ESOP valuation errors in India rarely surface immediately. They show up at the worst possible moment: during a funding round’s due diligence, in a tax notice three years after an exercise event, or when an employee files a complaint about incorrect TDS deduction. The Income Tax Act 2025 (effective April 1, 2026) tightened the valuation requirements further — including a hard 180-day FMV certificate validity rule under Rule 15, and extended tax deferral provisions that still do not eliminate employer TDS obligations. This guide covers the 7 mistakes RNC most frequently encounters, and what each one actually costs.
1. FMV validity rule tightened under Rule 15: The FMV certificate for unlisted shares at exercise must be obtained from a SEBI-registered Category I Merchant Banker and cannot be older than 180 days from the date of exercise. Not 181 days. This rule was previously under Rule 3(9)(ii) of the old IT Rules — now renumbered and restated under the Income Tax Act 2025.
2. Tax deferral extended from 48 to 60 months: Eligible DPIIT-recognised startups can defer ESOP perquisite tax for up to 60 months from the end of the tax year of allotment, or until the employee sells/leaves, whichever is earlier. The deferral applies to the employee’s cash payment — not to the employer’s TDS reporting obligation. This distinction is the source of one of the most common post-deferral compliance errors.
7 mistakes covered
- Using a stale FMV certificate for an exercise window
- Using the funding round price as ESOP FMV
- Using the wrong category of valuer for the wrong purpose
- Using the same valuation for accounting and tax purposes
- Not refreshing FMV after a significant funding event
- Assuming the tax deferral eliminates the TDS obligation
- Using the correct method for the wrong company stage
A startup completes a Series A round in January. The company gets an FMV valuation done for that transaction. Eight or ten months later, they open an ESOP exercise window. Someone in finance pulls out the January report and processes the exercises. The January report is now 250-plus days old — 70 days past the 180-day legal limit under Rule 15 of the Income Tax Rules 2026.
This is not a technicality. If the company’s fair market value at the time of exercise was actually higher than the January figure (which is likely after 8 months of operations), the TDS deducted on each exercise was short. The employer is liable for the TDS shortfall plus interest — and the Income Tax Department can reopen this even years after the exercise event.
Commission a fresh FMV certificate at least 3-4 weeks before every planned exercise window opens. Build the valuation timeline into your exercise window planning calendar, not as an afterthought after you’ve told employees the window is open.
This is the most analytically incorrect mistake, and it appears in two forms. The first: using the per-share price implied by a VC’s investment as the FMV for exercise pricing. The second: asking the VC’s own financial model team to produce the FMV figure as part of a due diligence deliverable, then reusing it for ESOP purposes.
Why this is wrong: Funding round valuations embed a premium for the specific class of securities issued to that investor — typically preference shares with liquidation preferences, anti-dilution protection, board seats, and other rights that ESOP holders do not have. The per-share price in a funding round does not represent the fair market value of the common equity underlying an ESOP. Applying it overvalues the ESOP, creating perquisite tax exposure for employees on a higher figure than the economic reality of their shares.
Post-2022 funding corrections have made this even more dangerous — employees who exercised based on peak-round FMV figures are now holding shares worth a fraction of what they paid tax on at exercise.
ESOP FMV must be an independent valuation of the common equity specifically, conducted by a SEBI-registered Category I Merchant Banker for tax purposes. It should explicitly account for the rights differential between preference share investors and common equity holders.
Used a funding-round price or stale valuation for a past exercise window? An independent FMV review can clarify your exposure.
ESOP valuation in India touches two distinct regulatory frameworks — Income Tax and Companies Act — and each requires a different category of professional. Many companies satisfy one and not the other.
For Income Tax (Rule 15, Income Tax Act 2025): FMV at exercise must be determined by a SEBI-registered Category I Merchant Banker. An IBBI Registered Valuer’s report does not satisfy this requirement for tax purposes.
For Companies Act Section 247 (share allotment at exercise): An IBBI Registered Valuer is required. A merchant banker’s report does not satisfy this requirement for the allotment filing.
SEBI’s December 2025 amendment (effective January 2, 2026) added another dimension: sweat equity valuations for listed companies now require an IBBI Registered Valuer specifically — replacing the earlier merchant banker option for that purpose. The interaction between these three distinct requirements (Income Tax / Companies Act allotment / SEBI sweat equity) confuses even experienced finance teams.
Before opening any exercise window, map the specific regulatory trigger to the correct valuer category. For most unlisted company exercise windows: you need both a merchant banker report (for tax FMV) and an IBBI Registered Valuer certificate (for Section 247 allotment). Work with a firm that understands both requirements rather than assuming one report covers all purposes.
Ind AS 102 accounting and Income Tax FMV are two separate valuations answering two separate questions at different dates.
Ind AS 102 (accounting): Values the option itself (not the share) at the grant date, using Black-Scholes or Binomial models. The output is an accounting expense amortised over the vesting period. This grant-date figure does not change — it’s a fixed accounting entry.
Income Tax FMV (tax): Values the underlying share at the exercise date, specifically for computing the perquisite income of the employee at that moment. This is a current-market-value figure that changes every time you open a new exercise window.
Reusing the grant-date Ind AS 102 share FMV as the exercise-date tax FMV is incorrect whenever the company’s valuation has moved between grant and exercise — which is nearly always, given that most companies use their ESOP to attract employees during growth phases.
Maintain two separate valuation engagement tracks: a grant-date engagement covering the Ind AS 102 fair value of options (using Black-Scholes inputs), and an exercise-date FMV engagement for each exercise window. These are related but distinct assignments.
