Beyond ESOPs: Types Of Share-Based Compensation In India
How RSUs, SARs, phantom stock and ESPPs actually work in India: dilution, tax triggers, compliance and which instrument fits which company.
The ESOP series
- What are ESOPs? ESOP meaning, vesting and tax in India
- Types of vesting: Time-based vs performance-based and vesting schedules
- Beyond ESOPs: RSUs, SARs, phantom stock and ESPPs – you are here
Key takeaways
The six things worth remembering
- ESOPs are one instrument among five. RSUs, SARs, phantom stock and ESPPs each solve a different problem and carry a different compliance load.
- The first design question is settlement. Equity-settled schemes dilute ownership but cost no cash. Cash-settled schemes protect the cap table but create a real, moving liability.
- The second question is whether the employee is rewarded only if the share price rises, as with ESOPs and SARs, or regardless of it, as with RSUs and phantom stock.
- Tax triggers differ by instrument: at exercise for ESOPs, at vesting for RSUs, at purchase for ESPPs and at payout as salary income for cash-settled SARs and phantom stock.
- Cash-settled instruments can be offered to consultants and advisors, who are not eligible for ESOPs under the Companies Act.
- The Corporate Laws (Amendment) Bill, 2026 proposes statutory recognition for RSUs and SARs, but until the underlying Rules are amended these instruments still operate within the existing ESOP framework.
Quick answer
What are the types of share-based compensation in India?
Share-based compensation in India runs to five instruments in common use: ESOPs, restricted stock units, stock appreciation rights, phantom stock and employee stock purchase plans. Each differs on three things that matter: whether it dilutes the cap table, whether the employee pays anything, and the moment tax falls due.
Most Indian companies treat share-based compensation and ESOPs as the same conversation. They are not. ESOPs are one instrument among five in common use and the wrong choice shows up years later as an exhausted option pool, an unexpected tax bill for a senior hire, or a scheme that quietly demotivates the people it was built to reward. This guide covers what each instrument is, how it is taxed in India and where each one genuinely fits.
01The two families: Equity-Settled Vs Cash-Settled
Every share-based instrument answers one structural question first: Does the employee end up holding actual shares, or cash calculated by reference to share value? That single split drives dilution, compliance load and accounting treatment more than any other design choice.
Equity settled
Dilutive – the cap table changes
- Employee Stock Option Plans (ESOPs)
- Restricted Stock Units (RSUs)
- Employee Stock Purchase Plans (ESPPs)
- Equity-settled Stock Appreciation Rights
Cash settled
Non-dilutive – the P&L absorbs it
- Cash-settled Stock Appreciation Rights (SARs)
- Phantom stock or phantom units
- Cash-settled Restricted Stock Units
The trade-off in one line
Equity-settled schemes dilute ownership but cost the company no cash. Cash-settled schemes protect the cap table but create a real liability that has to be funded and that moves with the share price every reporting period.
The table below is the fastest way to see the trade. Read across the dilution and cash columns first, because those two decide which family you are in before any of the employee economics matter.
Instrument | Settlement | Dilutes the cap table | Company cash cost | Accounting treatment |
|---|---|---|---|---|
ESOP | Equity | Yes | None, the employee pays in | Equity-settled, charge fixed at grant-date fair value |
RSU | Equity or cash | Yes, when equity-settled | None, when equity-settled | Equity-settled, higher charge per unit |
Equity-settled SAR | Equity | Yes, on the appreciation only | None | Equity-settled |
Cash-settled SAR | Cash | No | Real outflow at settlement | Liability, remeasured every reporting period |
Phantom stock | Cash | No | Real outflow at settlement | Liability, remeasured every reporting period |
ESPP | Equity | Yes | The discount, and any look-back value | Equity-settled, look-back adds complexity |
02The risk and return map
Plotting the instruments on two axes is the quickest way to see which ones can pay nothing at all.
The second question is whether the employee is rewarded only if the share price rises, or regardless of what the price does. Plot both axes together and the five instruments fall into distinct territory.
