Cost of acquisition for non-resident employees in ESOP transactions introduction

As equity compensation programmes become increasingly global,employees frequently live, work and create value across multiple jurisdictionsduring the lifecycle of an ESOP grant. While this has strengthened the role ofESOPs as a strategic talent and retention tool, it has also introduced severaltax complexities, particularly for internationally mobile employees.

One such challenge relates to situations where a non-residentemployee exercises ESOPs of an Indian company, is taxed on the resulting ESOPbenefit in a foreign jurisdiction, and subsequently disposes of the shares inIndia. In such cases, uncertainty has often existed regarding the appropriatecost of acquisition that should be adopted for capital gains purposes in India.

Notably, this is a challenge that Qapita had already identified inits Equity Compensation Trends & Insights Report 2025. The reporthighlighted the growing complexity arising from cross-border equitycompensation arrangements and employee mobility, as organisations increasinglygrant equity across multiple jurisdictions. With more than one-third ofcompanies now issuing equity awards across borders, the interaction betweenemployment taxation and capital gains taxation has become an increasinglyrelevant concern for both employers and employees.

Against this backdrop, the Mumbai Bench of theIncome Tax Appellate Tribunal (“ITAT”), in its decision dated 31 July 2026 inthe case of Mr. Rajesh R. Hemrajani v. ITO (International Tax), Ward 2(2)(1),Mumbai (ITA No. 1284/MUM/2025), has provided important judicial clarity byholding that the Fair Market Value (“FMV”) considered at the time of ESOPexercise can constitute the cost of acquisition under Section 49(2AA), evenwhere the ESOP perquisite itself was not taxable in India. The Tribunal alsoconsidered earlier ESOP-related decisions including Biplab Adhya v. DCITand Ramamurthy Sridharan v. ACIT, while distinguishing judicialprecedents dealing with the taxation of non-resident employment income.

The issue

A common issue in cross-border ESOP taxation arises where anon-resident employee exercises ESOPs of an Indian company while renderingservices outside India, and the resulting ESOP benefit is taxed as employmentincome in the foreign jurisdiction.

While such perquisite income may not be taxable in India, thesubsequent transfer of shares of an Indian company may nevertheless give riseto capital gains taxable in India.

In such circumstances, an important question arises as to whetherthe employee should be entitled to adopt the FMV considered at the time ofexercise as the cost of acquisition under Section 49(2AA), or whether the costshould be restricted to the exercise price actually paid for the shares.

The answer has significant implications for the computation ofcapital gains and the potential exposure to economic double taxation.

Mumbai ITAT ruling

The Tribunal held that Section 49(2AA) requires the FMV consideredfor the purposes of Section 17(2)(vi) to be adopted as the cost of acquisition.The ITAT observed that the statutory requirement is that the FMV should havebeen 'taken into account' for the purposes of Section 17(2)(vi). Theprovision does not mandate that the corresponding perquisite must have actuallybeen taxed in India. Accordingly, FMV substitution cannot be denied merelybecause the ESOP perquisite was taxed outside India or was otherwise notchargeable to tax in India.

Key takeaways

1.    Taxability of the ESOP benefitand determination of cost of acquisition are distinct concepts.

2.    Section 49(2AA) does notrequire the perquisite to be taxed in India.

3.    FMV considered at the time ofESOP exercise can constitute the cost base for capital gains computation underSection 49(2AA), even where the ESOP perquisite was taxed outside India.

Why this ruling matters

Had the Revenue's interpretation prevailed, a substantial portion ofthe ESOP spread could effectively have been subjected to tax twice: first asemployment income in the overseas jurisdiction and again through a lower costbase while calculating capital gains in India.

The Tribunal's interpretation aligns the capital gains computationmechanism with the legislative framework of Section 49(2AA) and substantiallymitigates the possibility of economic double taxation for globally mobileemployees.

Conclusion

The Mumbai ITAT has adopted a commercially pragmatic andtaxpayer-friendly interpretation of Section 49(2AA) by confirming that the FMVconsidered at the time of ESOP exercise can constitute the cost of acquisitioneven where the underlying ESOP perquisite was not taxable in India.

The ruling is likely to be welcomed by multinational employers,globally mobile employees and tax practitioners alike, as it significantlyreduces the possibility of economic double taxation and provides greatercertainty in the taxation of cross-border ESOP arrangements.

As equity compensation programmes continue to expand acrossjurisdictions, this decision represents an important development in theevolution of India's ESOP tax framework and provides useful guidance on thetreatment of non-resident employees holding shares of Indian companies through ESOPs.

Disclaimer

The ruling discussed above is a decision of the Mumbai Bench of theIncome Tax Appellate Tribunal. While it provides a well-reasoned andtaxpayer-favourable interpretation of Section 49(2AA), it does not constitutesettled law. The issue has not yet been conclusively adjudicated by a HighCourt or the Supreme Court and remains subject to potential appellate review.Accordingly, taxpayers should evaluate the applicability of the ruling based ontheir specific facts and circumstances before adopting any position.