Company Share Transfer

Detailed Analysis of Phantom Stock Option

Detailed Analysis of Phantom Stock Option

Employees play a crucial role in the growth and success of any organisation. There has been an increase in the no. of start-ups, booming e-commerce along with increased opportunities and prevailing competition, in recent times resulting in higher levels of attrition, necessitating the companies to offer attractive remuneration packages and incentives to their employees, particularly the senior and key employees, to ensure their retention in the long run.

One such incentive the company provides in the furtherance of the same is the Phantom Stock Option. However, most employers and employees are unable to avail the benefits of this due to a lack of clarity about the same.

The article discusses the Phantom Stock Option and various aspects related to it to provide a better understanding of this stock option.

What is Phantom Stock Option?

A phantom stock option can be defined as a performance-based incentive wherein the non-employee/employee is provided with the underlying value of the company’s shares in the form of cash entitlements upon the occurrence of certain events and completion of the prescribed timeline. The such incentive is provided to the employee/non-employee for effective performance and employee retention. 

What are the Types of Phantom Stock Option?

There are two types of phantom stock option plans, which are discussed below- 

Appreciation Only

In an “appreciation, only” phantom stock, the participant receives a cash payment equivalent to the difference between the stock price of the company at the redemption and the issuing price of the phantom stock. E.g. if the issuing price of the phantom stock is Rs.100. the company’s common share price, at redemption, was Rs 300. The cash payment per phantom stock shall be Rs 200.

Full Value Phantom Stock

Here the cash payment received by the participant is equivalent to the value of the underlying asset of the phantom stock at redemption. E.g. Issuing price of the phantom stock is Rs. 100. At redemption, the company’s common share price was Rs. 300. The cash payment per phantom stock would be Rs 300

What is the Legal Framework of Phantom Stock Option?

The legal framework of a phantom stock option is discussed below-

Companies Act 2013

The Companies Act 2013 provides rules regarding the issue of shares to the company’s employees under Stock Plans. However, it is silent on the granting  and exercising of SARs, including the issue of equity-settled SARs and Phantom Stock Option.

SEBI Employee Benefit Regulations:

The SEBI Employee Benefit Regulations r/w the Companies Act ESOP Provisions prescribes the  rules and regulations for formulating Stock Plans and the grant and exercise of equity-settled SARs by listed companies.

Informal Guidance sought by Mindtree Limited

It is worth mentioning that regarding SARs, SEBI has provided clarification in respect of the criteria to determine the  applicability of the SEBI Employee Benefits Regulations to an employee benefits scheme hrough  its informal guidance sought by Mindtree Limited. The board clarified that one way is that such a scheme should actually involve “dealing in, or subscription to, or purchase of securities of the company either directly or indirectly”; otherwise, the regulations won’t be applicable to the scheme.

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The employee benefits scheme of Mindtree[1] didn’t include the subscription or purchase of shares by eligible employees when they were exercising their rights; rather, it was through cash payments for the purpose of appreciation in the share prices of the co, Therefore SEBI clarified that the SEBI Employee Benefits Regulations wouldn’t apply to the employee benefits scheme of this company, but the views discussed in the informal guidance regarding Mindtree are specific to the facts circumstances of the case, so the clarification by  Mindtree, the views eby SEBI in the Mindtree informal guidance, cant be applied generically.

What are the Tax implications of the Phantom Stock Option?

The tax implication of the Phantom Stock Option can be better understood through 3 events which are elaborated below-

At the time of Issue of the Phantom Stock Option

At the time of the issue of phantom stock, the employee only receives the right to get a certain payment at a future date based on  the prescribed conditions. Therefore, there is no taxation trigger on the issue date.

Upon the Fulfilment of the Conditions

Upon the fulfilment of the conditions, there is a re-affirmation on the part of the employee regarding the right to get a certain payment at a future date as per certain conditions. Therefore, there is no taxation trigger on the vesting date.

At the time of the Redemption of Phantom Stock

In the event of redemption of phantom stock, the amount of cash that the employee receives (both under the appreciation-only plan and the full value plan) is taxed in the hands of the employee as pre requirements under the head income from salaries.

There is no specific tax obligation on the company (employer), except for deducting TDS at the applicable rates, as the payment is taxed under the head of income from salaries.

What is the Accounting Treatment of Phantom Stock Option?

The Accounting treatment for such stocks is dealt with under Ind AS 102 “Share-based Payments. Here the liability of the company must be recognised on the date of the grant, and the valuation of the same must be done at the end of the reporting period.

The formula for the calculation of the same is as follows

Fair Value of the Equity Instrument* No of Instrument Options issued to each employee*Cumulative Proportionate Period of vesting expired*No. Of employees to whom the option granted

Why Do Companies Use Phantom Stock?

