For early-stage startups, cash is usually tight. They often rely on employee stock option plans (ESOPs) to attract and retain top talent, crucial for AI and deep tech startups betting on specialised skills. So far, the Centre, through the Inter-Ministerial Board of Certification, allowed the employees of certain eligible startups to defer ESOP tax liability for four years.
Now, the government is reportedly considering extending this relief to all startups recognised by the Department for Promotion of Industry and Internal Trade (DPIIT). By allowing employees to defer tax on stock options until a liquidity event, the policy aims to ease cash-flow pressure and make equity compensation more meaningful.
A senior government official told The Economic Times that the proposal aims to correct timing mismatches in ESOP taxation and ensure that employees are not taxed on unrealised gains. The government wants to come to a resolution before the budget announcement.
Early-stage founders see an obvious upside to the proposed move. Ritik Gupta, founder of B2B startup Overstockbay, told AIM that the change would immediately improve the credibility of ESOPs as a hiring tool.
“Early-stage startups usually can’t match big-company salaries, so ESOPs become an important part of the overall offer. If employees don’t have to worry about paying tax before they actually see any real benefit, ESOPs feel more practical and less risky,” he ascertained.
Yet, while the reform would address a real pain point, founders and investors caution that it does not resolve deeper issues around liquidity, valuation risk, and over-reliance on equity as a substitute for cash compensation.
Hiring Relief and Tax Equity
Gupta highlighted that while the reform is not a cure-all, it makes ESOPs more usable in real compensation planning. “It may not solve everything, but it does make the option more attractive for both founders and team members,” he said.
From a founder’s standpoint, the benefit also shows up indirectly in cash management. “Anything that makes ESOPs more acceptable gives founders more flexibility while planning compensation. When cash is tight, even small policy changes that ease pressure on salaries can make a real difference in how confidently we plan hiring and growth,” Gupta added.
Removing upfront tax is a big stress buster. “It makes ESOPs feel fairer and more realistic for employees who are already taking a risk by joining an early-stage company,” the entrepreneur noted.
Vishal Soni, co-founder and CPO of Lightbulb AI, concurred that the proposal is “a smart way of collecting tax at the time of the liquidity/sell event rather than at the time of exercising,” noting that it reduces “the perquisite tax’s immediate impact.”
The proposal is also a step forward in correcting a fundamental flaw in how ESOPs have been taxed in India.
“Assessing perquisite liability upon exercise of options in illiquid securities imposes taxation on notional gains, a perverse outcome that forces taxation prior to any actual monetisation,” stressed Chinmay Bhosale, co-founder of NYAI, a compliance-intelligence platform. “This violates the fundamental principle that tax liability should crystallise upon disposal, not acquisition.”
Extending relief under Section 80-IAC of the Income Tax Act would be an equalising measure for the startup community, as only roughly 4,000 out of the more than two lakh DPIIT-registered startups currently avail the ESOP tax shelter.
“For AI enterprises dependent upon specialised technical talent, this reform is very crucial and absolutely welcome,” Bhosale noted, adding that it “transforms equity to [a] genuine wealth-creation vehicle” and allows startups to compete for scarce expertise without forcing employees to fund tax bills out of pocket.
A Paper Tiger?
However, the ESOP tax deferral alone does not turn paper wealth into real wealth. Founders feel the move may impart more psychological relief than actual financial relief. “Liquidity is still the bigger question for most startups,” Gupta observed.
Also, the impact on very early-stage startups may be overstated. “A seed/pre-seed startup may not see much value here because very few employees have the vision to understand what ESOPs can do for them, even when offered,” Soni added.
For later-stage startups, however, the calculus changes as they can control cash outflows, deploying more capital for business growth. This shift can alter fundraising strategies.
“Such a move does help in either raising a better round sooner due to an enhancement in business metrics or delaying the fund raise, as one may have enough funds to increase the runway,” he observed.
Still, employees face ambiguity. When asked whether this policy shift would alter how his team perceives long-term ownership and commitment, Soni said, “Views are mixed on this one because it’s clever packaging,” adding that the deferral “doesn’t protect the employees from any downward valuation risk” and that a four-year liquidity horizon is “a very optimistic view.”
Venture investors, however, see the reform as marginal rather than a game-changer.
Ranjeet Shetye, venture partner at YourNest and managing director at supply chain risk management company Everstream Analytics, told AIM, “A tax deferral policy doesn’t fundamentally reshape the economics of early-stage venture capital from a VC perspective.”
Its real impact, he argued, lies in employee behaviour and retention. “What it does is it delays the taxation load. And this does make a material difference to startup employees and hence impacts their retention in a positive way.”
Shetye explained how tax friction currently affects hiring. “Right now, when you write a term sheet, you’re pricing equity against the employee’s after-tax cost of capital. This is real friction,” he said, describing how a young engineer can face a ₹20–25 lakh tax bill on notional gains without having the cash to pay it. “So either you ask for a higher base salary, or you don’t join. Either way, the startup pays a price.”
With deferral, that friction reduces. “Valuations will adjust slightly upward because the risk premium on equity gets smaller,” he added, estimating a “5–10% valuation swing” at most. But he also flagged unintended consequences. “That discipline becomes less stringent,” he said, as founders may push lower salaries and higher equity because “the tax problem becomes the employee’s problem four years later.”
This can lead to job-hopping, financial stress, and compounded risk if exits disappoint. “A startup should help employees avoid the trap of trading away significant financial security for what is potentially a phantom upside on the options,” Shetye warned.
However, founders like Ankit Aggarwal of AI-enabled upskilling startup Unstop frame the reform more squarely as a trust-building measure.
“Extending ESOP tax deferral to all DPIIT-recognised startups is a practical and people-first step,” he said. “When employees are not burdened with an immediate tax liability on unrealised gains, ESOPs move from being a symbolic benefit to a genuine opportunity for wealth creation.”
Raj K Gopalakrishnan, CEO and co-founder of KOGO AI, agreed that the reform addresses a real behavioural barrier. “We’ve seen talented engineers hesitate to exercise ESOPs simply because of the immediate tax hit,” he remarked.
At the same time, he stressed that the proposed policy is “only the starting point.” “We need clearer liquidity pathways, simpler structures, and a culture that treats employees as true partners,” he entailed.
On whether the reform truly creates wealth or remains largely symbolic, Gopalakrishnan offered a measured view. “True wealth creation will only happen when this is paired with more structured buybacks and simpler valuation norms.” Until then, ESOPs, he cautioned, risk remaining “wealth just on paper for too many people.”
The real test will lie not in tax timing alone, but whether equity is used responsibly and not as an excuse to misalign compensation structures.
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