The risk and return map
Where each instrument sits on settlement type and dependence on share price growth.
Hover any instrument for detail
03ESOPs: The Default Startup Instrument
An Employee Stock Option Plan gives an employee the right, not the obligation, to buy company shares at a fixed exercise price after vesting conditions are met. The employee pays that price to convert the option into shares.
Settlement
Equity
Employee pays
Yes, at exercise
If price falls
Can be worthless
Tax point
Exercise, then sale
Where it works
- Conserves cash, which is why early-stage companies rely on it.
- Genuine wealth creation potential when the share price climbs steeply.
- Stable, predictable charge to the profit and loss account year on year.
- Creates a real sense of ownership, since employees end up on the cap table.
Where it strains
- Dilutive: Every grant reduces existing shareholders' percentage.
- Cannot be issued to consultants and advisors under Indian eligibility rules.
- In private companies, exercise creates a cash-flow strain, because tax falls due before any sale is possible.
- Employees who cannot influence the share price may not feel motivated by it.
Best suited to: Early and growth-stage private companies expecting significant appreciation, granting broadly across the team.
04RSUs: Value That Cannot Fall To Zero
A Restricted Stock Unit is a commitment to deliver shares, or the value of shares, at a future date once vesting conditions are met. There is no exercise price and no exercise step. The shares simply arrive on vesting.
Settlement
Equity or cash
Employee pays
Nothing, or face value
If price falls
Still holds value
Tax point
Vesting, then sale
Where it works
- Never underwater: The employee receives full value of the share, not just the appreciation.
- Protects employees from market swings that can leave options worthless.
- Easier for employees to value, since the worth is simply the share price.
- Commonly issued with strong performance conditions, since shares are given at little or no cost.
Where it strains
- Tax falls due at vesting on the full value, whether or not the employee sells.
- Rarely works as a broad-based tool in private companies, where shares are illiquid.
- Grants tend to be smaller than ESOP grants, so the upside is capped in practice.
- Higher accounting charge for the same number of units, since the units always have value.
Best suited to: Listed companies, Indian subsidiaries of listed multinationals and senior hires who want certainty rather than upside. RSUs are the dominant equity instrument in Indian arms of global technology firms for exactly this reason.
05SARs and phantom stock: Ownership Economics Without Ownership
A Stock Appreciation Right entitles an employee to the increase in share value between grant and exercise, settled in cash or in shares. Phantom stock is a variation that is always cash settled and structured as a bonus plan linked to share value, frequently issued with a strike price of zero. In both cases the employee never pays an exercise price.
Settlement
Usually cash
Employee pays
Nothing
Cap table
Unchanged
Tax point
Payout, as salary
Where it works
- Non-dilutive: The cap table is untouched, which matters when investors are watching ownership thresholds.
- Can be offered to consultants, advisors and in some structures promoters, unlike ESOPs.
- No cash-flow strain for the employee, since there is no exercise price to fund.
- Works well for Indian subsidiaries whose parent is listed outside India.
- Can be structured as rolling performance-linked schemes in place of cash bonuses.
Where it strains
- Profit and loss volatility: Cash-settled schemes are marked to market each period.
- Treated as a liability for accounting purposes, which increases gearing.
- Significant cash outflow for the company at settlement unless tied to a liquidity event.
- Employees get no actual ownership, so the psychological pull of being a shareholder is absent.
- Like ESOPs, a SAR can expire worthless if the share price does not rise above the strike price.
Best suited to: Companies unwilling to dilute, those rewarding consultants or advisors and Indian subsidiaries of overseas parents. Phantom stock is also the common fallback when an ESOP pool is exhausted and a senior hire still needs an equity-linked package.
06ESPPs: A Savings Plan In Company Shares
An Employee Stock Purchase Plan lets employees buy company shares at a discount, funded by fixed payroll deductions accumulated over an offering period. There is no vesting in the ESOP sense; purchases happen automatically on defined purchase dates.
Settlement
Equity
Employee pays
Via salary deduction
Typical discount
Around 5 to 15 percent
Tax point
Purchase, then sale
Where it works
- Gives employees a disciplined, recurring way to build a holding in the company.
