M&A Taxation and ESOP Rules Under Spotlight Ahead of Budget 2026

https://www.taxscan.in/tags/corporate-taxation As Finance Minister Nirmala Sitharaman prepares to present the Union Budget 2026 on February 1, Tax professionals are now highlighting measures to address structural ambiguity in corporate taxation. Tax experts are identifying issues such as cross-border mergers and acquisitions, employee stock option taxation, and fast-track corporate restructuring have emerged as priority areas requiring legislative clarity.

Cross-Border M&A: The ESOP Taxation Challenge

One of the most pressing concerns flagged by tax experts involves the disparate treatment of share swaps and employee stock options in cross-border transactions. While share exchanges conducted through tax-neutral mergers benefit from exemptions, stock options exchanged during such deals face uncertainty.

CA Vaibhav Gupta, Partner - Dhruva Advisors, explained that in cross-border share swaps, a lot of the time employees will receive both stock options and shares in a cross-border stock exchange, however, the tax treatment differs in stock and share. This lacuna complicates how employee stock options will be structured by employees and may further disincentivize foreign investment into Indian companies. Industry experts believe that if ESOP swaps could be afforded tax neutrality, this would increase the attractiveness of India for international mergers and acquisitions.

Fast-Track Demergers: A Legislative Gap

Another area of concern is the taxation of fast-track demergers. According to the law, fast-track mergers are considered "tax-neutral", however, there are no similar provisions for fast-track demergers. This creates uncertainty which may be detrimental to the Government's goal of simplifying the restructuring process for corporate entities.

The existing legal language creates uncertainty about tax-neutrality for fast-track demergers which undermines the Government's goal of simplifying corporate internal reorganisations. For companies that want to restructure without going through lengthy court processes, the uncertainty surrounding fast-track demergers creates operational difficulties.

Tax professionals believe that clarifying this tax status in the 2026 Budget will align with the Government's overall deregulation agenda and assist in creating an environment where corporate restructuring can occur with minimal disruption. Further, current tax provisions favor corporations that are reorganizing as domestic corporate mergers and demergers have been granted complete tax neutrality, while foreign corporate reorganizations will result in taxation regardless of the value of the transaction.

Earn-Out Arrangements Need Clear Guidelines

The increasing prevalence of earn-out arrangements in M&A transactions has also created a grey area in the tax law. Earn-outs create performance-contingent payments and give rise to a fundamental question - should earned income be taxed at the time of the closing or at the time of the actual payment?

As earn-out payments typically depend on achieving profitability or some other form of financial milestone, earned income does not accrue until the milestone, or milestones, have been achieved. Accordingly, experts believe that taxation should be based on when the income is received rather than when the transaction occurs.

Modernization of LLP Framework

Even though the law allows for LLP to merge into a company, the lack of tax neutrality for such transactions has constrained these types of reorganizations. Tax experts suggest that giving LLP mergers the same tax neutral status as company mergers have received. Subsequently, the treatment of converting from LLP to company will not trigger tax payable on the partnership until the partner receives shares when he or she converts to the company.

Real Estate Sector Seeks Targeted Support

Sanket Jain, CFO at The Wadhwa Group, emphasized that real estate creates jobs, supports consumption, and drives overall economic growth, making it deserving of focused budgetary attention.

Key demands from this sector include revising the affordable housing price limit of Rs 45 lakh, addressing high GST on construction costs, and granting the sector clear infrastructure-like status for improved access to long-term financing. Strong demand is emerging in tier-2 cities due to improved connectivity and infrastructure, and budgetary support for regional development could help sustain this growth while reducing pressure on metro cities.

Middle Class Expectations

Chirag Chauhan, Founder of CA Chauhan & Co., noted that with rebate and standard deduction, income up to Rs 12.75 lakh is effectively tax-free for salaried individuals, following substantial relief provided in recent budgets. Rather than dramatic slab restructuring, taxpayers anticipate targeted adjustments such as raising the 30% tax threshold from Rs 25 lakh to Rs 35 lakh to account for inflation, increasing standard deduction limits, and rationalizing surcharge structures to reduce marginal tax rate spikes.

Simplification and Compliance

Budget 2026 shall pay close attention to creating a simpler tax system as part of the implementation of the new Income Tax Act in April 2026. This includes providing one ITR form for all individuals and making it easier to fulfil your tax obligations.

As we near Budget Day, tax professionals across India are united in their belief that the evolution of India's tax policy over the next few years should focus on reducing uncertainty and creating stability in the tax environment for businesses rather than utilising populist approaches to lowering tax rates.

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