The Bengaluru ITAT has ruled that income from the repurchase of unexercised Employee Stock Options (ESOPs) qualifies as capital gains, not salary. This decision offers significant tax relief for employees, as capital gains are generally taxed at more favorable rates than salary income. The ruling addresses a dispute involving a former Flipkart executive, setting a clearer standard for the tax treatment of stock buybacks that occur before options are converted into shares.
The Income Tax Appellate Tribunal (ITAT) in Bengaluru has delivered a landmark ruling that provides clarity on how employees should pay tax on income earned from the repurchase of Employee Stock Options (ESOPs). In a decision dated July 30, 2026, the tribunal determined that if a company buys back vested stock options from an employee before they have been exercised, the income received should be treated as capital gains rather than salary income.
This ruling is significant for startup employees and executives who often receive stock options as part of their compensation. Under current tax rules, salary income is taxed according to an individual's tax slab, which can be as high as 30% or more, depending on the income level. In contrast, capital gains—specifically long-term capital gains—are often subject to lower tax rates, potentially leading to substantial tax savings for the recipient.
The tribunal's decision was made while addressing the case of Pramod Kumar Jain, a former senior executive at the e-commerce firm Flipkart. Mr. Jain had received approximately ₹2.33 crore from Flipkart when the company repurchased 2,653 of his vested stock options. While Mr. Jain classified this income as capital gains in his tax return, the tax department argued that it should be taxed as a salary perquisite, or a salary-related benefit, under Section 17(2)(vi) of the Income Tax Act.
The ITAT bench disagreed with the tax department's stance. The tribunal clarified that Section 17(2)(vi) only applies when an employee exercises their options and receives actual shares of the company. In this case, because Mr. Jain had never exercised the options and no shares were ever allotted to him, the tribunal concluded that the options could not be treated as 'specified securities' for salary taxation. Instead, the court viewed the unexercised options as capital assets, meaning the transaction was a transfer of an asset, which falls under capital gains.
While this ruling provides a favorable precedent, taxpayers should be aware that tax matters remain complex. The classification of income can still be challenged based on the specific facts of an individual case. Furthermore, given that there have been varying interpretations in past cases by different judicial bodies, including some high courts, there is always a possibility that the Income Tax Department may choose to challenge similar interpretations in higher courts.
For employees who have previously reported such income as salary, this ruling may open avenues for seeking rectifications or refunds, though this process requires careful documentation and professional tax advice. Moving forward, the key monitorable for employees and companies will be the consistency of this interpretation by tax authorities across different jurisdictions. Maintaining clear and accurate records of ESOP agreements and buyback terms will remain essential to support the classification of such gains during tax filings.