An ESOP trust buyback in India may involve an ESOP trust purchasing an employee’s shares using company funding subject to the Rule 16 requirements, including the 5% ceiling on the loan outstanding to the trust, or the company itself buying back eligible securities under Section 68 of the Companies Act, 2013. Since April 2026, the seller pays capital gains tax either way.
My company drafts ESOP schemes and advises startups and smaller businesses on them, and my advice to a founder is to decide which of those two routes you’ll use before the first grant letter goes out. The scheme and the trust deed decide whether you can call for a leaver’s shares at all. The trust also needs its own special resolution before the company can fund it, and a listing brings SEBI’s limits on top. Leave it until your first senior hire resigns and you’ll be choosing between routes you haven’t set up.
The tax on those routes changed in April 2026. Until then, if a company bought back your shares, the whole payment was taxed as a dividend at your slab rate, and what you had paid for those shares could only be claimed as a capital loss. Now buyback money is capital gains again, so you’re taxed only on what you actually gained, and promoters pay an extra tax on top.
The timing matters, because startups are buying back ESOP shares at a pace not seen in two years. Entrackr counted about $220 million of startup ESOP buybacks in the first three months of 2026, more than in all of 2024 or all of 2025.
A trust comes into this at all because Indian company law doesn’t let a company trade in its own shares. Section 67 of the Companies Act, 2013 bars a company from buying its own shares unless it reduces its capital, and it bars a public company from paying for anyone else to buy them. Section 67(3)(b) makes one exception that matters here. It lets a company put up money, under a scheme its shareholders approve by special resolution, for fully paid shares that trustees buy and hold for employees.
That exception is the legal basis of the ESOP trust. The trust can take back a leaver’s shares and hold them for the next grant, and the company’s capital doesn’t move.
The trust is only one of the buyers people mean when they say “buyback”, and anyone drafting a scheme has to keep them apart. The word “buyback” covers four different transactions, and the law treats each one differently.
The ESOP trust can buy your shares, the company can buy them back itself under Section 68, the company can pay you cash for options you haven’t exercised, or an outside investor can buy your shares. From 1 April 2026, a company’s own Section 68 buy-back is again taxed as capital gains. Sales of shares by an employee to an ESOP trust or an outside investor continue to be dealt with under the ordinary capital-gains provisions. Only the Section 68 buyback carries the promoter tax, and the tax on cash paid for unexercised options is still disputed.
Which of those buyers can take back a departing employee’s shares, and with whose money, is easiest to see in one exit. Take an unlisted private company with a foreign investment company among its shareholders, which set up an ESOP trust when it adopted its scheme. A senior engineer who exercised options three years ago is leaving with 20,000 shares. The founders want those shares back so the trust can grant them again.
For those founders, the choice is between the trust and the company. The trust can buy the shares at a registered valuer’s price, with money the company lends it under Section 67(3)(b),The trust buys at a registered valuer’s price on company money, with the shares and the funding together within 5% of paid-up capital and free reserves. The company can instead buy them back under Section 68, but that has to be paid for out of free reserves or the securities premium account. It also needs a special resolution unless it stays within the 10% the Board can approve, and it starts a one-year wait before the company can make another buyback offer.
The trust route fits this exit, because it’s built for one leaver and it doesn’t reduce the company’s capital.For ESOP shares covered by Section 17(1)(d), the FMV taken into account for the salary perquisite generally becomes the cost of acquisition for capital-gains purposes under Section 73. The subsequent capital gain therefore generally reflects the change in value after that perquisite valuation., and because the shares have been held for more than 24 months, that gain is long-term and taxed at 12.5%. Every step of that route runs on Section 67(3)(b) and Rule 16.
The ESOP trust as buyer in an unlisted company
The ESOP trust in an unlisted company can buy your shares with money the company provides under Section 67(3)(b) of the Companies Act, 2013, as long as the company meets the conditions in Rule 16 of the Companies (Share Capital and Debentures) Rules, 2014. It buys shares, never options. Rule 12(8) of the same Rules makes an unlisted company’s options non-transferable, so you have to exercise before the trust has anything to buy.