- Look-back provisions can set the price at the lower of two dates, adding real value in a rising market.
- Employees choose their own contribution level, so participation is genuinely voluntary.
- Rising share prices lift total compensation without any new grant decision.
Where it strains
- Administratively complex, requiring tight governance of contributions and discounts.
- Look-back features make the accounting materially harder.
- Employees may resent a salary deduction, or see little benefit in the short run.
- Requires liquid, freely traded shares, so it rarely suits unlisted companies.
Best suited to: Listed companies with well-traded shares and companies close to a listing. ESPPs remain uncommon in India relative to other markets and are not a realistic instrument for startups.
Choosing an instrument is really choosing who carries the risk: the cap table, the profit and loss account, or the employee's own bank balance.
07When tax actually hits: A Side-By-Side View
Each instrument triggers tax at a different moment. Getting that moment wrong is what causes incorrect withholding.
The single most useful thing to understand about these instruments is that they trigger tax at different moments. Getting this wrong leads to incorrect TDS deduction and errors in filing.
Instrument | First tax event | What is taxed | Second tax event |
|---|---|---|---|
ESOP | Exercise | FMV on exercise date less exercise price, as a salary perquisite | Capital gains on sale, measured from FMV at exercise |
RSU | Vesting | Full FMV of the shares received, as a salary perquisite | Capital gains on sale, measured from FMV at vesting |
ESPP | Purchase | FMV on purchase date less the price actually paid | Capital gains on sale, measured from FMV at purchase |
SAR (cash settled) | Payout | The entire cash amount, as salary income | None – the employee never holds shares |
Phantom stock | Payout | The entire cash amount, as salary income | None – the employee never holds shares |
The startup deferral and who gets it
Employees of DPIIT-recognised eligible startups can defer TDS on the ESOP perquisite under Section 192(1C), until the earliest of roughly five years from grant, the sale of the shares, or leaving the company. This relief is specific to stock options in eligible startups. It does not extend to cash-settled instruments, where the payout is taxed as ordinary salary income when received.
For unlisted companies, fair market value must be determined by a registered merchant banker or registered valuer on the specified date. Internal valuations are not acceptable for tax purposes and are among the first things scrutinised in diligence.
Tax
When each instrument is first taxed
The first taxable moment is the number that decides whether an employee can actually afford the instrument. Check it against the liquidity route before you grant.
08What Indian law requires
Compliance load, not economics, is often what decides which instrument a company can realistically run.
Compliance load varies sharply by instrument and this is often the deciding factor rather than the economics.
1 year
Statutory minimum between grant and vesting for options
Special
Resolution required from shareholders for share-issuing schemes
Excluded
Promoters, independent directors and 10 percent-plus directors, with a startup carve-out
60 days
Window to report overseas grants in Form OPI after each half-year
- Unlisted companies: ESOPs are governed by Section 62(1)(b) of the Companies Act, 2013 read with Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014, as published by the Ministry of Corporate Affairs. Equity-settled SARs and RSUs have historically been issued within this same framework.
- Listed companies: The SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021, last amended in December 2025, govern ESOPs, RSUs and equity-settled SARs. For listed entities, cash-settled SARs sit outside those regulations.
- Cash-settled phantom stock: Because no securities are issued, it generally avoids equity-issuance compliance altogether and is documented as a bonus plan. SEBI's 2015 informal guidance in the Mindtree matter is the reference point most advisors still cite here.
- Cross-border grants: Where the parent is overseas, FEMA obligations apply, including Form OPI reporting and the Liberalised Remittance Scheme limit, with no limit in the case of cashless exercises.
