The Union Budget 2026 focused on removing artificial distortions in the law and making tax administration and taxation easier for taxpayers. Yet it perpetuated the flawed treatment of buyback taxation in India. While the new regime offers relief to employees, it maintains a punitive status quo for the builders of the Indian startup ecosystem.
The Tax Conflict: Dividend Vs. Capital Gains
The previous buyback regime, introduced in 2024, treated all gains from buybacks as dividend income, with the corresponding acquisition cost being treated as a capital loss. This distorted the true nature of buybacks and imposed a compliance burden on shareholders.
A buyback is legally a Capital Gains event. It meets the definition in letter and spirit:
- Asset: The security
- Transfer: The extinguishment of the share
- Gain: The profit realised
The Winners: Employees And Small Shareholders
The buyback changes are positive for employees and small shareholders as it treats buyback income as “capital gains” for all shareholders who hold less than 10% of a Company.
This allows buybacks to become an acceptable exit avenue for employees who must pay tax at slab rates upon exercising their ESOPs. Taxing the subsequent gains as ordinary income fully negates the benefits of ESOPs.
ESOP buybacks were a common way to create liquidity for employees and inspire confidence in ESOPs as a tool of wealth creation. The pernicious tax treatment offered to buybacks in 2024 reduced the attractiveness of this route, leading to higher cash outflows for startups.
The “Promoter” Penalty: The Devil In The Details
However, the devil in the details lies in how promoters are treated during a buyback. The definition of a promoter is similar to SEBI and the Companies Act, 2013, but also includes shareholders holding more than 10% of the Company. Their buyback gains are taxed at 22% for corporates and at 30% for non-corporates.
Foreign shareholders would benefit, as their buyback income would be capped at 30% rather than the slab rate.
For Founders, the status quo unfortunately continues. This will also affect secondary discussions and pricing for companies looking to fundraise in the future.
The (un)intended Consequences For Investors
The clubbing of shareholders above 10% as “promoters” is of particular concern, as financial investors often insist on language that they are not to be considered as promoters for any purposes.
Startup deals are highly negotiated, and a 10% shareholding does not constitute control or significant influence. But this deemed promoter status that denies buyback benefits is concerning.
A Bittersweet Victory
The new regime creates a bifurcated system that effectively punishes the “builders.” Startup founders and financial investors, the very people who take the greatest risks, are the ones most likely to hold concentrated stakes above the 10% threshold.
By tethering capital gains to ownership percentages, India has replaced one complexity with another. For the startup ecosystem, this “partial sense” is a bittersweet victory: the exit door is open, but the toll for those who built the house remains disproportionately high.
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