Getting the trust to that point takes two shareholder approvals. The shareholders approve the ESOP scheme itself by special resolution under Rule 12(1), and a company that wants to fund a trust needs a separate special resolution for that funding under Rule 16(1)(a). Rule 12(6)(a) also puts at least one year between grant and vesting, so nobody holds shares the trust could buy until at least a year after the grant. How grant, vesting and exercise work is set out in how an ESOP scheme works in listed and unlisted companies.
Funding the ESOP trust under Section 67(3)(b) and Rule 16
Funding the ESOP trust under Section 67(3)(b) needs a scheme approved by special resolution, and Rule 16(1) adds conditions on the money itself. If the shares are unlisted, a registered valuer has to fix the price the trust pays. Under Rule 16(1)(d), the value of the shares the trust buys, taken together with the money the company provides, can’t exceed 5% of the company’s paid-up capital and free reserves. Breach Section 67 and the company faces a fine of ₹1 lakh to ₹25 lakh, while every officer in default faces up to three years in prison and a fine in the same range.
Rule 16(2) sets out what shareholders must be told before they vote on that resolution. They have to know which employees benefit, who the trustees are and how they’re connected to promoters, directors or key managerial personnel, and what interest those people have in the scheme. They also have to know who will vote the trust’s shares and how. Rule 16(3) stops directors, key managerial personnel, promoters, their relatives and anyone holding 10% or more of the paid-up capital from being trustees, and if employees don’t vote the shares themselves, Rule 16(4) makes the Board’s report disclose who did, at which meetings and which way.
A private company may be outside all of this. A 2015 exemption notification, G.S.R. 464(E), says Section 67 doesn’t apply to a private company that meets three conditions. No other body corporate has invested money in it. Its borrowings from banks, financial institutions and bodies corporate are below twice its paid-up capital or ₹50 crore, whichever is lower, and it isn’t in default in repaying those borrowings at the time of the transaction.
A startup with any company on its share register, a foreign investment vehicle for instance, fails the first condition and can’t use the exemption. Section 67(2) by its own words reaches only public companies, so how far Section 67 binds a private company outside the exemption isn’t settled. The safer course for such a company is to follow Rule 16 in full.
ESOP trust buyback from a departing employee
An ESOP trust buyback from a departing employee depends first on the scheme and the trust deed, because the Companies Act gives neither you nor the company a right to force the sale. The leaver clauses usually decide whether the company or its trust can call for your shares, at what price, by when, and whether a good leaver is treated differently from a bad one.
For unlisted shares, the price comes from a registered valuer’s report under Rule 16(1)(c), and the trust may fund the acquisition using the money provided by the company under the approved arrangement, together with other funds available to it as permitted under the scheme, trust deed and applicable law. When the next employee exercises options against those shares, the exercise price goes to the trust, and the trust deed usually has the trust use it to repay the company. Where the scheme and trust deed permit reuse of shares, shares held by the trust may subsequently be appropriated or transferred to other eligible employees.
While the trust holds the shares between grants, the company’s share capital doesn’t change. The trust can also sell to the company in a general Section 68 buyback, which is how an unlisted company gets cash to every holder rather than one leaver, as the procedure for buy-back of shares in unlisted companies sets out. All of this works only while the company is unlisted, because listing brings SEBI in as a second regulator.
Secondary acquisition limits on a listed company’s ESOP trust
Secondary acquisition limits on a listed company’s ESOP trust come from Regulation 3 of the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021. Secondary acquisition by an ESOP trust is subject to a 2% annual ceiling under Regulation 3(10). The overall ceiling under Regulation 3(11) depends on the category of scheme: 5% for schemes under Parts A, B and C, 2% for schemes under Parts D and E, and 5% for all schemes taken together. The Regulations define secondary acquisition as buying on a recognised stock exchange for cash, so a listed trust has no route to buy a leaver’s shares in a private deal. Rule 16(1)(b) says the same for listed shares bought with the company’s money.
I took a bootstrapped company to a listing on the NSE’s SME platform, and Once the company’s shares are listed, the ESOP trust becomes subject to the applicable SEBI employee-benefit regulations in addition to the Companies Act framework. From the date of listing the SEBI Regulations apply alongside Rule 16, and they make a trust compulsory for any scheme that involves buying shares in the market.
SEBI also controls who runs a listed trust and what it can do. Directors, key managerial personnel and promoters of the company or its group companies, their relatives, and anyone holding 10% or more of the shares can’t be trustees. The trustees can’t vote the trust’s shares, the trust can’t deal in derivatives, and its holding counts as neither promoter nor public shareholding.
