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NISM-Series-X-B: Investment Adviser (Level 2) · Taxation of Equity Products

Taxation of Other Equity Products: ESOPs, Bonus, Rights and IPOs

Updated 11 October 2026 · Fact-checked

ESOPs are taxed twice: as a salary perquisite on exercise (market value minus exercise price), then as capital gains on sale, with cost equal to the value taxed as perquisite. Bonus shares have nil cost. Rights shares cost the price paid. Holding period starts from allotment.

Understand Taxation of Other Equity Products (ESOPs, Bonus, Rights, IPOs)

These products all create shares without a normal market purchase. So the main question is always the same: what is the cost of acquisition, and when does the holding period start? Get these two right and the capital gains follow.

ESOPs (employee stock options) are taxed at two points. When you exercise the option and get shares, the benefit is taxed as a perquisite under the head Salaries. The perquisite is the fair market value (FMV) on the exercise date minus the exercise price you paid. For listed shares, FMV is based on the average of the opening and closing prices on the exercise date on the exchange (the stock exchange with the highest trading volume, if listed on more than one). Employers deduct TDS on it. Nothing is taxed at grant or at vesting.

When you later sell the shares, you pay capital gains. The cost of acquisition is the FMV already taxed as perquisite. The holding period starts from the date of allotment on exercise. For listed shares, holding more than 12 months makes the gain long term. Check the current rates in your study material for STT-paid listed equity.

Bonus shares are free shares issued from reserves. They are not taxed when received. Their cost of acquisition is nil, so the entire sale price is a capital gain. The holding period starts from the date of allotment of the bonus shares, not the date of the original shares. The original shares keep their own cost and holding period. A stock split works similarly: the original cost is spread over the larger number of shares, and the holding period of the original shares carries over to the split shares.

Rights issue: you get a right to subscribe to new shares, usually at a discount. Subscribing is not taxed. The cost of the new shares is the price you paid, and the holding period starts from the allotment date. If you sell the rights entitlement itself, the gain is a short-term capital gain. The cost of the entitlement is nil if it was received free on the basis of your existing shares. If you buy a rights entitlement from someone else, the price you paid is its cost. When you renounce it in favour of another person, the cost of the shares to that buyer is the price paid for the entitlement plus the price paid to the company.

IPO allotment: the cost of acquisition is the issue price you paid. The holding period starts from the date of allotment. Selling the shares after listing is taxed like any other listed equity share sale.

Key formulas to remember

ESOP perquisite
Perquisite = FMV on exercise date − exercise price paid
Taxed as salary in the year of exercise. Not taxed at grant or vesting.
ESOP cost of acquisition
Cost = FMV taken for perquisite on exercise date
Holding period runs from the date of allotment on exercise.
Bonus shares cost
Cost of acquisition = ₹0
Holding period runs from the date of bonus allotment.
Rights shares cost
Cost = price paid to the company
Holding period runs from the date of allotment of the rights shares.
Rights entitlement sold
Gain = sale price of entitlement − cost (₹0 if received free)
Short-term capital gain. Cost is the price paid if bought from another person.
IPO shares cost
Cost = issue price paid
Holding period runs from the date of allotment.
Listed equity long-term test
Holding period > 12 months = long term
Applies to listed equity shares. The period is counted from the allotment date.

How to solve Taxation of Other Equity Products (ESOPs, Bonus, Rights, IPOs) questions

Use this method for any question on ESOPs, bonus, rights, splits or IPOs.

  1. 1Identify the product: ESOP, bonus, rights share, rights entitlement, split or IPO.
  2. 2Decide if any tax arises at the receipt stage. Only ESOP exercise creates a perquisite. Bonus, rights subscription and IPO allotment do not.
  3. 3Fix the cost of acquisition using the rule for that product: FMV on exercise, nil, price paid, or issue price.
  4. 4Fix the holding period start date. It is the allotment date of those particular shares.
  5. 5Classify the sale as short or long term using the 12-month test for listed equity.
  6. 6Compute the gain: sale price minus cost, minus transfer expenses if the question gives them.
  7. 7Apply the rate or exemption given in the question and check whether the question wants perquisite, capital gain or both.

