For startup employees, watching an equity pool grow on paper is exciting, but nothing beats the feeling of real liquidity. Typically, employees wait for an IPO or a secondary sale to cash out. However, an increasingly popular alternative has emerged in the Indian corporate ecosystem: the corporate buyback of stock options.

With prominent companies like Unacademy and Atlys orchestrating multi-crore buybacks in early 2026, alongside massive historic events from the likes of Flipkart, Meesho, and Darwinbox, option buybacks have become a proven tool for rewarding talent.

But how do these buybacks work under the hood, and what are the tax positions involved? Let’s unpack the core concepts.

The Corporate & Employee Dynamics

An ESOP buyback is a strategic balancing act between the company’s financial planning and the employee’s wealth goals.

From the Company’s Perspective:

• Capital Allocation: The company must arrange significant cash reserves to fund the payout.
• Equity Concentration: Buying back and cancelling options reduces the potential diluted share pool, often resulting in a proportionate increase in the shareholding of existing promoters and investors.
• Pricing: Buybacks can be executed at a discounted price before a major liquidity event, with the valuation determined by a registered Merchant Banker.

From the Employee’s Perspective:

• Early Liquidity: Employees get a tangible cash payout without waiting for an uncertain IPO timeline.
• Tax Optimization Opportunities: It opens up a vital debate on how the income should be categorized.

The Big Tax Debate: Salary vs. Capital Gains

When a company buys back unexercised stock options directly from an employee, the tax treatment is a grey area that requires careful navigation. Currently, two distinct positions can be evaluated:

Position 1: Taxed as Salary

The standard, lower-risk position treats the buyback proceeds as a cash incentive arising directly out of employment. Under this view, the company deducts TDS under the head “Salaries” at the employee’s normal slab rate, which can go as high as 39% (including applicable surcharges and cess).

Position 2: Taxed as Capital Gains

Stock options may be regarded as a ‘security’ and a capital asset. A tax position of treating the buyback of these options as a capital gains transaction may be explored. If this position holds, the tax rate could drop significantly to a beneficial long-term capital gains rate of 14.95% for options held for at least 24 months.

Treating an option buyback as a capital gain is highly nuanced and carries a notable risk of litigation from the tax department. Companies and individuals look at this on a case-by-case basis.

Summary

An ESOP buyback is an excellent mechanism for companies to clean up their cap tables while putting real cash into the pockets of their workforce. However, because the legal and tax positions surrounding option cancellations are intricate and subject to scrutiny, corporate finance teams routinely evaluate these structures alongside specialized legal and tax counsel to mitigate future litigation risks.