A company buyback can push the trust over its limit without the trust buying a single share, because the company’s capital shrinks while the trust’s holding stays the same. SEBI’s FAQs on the Regulations say the trust can keep its shares in that case, but it can’t buy any more.
Permitted sales by a listed company’s ESOP trust
Permitted sales by a listed company’s ESOP trust are narrow, because Regulation 3(15) says the trust must not become a mechanism for trading in shares. It can sell on the exchange only for set purposes. Among them are covering the exercise price and tax in a cashless exercise, repaying the company’s loan when shares haven’t been appropriated to grants in time, winding up, and taking part in a buyback, open offer or delisting. Outside those purposes, a trust running a stock option, share purchase or stock appreciation scheme needs SEBI’s approval to sell, sought on payment of a ₹1 lakh fee.
Shares the trust buys on the market have to be held for at least six months. Regulation 3(13) makes an exception only for transfers in an open offer, buyback, delisting or other exit offered to shareholders generally. Read literally, that leaves no exception for passing shares to employees within the six months, and SEBI’s FAQs don’t address the point.
Off the exchange, the trust can transfer shares only to employees under the scheme, or in an open offer, buyback, delisting or other exit offered to shareholders generally. The Buy-back Regulations separately bar any buyback through a negotiated deal or private arrangement. A listed trust therefore can’t sell its shares back to the company privately.
Buyback of ESOP shares by the company under Section 68
A buyback of ESOP shares by the company itself is allowed under Section 68(5)(c) of the Companies Act, 2013, which lets a company buy back securities issued to employees under a stock option or sweat equity scheme. The usual Section 68 conditions still apply. The money has to come from free reserves, the securities premium account or the proceeds of a different kind of issue. The buyback has to stay within 25% of paid-up capital and free reserves, the company’s debt afterwards can’t exceed twice its capital and free reserves, and only fully paid shares qualify.
The Board alone can approve a buyback of up to 10% of paid-up equity capital and free reserves, and anything larger needs a special resolution. There has to be a year between one offer closing and the next, the buyback has to be completed within a year of the resolution, and the shares bought back have to be extinguished within seven days. For six months afterwards the company can’t make a further issue of the same kind of shares. Section 68(8) excepts bonus issues and subsisting obligations under stock option and sweat equity schemes, so employees can still exercise options they already hold.
ESOP buyback procedure in an unlisted company under Rule 17
The ESOP buyback procedure in an unlisted company runs under Rule 17 of the Share Capital and Debentures Rules. The company files a letter of offer in Form SH-8 and a declaration of solvency in Form SH-9 with the Registrar, sends the offer to shareholders within 20 days, and keeps it open for 15 to 30 days, or less than 15 days if all members agree. Once acceptances are verified, it pays within seven days, records the shares in a register in Form SH-10, and files a return in Form SH-11.
The company can’t pay with money borrowed from banks or financial institutions. Before the offer goes out, a private company that isn’t a small company or a government company also needs its promoters’, directors’ and key managerial personnel’s holdings in demat form, under Rule 9B of the Companies (Prospectus and Allotment of Securities) Rules, 2014. If more shares are tendered than the company offered to buy, acceptances are made in proportion.
A selective Section 68(5)(c) buyback from the company’s own ESOP trust alone is doubtful. The trust’s shares weren’t issued to it as an employee, and Section 68(5)(c) speaks only of securities issued to employees.
Parliament is also considering changes to Section 68. The Corporate Laws (Amendment) Bill, 2026, which a Joint Parliamentary Committee reported on in August 2026, would let prescribed classes of companies do up to two buybacks a year, six months apart. It would also extend the Section 68(5)(c) employee route to schemes linked to the value of share capital, such as restricted stock units. The Bill hasn’t been enacted.
The ESOP trust tendering in a listed company’s buyback
The ESOP trust tenders in a listed company’s buyback the way any other shareholder does. Regulations 3(14)(b) and 3(15)(d) of the SEBI employee benefit regulations let it transfer or sell shares in a buyback offered to shareholders generally. What it can’t do is sell to the company privately, because Regulation 4(vi) of the SEBI (Buy-Back of Securities) Regulations, 2018 bars that.
