Mundhra noted that one country may tax ESOPs based on exercise, while another may tax the same benefit because services were rendered there during vesting.

“This can lead to double taxation, even when tax treaties exist, because benefit sourcing rules differ and treaties do not always clearly allocate taxing rights for ESOPs,” he said.

This issue has gained urgency as remote work and cross-border assignments become more common across industries.

India’s policy gap

Anita Basrur, Partner at Sudit K Parekh & Co. LLP, said India’s ESOP framework is out of step with several developed jurisdictions.

“While the existing law works well for employees employed entirely in India, it is not conducive for expatriates or individuals who have rendered services both in India and abroad. Many developed countries tax ESOPs at the time of grant, whereas India taxes them at exercise, which can lead to double taxation,” Basrur said.

She added that although salary income is clearly linked to where services are rendered, “there is no mechanism under the law to compute or apportion ESOP perquisites based on service location.”

Budget 2026 expectations

Divya Baweja, Partner at Deloitte India, highlighted that the absence of apportionment rules has led to inconsistent treatment by tax authorities.

“While the ESOP taxation framework works for domestic employees, it does not address concerns for cross-border employees who have rendered services both in India and abroad during the grant-to-vesting period,” Baweja said.

According to Deloitte’s pre-Budget recommendations, this gap has resulted in litigation, hardship for mobile employees, and increased compliance complexity. Baweja said Budget 2026 offers an opportunity for reform.

“Clear guidelines from the CBDT on apportioning ESOP taxation based on service location, supported by standard formulas and documentation requirements, would align India with international best practices and significantly reduce disputes,” she said.

Experts believe Budget 2026 could codify apportionment principles either through an explanatory provision under Section 17(2) or a clarification aligned with Section 9(1)(ii). Such a move would be consistent with the government’s stated objective of reducing litigation and improving tax certainty, especially as India prepares for a simplified income-tax regime in the coming years.