Recipient | ESOP / RSU / equity SAR | Phantom stock or cash SAR | Note |
|---|---|---|---|
Permanent employees | Eligible | Eligible | The standard population for every instrument |
Whole-time and executive directors | Eligible | Eligible | Subject to the scheme's own limits |
Independent directors | Not eligible | Generally avoided | Excluded under Rule 12 |
Promoters and promoter group | Not eligible | Possible, as a bonus plan | Recognised startups get a time-limited carve-out |
Directors holding over 10 percent | Not eligible | Possible | Same startup carve-out applies |
Consultants and advisers | Not eligible | Eligible | The single most common reason to reach for phantom stock |
Change on the horizon – Corporate Laws (Amendment) Bill, 2026
Introduced in the Lok Sabha on 23 March 2026 and since referred to a Joint Parliamentary Committee, as recorded on the PRS Legislative Research bill tracker, the Bill proposes expanding Section 62(1)(b) to cover schemes linked to the value of share capital. That would give RSUs and SARs explicit statutory recognition for private companies and bring the Companies Act closer to the SEBI regime. Until the underlying Rules are amended, these instruments continue to operate within the existing ESOP framework. Confirm the current position before designing a scheme around it.
An instrument the employee cannot afford to exercise is not compensation. It is a bill with a hopeful covering note.
09Which instrument fits your company
The right instrument follows from the company stage and risk profile, not from what peer companies happen to grant.
The right answer follows from the company's own risk and reward profile, not from what peer companies happen to be doing.
Are you unlisted and expecting steep share price growth?
→
ESOPs – maximum wealth creation for a given P&L charge
Listed, or a subsidiary of a listed parent, with stable growth?
→
RSUs – guaranteed value, protected from market swings
Unwilling to dilute, or rewarding consultants and advisors?
→
SARs or phantom stock – economics without cap table impact
Listed with liquid shares, wanting broad voluntary participation?
→
ESPP – a recurring, employee-funded ownership route
Fit
Where each instrument earns its place
Use the map to check your instinct. If your shortlist sits entirely in one quadrant, you have probably answered only one of the five questions above.
10Getting the choice right
Choosing the instrument is only the first decision. The provisions inside the scheme decide whether it works: Vesting conditions, settlement rules, treatment of employees who leave and the plan for liquidity.
- Match the risk profile: A plan that only pays on steep appreciation suits a company that expects steep appreciation and frustrates one that does not.
- Design for the tax reality: If employees cannot fund the exercise and the tax, the instrument is not compensating them, whatever the paper value says.
- Plan the liquidity route early: Buybacks, tender offers and secondary sales are what convert any of these instruments into money.
- Do not treat it as a document exercise: The scheme should follow from the business plan and compensation philosophy, not from a template.
The point worth remembering
ESOPs are the most widely used share-based instrument in India, but they are not automatically the right answer. Structured well, any of these plans can create real wealth for employees at a reasonable cost to the income statement. Structured poorly, they become a drag on financial performance and a source of quiet resentment among the very people they were meant to reward.
11The five questions before you pick an instrument
Five questions decide most of it. None of them are about which instrument sounds most sophisticated.
Most instrument choices go wrong because the company starts from what other companies use rather than from its own constraints. Answer these five questions in order and the shortlist usually collapses to one or two options before anyone opens a scheme template.
Question | If the answer is yes | If the answer is no |
|---|---|---|
1. Can you afford to dilute? | ESOPs, RSUs, ESPPs stay on the list | Cash-settled SARs and phantom stock only |
2. Can employees fund an exercise price and the tax on it? | ESOPs work | RSUs, SARs or phantom stock, where nothing is paid in |
3. Is there a credible liquidity route inside five years? | Any equity instrument is defensible | Cash-settled, or an equity plan with a funded buyback commitment |
4. Are the recipients employees under Rule 12? | The full equity menu is open | Phantom stock or cash SARs for advisers and promoters |
5. Can the profit and loss account absorb a moving liability? | Cash-settled instruments are viable | Stay equity-settled and take the dilution instead |
Framework
Five questions, one shortlist
Work top to bottom and stop at the first firm no. The order matters: it eliminates on constraints you cannot change before it asks about preferences you can.
12Share-based compensation terms, defined
These terms recur across scheme documents, board resolutions and audit queries. The definitions below are the ones an Indian finance team will recognise.
ESOP
An Employee Stock Option Plan: a right to buy company shares at a fixed exercise price once vesting conditions are met.