A company uses phantom stocks due to the following reasons

  • The reluctance of the company to issue additional shares
  • In case of legal issues 
  • For offsetting the stock dilution’s effect 

The no. of shares given to an employee is on the basis of their seniority in the company in terms of position as well as their performance. The phantom stock option provides money to the employees in the long term, wherein the benefits are paid out in two, three, or even five years, with some being subject to certain milestones as well.

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Phantom Stock Option: Benefits and Drawbacks 

The benefits and drawbacks of the Phantom stock option are discussed below- 


The benefits of a phantom stock option are-

Financial Gain at Zero Debt

The employers save a lot on their employees as they tranfer the vaue of stocks of the company, which means that the employees get the opportunity for retaining quality talent without h drain their financial resources. Along with this, phantom stocks don’t mess with existing shareholders’ control over the company. The phantom stock scheme helps the employees in receiving the value of the stock as compensation rather than the stock itself  hence eliminating the chances of equity dilution.

Better Employee Productivity

The phantom stock option encourages the employees, and they perform with an enthusiasm which enhances their productivity along with better employee retention for the employers as the phantom stock options provide them with better compensation, so the employees do not search for better job opportunities.

Provides Voting Rights to the Employees

There is a need for experienced, senior-level employees in managerial and leadership-related positions in every company; however, financing the recruitment and retention of such talent can be expensive for the company, and that’s where phantom stocks step in as the transfer of real stocks to an employee, provides them with the voting rights in the decisions of the company.

Easier Exit Mechanism

These stocks provide an easy exit mechanism in comparison to ESOPs. The fact that they are not actual stocks avoids the complexities in respect of the repurchase of the stocks from the employee or the secondary market, where an employee might sell the shares. Employees stop availing of the benefits of phantom stocks upon leaving, but their profits aren’t compromised here because, unlike ESOPs, phantom stocks are much more flexible, and the employees are not required to wait till their retirement to access the cash benefits as the same can be availed during their service. Here, the employees are only provided financial help if they meet specific requirements.

Non-Taxable before Maturity

Holding of the equity shares by the employees is considered a part of the taxable income of the company, but the issue of phantom stock options to the employees is non-taxable until maturity making it a better option for employee benefit for the employer as it saves the tax paid by the employer in respect of the income of the company, however, even when it matures and the employee wishes to release the cash settlement, the tax for such transaction shall be in governance with the guidelines set for the salary income head.

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Even after so many benefits, there are certain drawbacks of the phantom stock option, which are discussed herein under

Requirement of Cash in Hands at the time of Settlement

Irrespective of the situation of the company, the settlement of cash benefits of the employees there must be means to compensate such employees that require cash in hand, which is often difficult for the company. 

Fear of Initiation of Legal Proceedings 

The phantom stock options only benefit employees through monetary compensation. Any failure in such payment would induce their right to take legal action against the employer. 

Payment for Third-Party Stock Valuation

If the company needs to opt for a third-party stock valuation, it will have to bear the fees of the advisory firm alone. Since the company has implemented the phantom stock scheme, their entitled employees can’t share the cost of such fees. 

Non-Applicability of Capital Gains Treatment 

Since phantom stocks aren’t real stocks, the employees will miss out on quite a few benefits with Phantom stocks. Regular stocks undergo capital gains treatment, under which there is a need to pay tax on the profit generated from the sale of the stock.

However, phantom stocks aren’t real, and they only benefit the employee financially. Hence, it gets taxed as ordinary income, which needs to be paid by the employee. 

The disadvantage is that capital gains have lower tax rates than regular income. So although there shall be savings on capital gains tax, the employee needs to make payment of tax on the extra benefit. This might give them second thoughts about the arrangement and reconsider if it’s worth it. 

Key Considerations for Formulating a Phantom Stock Plan

Companies should address the following when formulating a phantom stock plan-

  • The short-term and long-term goals of the co, must be clearly defined
  • The company must be clear about the behaviour or performance that it is planning to incentivise
  • The participants of the plan
  • The stock units (number of shares) that needs to be dedicated for this plan
  • Type of plan
  • The frequency of the grant of stock units be granted (i.e., upfront, quarterly or annually?)
  • Vesting conditions – are they time-based, milestone-based (or both)
  • Forfeiture conditions – minimum performance, termination/exit
  • The funding mechanism to fund the payouts and the probabilities and expected timelines of these payouts
  • The valuation methodologies for determining the value of the stock – applicable for unlisted companies


Phantom Stock Option allows the sharing a portion of profit by companies or appreciated valuation, thereby promoting better incentives and retention of the employees without the dilution of the shareholding of such companies. Therefore it is essential for the employer and employee to be aware of the concept as it can immensely contribute in the growth of the company and the employee.

Read Our Article: Employee Stock Option Plans (ESOPs)- An Overview

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