SEBI’s July 2026 amendment to the Buy-back Regulations brings back the open-market route through the stock exchange from 1 August 2026, for buybacks below 15% of paid-up capital and free reserves. That route had been shut since 1 April 2025. In between, a listed company could use a tender offer or the book-building route, and a listed trust took part in a tender offer by tendering like any other shareholder.
The company can keep honouring its stock options during the buyback period. Regulation 24(i)(b), as amended in November 2024, carves subsisting obligations under stock option and sweat equity schemes out of the bar on issuing new shares. SEBI’s non-binding informal guidance to Infosys in 2019 had taken a narrower line, allowing grant letters during a buyback period but not the conversion of options into shares until it ended, and the 2024 amendment has since overtaken part of that view. Whichever way the shares go back, that route decides the seller’s tax.
Tax on the employee selling in an ESOP trust buyback
From 1 April 2026, a company’s Section 68 buy-back is taxed under the capital-gains regime in Section 69 of the Income-tax Act, 2025. A sale of ESOP shares to an ESOP trust or an outside investor is instead an ordinary transfer and is generally taxed under the applicable capital-gains provisionsy.
You’d expect that to mean the route no longer matters, but it still does, because of one extra tax. The additional tax on promoters under Section 69(2) applies only when the company buys its own shares under Section 68, and For an unlisted company, the promoter definition in Section 69 includes a person who directly or indirectly holds more than 10% of the company’s equity share capital, subject to the other elements of the statutory definition. The Explanatory Memorandum to the Finance Bill puts the effective rate at 22% for a promoter that’s a company and 30% for any other promoter. A separate interpretive question is whether an ESOP trust holding more than 10% of an unlisted company’s equity share capital falls within this promoter limb. The statutory text does not expressly address an ESOP trust in this context, so this point should not be treated as settled.
Capital gains on an ESOP trust buyback after 1 April 2026
Capital gains on an ESOP trust buyback after 1 April 2026 are counted from the value you were already taxed on at exercise. When you exercise, the gap between the fair market value and the exercise price is taxed as a salary perquisite under Section 17(1)(d) of the Income-tax Act, 2025, which replaced Section 17(2)(vi) of the 1961 Act. Section 73 then makes that fair market value your cost when you sell. The buyback gain is therefore only the growth after exercise, and the salary side is covered in the iPleaders note on taxation of stock options and employee compensation.
The rate depends on whether the shares are listed. Unlisted shares turn long-term after 24 months, and a long-term gain on them is taxed at 12.5% under Section 197 with no ₹1.25 lakh exemption. A short-term gain on unlisted shares is added to your income and taxed at slab rates. Listed shares on which securities transaction tax is paid turn long-term after 12 months, with long-term gains taxed at 12.5% above ₹1.25 lakh under Section 198 and short-term gains at 20% under Section 196.
Sales between 1 October 2024 and 31 March 2026 ran on the old rule. In a Section 68 buyback the whole payment was taxed as a dividend at your slab rate, and the cost of the shares became a capital loss you could set off against other capital gains. A sale to the trust or to an investor was never caught, because that rule applied only to a company buying its own shares under Section 68.
Cash-out of unexercised ESOP options
A cash-out of unexercised ESOP options isn’t a buyback of shares at all, because there are no shares until you exercise. It’s usually taxed as salary, and your employer deducts tax on it as salary. How exercise works and when it creates shares is covered in how Employee Stock Option Plans are exercised.
The Income Tax Appellate Tribunal at Bangalore took a different view in July 2026, in Pramod Kumar Jain v. DCIT (ITA No. 3034/Bang/2025). Flipkart’s Singapore parent had paid about ₹2.33 crore to buy back 2,653 vested options the employee hadn’t exercised. The Tribunal held that money to be long-term capital gains, not a perquisite, because an option isn’t a “specified security” until it’s exercised.
The Delhi High Court reached a related result in 2024, in Sanjay Baweja v. DCIT. It held that a one-time voluntary payment by Flipkart’s Singapore parent to option holders, for the fall in value of their unexercised options after PhonePe was separated, wasn’t a perquisite taxable as salary.
The Tribunal’s ruling doesn’t bind any High Court, and the Revenue can still appeal. It was decided under the 1961 Act, so how it applies to Section 17(1)(d) of the 2025 Act hasn’t been tested.