RSU
A Restricted Stock Unit: a promise to deliver shares, or their value, on vesting, with no exercise price to pay.
SAR
A Stock Appreciation Right: an entitlement to the increase in share value between grant and exercise, settled in cash or shares.
Phantom stock
A cash-settled bonus plan whose payout tracks share value, usually with a strike price of zero and no securities issued.
ESPP
An Employee Stock Purchase Plan: payroll-funded purchase of company shares at a discount over defined offering periods.
Equity-settled
A scheme that delivers actual shares. It dilutes ownership but costs the company no cash.
Cash-settled
A scheme that pays money calculated by reference to share value. It protects the cap table but creates a liability.
Dilution
The reduction in existing shareholders' percentage ownership caused by issuing new shares to employees.
Look-back
An ESPP feature that prices the purchase at the lower of two dates, adding value in a rising market.
Perquisite
The salary-taxable benefit arising when an employee receives shares below market value, taxed at the first taxable moment.
Mark to market
The requirement to remeasure a cash-settled scheme's liability at each reporting date as the share price moves.
Form OPI
The FEMA return through which Indian residents report overseas equity received under a foreign parent's scheme.
Rule 12
The rule in the Companies (Share Capital and Debentures) Rules, 2014 that governs ESOP issuance by unlisted companies.
Special resolution
The 75 percent shareholder approval required before a share-issuing employee scheme can be adopted.
How Tallect approaches ESOPs
Every instrument modelled in one place, before you commit
Tallect is a modular Total Rewards platform built by Total Rewards practitioners. The Equity module sits in the same system as compensation planning, benchmarking, bonus and sales incentives and benefits, so equity data lives next to the rest of the reward picture rather than in a standalone tool.
ESOPs, RSUs, SARs, phantom units and ESPPs are all supported, for listed and unlisted companies alike. Plan design, grant administration, vesting logic, valuation support, accounting treatment and buyback management run in one place, with the compliance trail each instrument requires and a live view for both the finance team and the people holding the awards.
5
instruments in common use
2
settlement families to choose between
1 yr
statutory minimum before vesting
60
days to report overseas grants
13Frequently asked questions about share-based compensation in India
What is the difference between an ESOP and an RSU?
An ESOP is a right to buy shares at a fixed exercise price, so it only has value if the share price rises above that price and the employee must pay to exercise. An RSU is a promise to deliver shares at no cost once vesting conditions are met, so it retains value even if the share price falls and requires no payment from the employee at all.
What is the difference between a SAR and phantom stock?
A stock appreciation right pays the increase in share value between grant and exercise and can be settled in cash or in shares. Phantom stock is always cash settled and is structured as a bonus plan linked to share value rather than a right to acquire shares, often with a strike price of zero. In practice the two overlap heavily and the label matters less than the settlement mechanism.
Are RSUs and SARs allowed under the Companies Act in India?
Unlisted companies have historically issued RSUs and equity-settled SARs within the ESOP framework under Section 62(1)(b) and Rule 12. The Corporate Laws (Amendment) Bill, 2026 proposes expanding Section 62(1)(b) to cover schemes linked to the value of share capital, which would give both instruments statutory recognition. The Bill sits with a Joint Parliamentary Committee, so confirm the position before designing around it.
Which share-based instrument does not dilute the cap table?
Cash-settled instruments. Cash-settled stock appreciation rights and phantom stock pay money calculated by reference to share value, so no securities are issued and existing shareholders keep their percentages intact. The trade-off is a real liability on the balance sheet that is remeasured every reporting period and a genuine cash outflow at settlement.
Can consultants and advisers receive ESOPs in India?
No. Rule 12 restricts ESOP eligibility to permanent employees and directors, excluding independent directors, promoters and directors holding more than ten percent of equity, with a time-limited carve-out for recognised startups. Companies that want to reward consultants or advisers with share-linked value usually reach for phantom stock or cash-settled stock appreciation rights instead.
When are RSUs taxed in India?
