The Income Tax Appellate Tribunal (ITAT) ruled that gains from the repurchase of vested but unexercised employee stock options (ESOPs) are taxable as long-term capital gains, not as salary income. This overturns the tax authority’s aggressive stance of treating such buybacks as perquisites under Section 17(2)(vi) of the Income Tax Act. The case involved a Bengaluru-based startup, though the ruling sets a precedent for the broader ecosystem where ESOPs are a critical retention tool. Industry estimates suggest Indian startups have issued ESOPs worth over $6B in the past five years, with unexercised options often repurchased during down rounds or liquidity events.

This ruling is a lifeline for cash-strapped startups and employees alike. Previously, the taxman treated unexercised ESOP buybacks as income, slapping them with slab rates as high as 30% plus surcharges. Now, gains will be taxed at 10-15% under capital gains, assuming the holding period exceeds 24 months. For startups, this reduces the liability when repurchasing options to conserve cash or restructure cap tables. For employees, it aligns incentives, making ESOPs more attractive despite the risk of illiquidity. The second-order effect is a potential surge in ESOP issuance, as startups use equity more aggressively to attract talent in a tight labor market.

Winners: Indian startups (especially those in late-stage funding crunches like Ola, Oyo, and Unacademy), ESOP-holding employees, and venture-backed firms with complex cap tables. Losers: The Income Tax Department, which may see a short-term revenue hit as startups restructure past transactions. Tax consultants win too, as they scramble to amend filings for prior years under the new precedent.

Expect the CBDT to challenge this ruling in higher courts, as the revenue implications could run into hundreds of crores. Startups will likely accelerate ESOP buybacks before any potential reversal. Also watch for SEBI’s reaction, as this may influence its pending ESOP norms for listed companies.