Whether the options have been exercised is one of four facts that decide how an exit should be structured, and you can settle all four before anyone signs:
- Whether the company is listed, which decides whether SEBI’s 2% and 5% limits and its exchange-only rule govern the trust.
- Who’s buying, whether the trust, the company under Section 68 or an investor, which decides whether the promoter tax can apply at all.
- Whether the options have been exercised, which decides whether there are shares to sell or only options to cash out.
- Whether any seller holds more than 10% of an unlisted company, which makes that seller a promoter in a Section 68 buyback.
Frequently asked questions
Is money from an ESOP buyback taxed as salary or as capital gains? Money from an ESOP buyback of shares is taxed as capital gains from 1 April 2026, whether the company buys under Section 68 or the ESOP trust buys. The value up to exercise was already taxed as salary when you exercised, and the buyback gain is counted from there. A payment for options you never exercised is usually taxed as salary, though the Income Tax Appellate Tribunal at Bangalore treated one such payment as capital gains in July 2026.
Can an ESOP trust buy back shares from an employee who leaves? An ESOP trust can buy shares from an employee who leaves, if the scheme and the trust deed allow it. In an unlisted company a registered valuer sets the price, and the loan outstanding to the trust must remain within the statutory 5% ceiling based on the company’s paid-up capital and free reserves. A listed company’s trust can buy only on the stock exchange, within 2% of paid-up equity capital a year.
Is the ₹1.25 lakh exemption available on a buyback of unlisted startup shares? The ₹1.25 lakh exemption isn’t available on a buyback of unlisted startup shares. Section 198 of the Income-tax Act, 2025 gives it only on listed equity shares on which securities transaction tax has been paid. A long-term gain on unlisted shares is taxed at 12.5% under Section 197, with no threshold of its own.
Is TDS deducted on an ESOP buyback payment? TDS on an ESOP buyback payment depends on how the payment is taxed. Between October 2024 and March 2026, payments in a company’s own Section 68 buyback were taxed as dividends, with tax withheld as on a dividend, and cash paid for unexercised options that the company treats as salary has tax deducted as salary. Tax on the value of your shares at exercise is also deducted as salary when you exercise. An eligible start-up can defer that deduction under Section 392(3) of the Income-tax Act, 2025 until you sell the shares, leave the company, or reach sixty months from the end of the tax year, whichever comes first.
References
Companies Act, 2013 (sections cited: 67 and 68)
Companies (Share Capital and Debentures) Rules, 2014 (rules cited: 12, 16 and 17)
Companies (Prospectus and Allotment of Securities) Rules, 2014 (rule cited: 9B)
G.S.R. 464(E), Ministry of Corporate Affairs, 5 June 2015 (exemptions to private companies)
Securities and Exchange Board of India (Share Based Employee Benefits and Sweat Equity) Regulations, 2021, as amended up to 4 December 2025 (regulations cited: 2(1)(nn), 3)
Securities and Exchange Board of India, Frequently Asked Questions on the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (November 2021)
Securities and Exchange Board of India (Buy-Back of Securities) Regulations, 2018, as amended up to 20 November 2024 (regulations cited: 4(vi), 24(i)(b))
Securities and Exchange Board of India (Buy-Back of Securities) (Amendment) Regulations, 2026 (in force 1 August 2026)
Income-tax Act, 2025 (sections cited: 17, 69, 73, 196, 197, 198 and 392)
Finance Act, 2026 (Act 4 of 2026) and the Explanatory Memorandum to the Finance Bill, 2026
Corporate Laws (Amendment) Bill, 2026 (Bill No. 85 of 2026, pending)
Pramod Kumar Jain v. Deputy Commissioner of Income Tax, ITA No. 3034/Bang/2025 (Income Tax Appellate Tribunal, Bangalore, 30 July 2026)
Sanjay Baweja v. Deputy Commissioner of Income Tax (High Court of Delhi, 30 May 2024)
Entrackr, “Indian startup ESOP buybacks in Q1 2026 beat 2024 and 2025” (April 2026)
Disclaimer
This article is for informational purposes only and doesn’t constitute legal or tax advice. How a particular ESOP exit is treated depends on the scheme, the trust deed, whether the company is listed and the facts of the sale, and parts of the position under the Income-tax Act, 2025 haven’t yet been tested before the courts.