At vesting, on the full value of the shares delivered, taxed as a salary perquisite regardless of whether the employee sells anything. A second tax event follows at sale, when the gain over the value already taxed is treated as capital gains. This is the key difference from ESOPs, where the first tax event is deferred to exercise rather than vesting.
When are ESOPs taxed in India?
Twice. First at exercise, when the difference between fair market value on the exercise date and the exercise price is taxed as a salary perquisite. Second at sale, when the gain over that fair market value is taxed as capital gains. Employees of certified startups can defer the perquisite tax under the startup deferral provisions.
How is phantom stock taxed?
As salary income at the point the cash payout is made, with tax deducted at source in the normal way. Because no securities are ever issued, there is no capital gains event afterwards and no perquisite valuation exercise. This single-event treatment is one reason phantom stock is administratively lighter than any equity-settled instrument.
Why do Indian subsidiaries of multinationals mostly use RSUs?
Because the parent is usually listed, its shares are liquid, and RSUs deliver certain value without asking the employee to fund an exercise price. The parent's global plan is typically RSU-based already, and extending it is simpler than running a separate Indian scheme. Cross-border grants bring FEMA obligations, including Form OPI reporting each half-year.
Are ESPPs common in India?
Not particularly. Employee stock purchase plans need liquid, freely traded shares and tight governance of payroll deductions, discounts and purchase dates, which makes them impractical for unlisted companies. They appear mainly in listed companies and Indian arms of listed multinationals, and are not a realistic instrument for a startup.
What happens if the ESOP pool runs out?
The company either goes back to shareholders for a special resolution to expand the pool, which dilutes existing holders further, or it switches a senior hire to a cash-settled instrument. Phantom stock is the common fallback in exactly this situation because it needs no pool and no fresh shareholder approval for share issuance.
Which instrument is best for an early-stage startup?
ESOPs, in almost every case. They conserve cash, the employee funds the exercise price, and the accounting charge is fixed at grant-date fair value rather than moving with the share price. The design work that matters is not the instrument choice but the vesting terms, the exercise window and a credible plan for liquidity.
What is the accounting difference between equity-settled and cash-settled schemes?
An equity-settled scheme is measured once, at grant-date fair value, and that charge is spread over the vesting period. A cash-settled scheme is treated as a liability and remeasured at every reporting date as the share price moves, so it introduces volatility into the profit and loss account that an equity-settled scheme does not.
Do cash-settled schemes need shareholder approval?
Generally not in the same way, because no securities are issued. Phantom stock and cash-settled stock appreciation rights are usually documented as bonus plans approved by the board rather than by special resolution. Governance still matters: the scheme should have clear valuation rules, defined settlement triggers and a funding plan for the eventual outflow.
How do I choose between these five instruments?
Answer five questions in order: can you afford to dilute, can employees fund an exercise price and its tax, is there a credible liquidity route inside five years, are the recipients employees under Rule 12, and can the profit and loss account absorb a moving liability. Five answers usually leave one or two instruments standing.
14The bottom line
There are five share-based instruments in common use in India and they are not interchangeable. Settlement is the first fork: equity-settled schemes dilute the cap table but cost no cash, while cash-settled schemes protect ownership and create a liability that moves every reporting period. The second fork is whether the employee is rewarded only on appreciation, as with ESOPs and stock appreciation rights, or on the whole value, as with restricted stock units.
The instrument that fits is the one your constraints allow, not the one your peers use. Work through dilution capacity, employee funding capacity, the liquidity route, Rule 12 eligibility and profit and loss tolerance, in that order. Then spend the real effort where it pays: on vesting terms, leaver treatment and a credible path to converting paper into money. A well-chosen instrument with a vague liquidity plan still ends up as quiet resentment.
This article is intended for general informational purposes only and does not constitute legal, tax or financial advice. Statutory provisions, tax rates and regulatory positions change and the Corporate Laws (Amendment) Bill, 2026 referred to above was a proposal at the time of writing rather than enacted law. Scheme terms vary by company; companies and employees should consult their specific scheme documents and a qualified professional before acting.