RNC Valuecon — Observations from ESOP Valuation Reviews
What we find when companies come to us after an exercise window
~40%
Of startups approaching RNC post-funding-round are still using a pre-round FMV for new exercise windows
3–4 wks
1 in 5
Companies reviewed had a prior merchant-banker-only valuation being used for Companies Act allotment purposes — creating a Section 247 compliance gap
Even within the 180-day validity window, a FMV certificate can become effectively stale for good reasons: the company raised a new round, made a significant acquisition, lost a major client, or underwent a restructuring that materially changes its value.
Using a technically-valid-by-date-but-economically-stale FMV creates two risks. First, if FMV should be higher (post-growth event) the TDS is undercalculated — tax liability. Second, if FMV should be lower (post-correction), employees pay excess perquisite tax, creating employee relations problems and potential refund claims.
Trigger a fresh FMV engagement after any material corporate event — new funding round, significant revenue milestone, major customer win or loss, restructuring — regardless of whether the existing certificate is within 180 days.
The Income Tax Act 2025 extended the perquisite tax deferral for DPIIT-recognised startups from 48 months to 60 months from the end of the tax year of allotment (or until sale/departure, whichever earlier). This is genuinely helpful for employees who face a perquisite tax bill with no immediate liquidity to pay it.
The mistake: several founders and CFOs interpret this as meaning “if we’re DPIIT-recognised, we don’t have to worry about TDS at exercise.” This is incorrect. The deferral applies to the employee’s cash payment timeline — not to the employer’s TDS computation and reporting obligation. The employer must still compute the perquisite income, withhold the notional TDS liability, and report it correctly — even if the actual cash payment by the employee is deferred. Failure to correctly compute and report creates employer-side TDS proceedings, which are entirely separate from the employee’s deferral benefit.
Even if you’re DPIIT-recognised: commission a proper FMV at exercise, compute the perquisite income correctly, report the TDS computation accurately. The deferral changes when the employee pays — it does not change what the employer must report and when.
About to open an exercise window? Get your FMV and TDS compliance reviewed before you proceed.
Not all FMV methods produce defensible results for all company types. The valuation method must match the company’s stage, structure, and purpose.
- Pre-revenue or early stage: NAV or probability-weighted expected return methods are most appropriate. Applying a full DCF with projected revenues to a pre-revenue startup produces a number that an Assessing Officer can challenge for being speculative.
- Post-Series A with revenue traction: DCF with market approach cross-check is appropriate. A simple NAV typically undervalues a company that has demonstrated revenue, as it ignores going-concern and intangible value.
- Complex capital structure (SAFE, CCD, preference shares): Option pricing models (OPM) or probability-weighted expected return method (PWERM) are required to allocate value correctly across instrument classes. Using a simple share-price approach without accounting for liquidation preferences systematically overvalues the common equity underlying the ESOP.
The Income Tax Rules permit multiple methods — choosing the wrong one doesn’t automatically create a compliance violation, but it creates a defensibility problem when the Assessing Officer questions whether the method was appropriate for the company’s specific situation.
Method selection should be made by the valuer based on the company’s stage, capital structure, and the purpose of the valuation — not by the founder based on which method produces the most convenient number. Document the method selection rationale in the valuation report.
A Quick Self-Audit: Before Your Next Exercise Window
Run through this checklist before opening any ESOP exercise window:
- Is the FMV certificate dated within 180 days of the planned exercise date? If not — stop and commission a fresh one before proceeding.
- Is the FMV from a SEBI-registered Category I Merchant Banker (for Income Tax purposes) and separately from an IBBI Registered Valuer (for Section 247 allotment)?
- Has the company had a material corporate event (new funding, major customer change, restructuring) since the last FMV? If yes — fresh FMV regardless of the date.
- Does the FMV explicitly account for your capital structure’s liquidation preferences and anti-dilution provisions if you have preference shareholders?
- If DPIIT-recognised and deferring employee tax payment — is the TDS computation and reporting still being done correctly on the company’s side?
- Is the method selected appropriate for the company’s current stage (pre-revenue / traction / growth)?
Frequently Asked Questions
1. Can I use my company’s funding round valuation as the FMV for ESOP exercise?
2. How long is an ESOP FMV certificate valid in India?
3. What happens if an exercise window uses a stale FMV?
4. Who can perform the ESOP FMV valuation for Indian tax purposes?
5. What is the ESOP tax deferral for startups under the Income Tax Act 2025?
6. What is the most common ESOP valuation mistake in India?
7. Can I use my company’s funding round valuation as the FMV for ESOP exercise?
8. How long is an ESOP FMV certificate valid in India?
9. What happens if an exercise window uses a stale FMV?
10. Who can perform the ESOP FMV valuation for Indian tax purposes?
11. What is the ESOP tax deferral for startups under the Income Tax Act 2025?
12. What is the most common ESOP valuation mistake in India?
RNC VALUECON LLP · IBBI REGISTERED VALUERS
Get Your ESOP Valuation Done Right — Before the Exercise Window Opens
Get Your ESOP Valuation Done Right — Before the Exercise Window Opens
IBBI Registered Valuers and SEBI merchant banker coordination for every exercise window. Section 247 compliant, SEBI 2026-aligned, 5–7 day turnaround.
About the author:
Sahil Narula
Sahil Narula is the Managing Partner at RNC Valuecon LLP and a Registered Valuer with IBBI. He brings over a decade of experience in Valuation Services, Corporate Finance, and Advisory, having led numerous complex assignments under the Insolvency & Bankruptcy Code, 2016, Mergers & Acquisitions, Insurance, and Financial Reporting.
He is a regular speaker at national forums (ASSOCHAM, CII, ICAI, IBBI, Legal Era) and currently serves as Co-Chairman of ASSOCHAM’s National Council on Insolvency & Valuations and a member of CII’s Task Force on Insolvency & Bankruptcy.
🤝Connect with Sahil on LinkedIn.