Budget 2026: Can FM Finally Bury Angel Tax and Fix ESOP Chaos?

Founders and investors urge FM Sitharaman to close legacy tax cases and fix ESOP rules to revive risk-taking and growth

Startups Brace for Budget 2026 Amid Lingering Uncertainty

India’s startup ecosystem has matured past hypergrowth and into a capital-disciplined “new normal.” In 2025, startups raised $11 Bn across 936 deals, an 8% YoY dip and far below the exuberance of 2021–22.

In this climate, regulatory clarity has become as critical as capital. With the Union Budget 2026–27 on the horizon, founders and VCs are focused on two unresolved pain points: the ghost of the angel tax, and structurally broken ESOP taxation.

Can policy finally match the ambition of India’s startup economy?

Angel Tax May Be Dead, But Its Ghost Lingers

The angel tax—scrapped in July 2024—was one of the most feared hurdles for startups. It let authorities tax investments above “fair market value” as income under Section 56(2) of the Income-tax Act.

While its repeal was celebrated, the legacy cases remain unresolved, with thousands of startups still facing old notices, fund seizures, and penalties that impact fundraising, due diligence, and in some cases, survival.

“The law may no longer exist, but the demand raised in 2017 still stands,” said Nikunj Bubna, whose startup was shuttered after a ₹50–60 lakh tax notice derailed a funding round.

Key numbers:

• At least 2,743 DPIIT-recognised startups were under scrutiny in 2023
• INR 35 lakh recovered from TravelKhana’s account despite compliance
• OYO faced INR 1,140 Cr in tax demand under this clause till mid-2024

Investors like Sridhar Parthasarathy (Bluehill Capital) and Abhishek Prasad (Cornerstone Ventures) warn that unresolved tax baggage is often priced into deals—or kills them entirely.

“This regulatory overhang hurts founders and investors even when they’re building in good faith,” said Prasad.

Double Trouble: The Broken ESOP System

For employees and founders alike, ESOPs remain structurally flawed in India—eroding trust in a system meant to reward risk and loyalty.

India’s ESOP taxation levies two layers of tax:

1. Perquisite tax at time of exercise (on notional gains)
2. Capital gains tax on sale (on actual gains)

This means employees often pay taxes on illiquid shares, with no clear exit timeline. While a 2020 deferral clause offers relief, it:

• Applies only to DPIIT-recognised startups
• Requires IMB certification under Section 80-IAC
• Doesn’t eliminate the dual taxation structure

“Do the math—it significantly reduces the ESOP upside,” said Abhishek Prasad.

In PhonePe’s IPO filing, CEO Sameer Nigam clarified that a ₹4,000 Cr secondary sale was to meet ESOP tax obligations—not personal cash-out.

Systemic impact:

• Employee retention is hit as ESOPs lose appeal
• Founders can’t receive ESOPs post-IPO under current rules
• Cash-flow mismatches discourage exercise before liquidity

VCs like Siddharth Pai (3one4 Capital) and Parthasarathy argue for a modernised ESOP framework, one that:

• Ends double taxation
• Enables controlled ESOP allocation to founders, even post-listing
• Aligns incentives like in the US—rewards only when shareholders benefit

“Why should the government block founders from being rewarded if the board and shareholders approve it?” asked Pai.

The Ask: Budget 2026 as a Turning Point

What the startup community is seeking isn’t subsidies or handouts—it’s decisive clarity. The Union Budget is seen as an opportunity to:

1. Resolve legacy angel tax cases through a sunset clause or amnesty
2. Rationalise ESOP taxation to reward innovation and retain talent
3. Modernise post-IPO rules to let founders access incentive structures

With India chasing a $1 Tn digital economy goal, these foundational reforms could fuel the next phase of clean, scalable, founder-led innovation.

“Fixing this in the Budget won’t just ease pressure. It could unlock capital, talent, and trust,” said Parthasarathy.

TL;DR
Despite the repeal of angel tax in 2024, unresolved legacy cases continue to derail fundraising and kill startups. Simultaneously, India’s broken ESOP rules—double taxation, limited deferral, and post-IPO founder restrictions—hurt retention and founder alignment. Budget 2026 is a critical opportunity for decisive policy reform.

AI Summary

• Angel tax was abolished in 2024, but thousands face old demands
• Legacy tax cases hurt funding, due diligence, and startup survival
• ESOPs taxed twice—at exercise and on sale—causing liquidity strain
• Only a narrow group of startups benefit from current tax deferral rules
• Investors want modernised ESOP policies and sunset clauses on past angel tax cases