Quickest way: Cost and date shortcut

When to use it: Use when the option list shows several numbers and you have little time.

  1. Write the cost in one word: ESOP = FMV, bonus = nil, rights = price paid, IPO = issue price.
  2. Write the start date: always allotment of those shares.
  3. For an ESOP, check that you used FMV minus exercise price for salary and FMV as cost for capital gains.
  4. Eliminate any option that taxes the bonus at receipt or uses the original share's date for bonus shares.

Common mistakes in Taxation of Other Equity Products (ESOPs, Bonus, Rights, IPOs)

  • Taxing ESOPs at grant or vesting

    Students link tax to the date the benefit is earned.

    Fix: Remember that the perquisite arises only on exercise of the option.

  • Using the exercise price as the cost for later capital gains

    It looks like the amount actually paid.

    Fix: Use the FMV that was taxed as perquisite, otherwise the benefit is taxed twice.

  • Giving bonus shares the cost and holding period of the original shares

    Bonus shares feel like part of the same holding.

    Fix: Bonus shares have nil cost and their own holding period from the bonus allotment date.

  • Treating a free rights entitlement as having a cost

    Students mix up the entitlement with the shares subscribed.

    Fix: A free entitlement has nil cost. The price paid to the company is the cost of the shares, not the entitlement.

  • Starting the holding period from the IPO application or listing date

    These dates are more visible than allotment.

    Fix: Count from the date of allotment.

Worked examples

Example 1

Priya exercises 100 ESOPs at an exercise price of ₹200 when the FMV is ₹500. She sells all 100 shares 14 months later at ₹650 on a recognised exchange. Find the perquisite and the capital gain, ignoring transaction costs.

Show the solution
  1. Perquisite per share = 500 − 200 = ₹300.
  2. Total perquisite = 300 × 100 = ₹30,000, taxed as salary.
  3. Cost of acquisition = FMV ₹500 per share, so ₹50,000 in total.
  4. Sale value = 650 × 100 = ₹65,000.
  5. Gain = 65,000 − 50,000 = ₹15,000.
  6. Holding period is 14 months from allotment, which is more than 12, so the gain is long term.

Answer: Perquisite ₹30,000 (salary); long-term capital gain ₹15,000.

Example 2

Rahul holds 50 shares bought at ₹400 each. The company issues 1:1 bonus shares, and he receives 50 bonus shares. Eight months after the bonus allotment he sells the 50 bonus shares for ₹300 each. Find the capital gain and its nature.

Show the solution
  1. Cost of the bonus shares is nil.
  2. Sale value = 300 × 50 = ₹15,000.
  3. Gain = 15,000 − 0 = ₹15,000.
  4. Holding period runs from the bonus allotment date, which is 8 months, so it is not more than 12 months.
  5. The gain is therefore short term.

Answer: Short-term capital gain of ₹15,000.

Exam tips

  • Expect questions on the two-stage ESOP tax. The trap option usually taxes only one stage.
  • Memorise the cost and date for each product. Most MCQs test only these.
  • Read whether the question asks for the perquisite or the capital gain. They use different numbers.
  • Watch the date wording. Allotment date decides the holding period, not the original purchase date for bonus shares.

Practice questions from Taxation of Equity Products

Taxation of Other Equity Products (ESOPs, Bonus, Rights, IPOs): frequently asked questions

When are ESOPs taxed in India?

The perquisite is taxed in the year you exercise the option, as salary income. A second tax arises as capital gains when you sell the shares. There is no tax at grant or vesting.

What is the cost of acquisition of bonus shares?

It is nil. The full sale price is a capital gain. The holding period starts from the date the bonus shares are allotted.

How are rights entitlements taxed?

Subscribing to rights shares is not taxed. If you sell the entitlement, the gain is short term and the cost is nil if you received it free. If you bought it, your price is the cost.

What is the cost of acquisition of shares after a stock split?

The cost of the original shares is spread over the larger number of split shares. The holding period of the original shares continues for the split shares.