Phantom Shares: The illusion that pays?

Introduction

“Phantom stock options” are a form of share-based employee benefits based on the underlying value of equity shares of the employer company. The settlement of such options is made in cash and not in equity shares of the company.

To simplify, phantom shares (also known as shadow stock) are a type of employee incentive plan that gives employees the economic benefits of owning shares such as appreciation in value without actually giving them real shares or ownership. 

They are often called “invisible equity” because they provide employees with the same economic benefits that an actual equity holder would enjoy. Under this scheme, no real shares are issued — meaning employees do not receive voting rights or ownership. Instead, the company adopts a system of cash payouts linked to the value of its shares. The company promises to pay the employee an amount equal to the increase in the company’s share price (or a fixed value) over a certain period.

Phantom shares are used for retention and motivation amongst employees without diluting any ownership. Such issues are often tied to performance or tenure. Think of it as a bonus that mirrors stock performance but paid in cash instead of equity.

For example, if the company’s share price goes from ₹100 to ₹150, and you have 1,000 phantom shares, you get ₹50 × 1,000 = ₹50,000 as a cash bonus.

Let us understand the concept of Phantom Shares with this simple analogy. Imagine a popular restaurant. The actual owners (shareholders) own the restaurant—they decide the menu, hire chefs, and share profits. Now, the head chef (employee) is promised: “You won’t own the restaurant, but if its value goes up or it makes big profits, we’ll give you a cash bonus equal to what you would have earned if you owned a small piece.” The chef never gets a seat at the owners’ table — no voting rights, no actual ownership — but still benefits financially from the restaurant’s success.

Advantages and disadvantages of Phantom Shares

Advantages:

1.       The Company can offer incentive to retain talent without diluting their ownership or control.

2.       Phantom Shares schemes can be tailored to specific performance goals or tenures.

3.       Employee can benefit from the Company’s growth despite not owning shares.

Disadvantages:

1.       Employees do not get any equity rights (such as voting rights) besides the economic benefit.

2.       Income from Phantom Shares are taxed under ordinary income regulations, which may be higher than capital gains tax rates for actual stock.

Provisions regulating Phantom Shares

1. In India, there are no specific statutes or SEBI regulations for phantom shares:

   Phantom stock plans are not governed by SEBI’s Share Based Employee Benefits (SBEB) Regulations, because they are cash-settled and do not involve issuance or dealing in actual securities. They are treated as contractual agreements between the company and the employee. This makes them common for private/unlisted companies where issuing real shares is complex.

   SEBI’s SBEB and Sweat Equity Regulations, 2021 apply to ESOPs, RSUs, SARs (equity-settled), but not to phantom stock options, because these are cash-settled SARs. SEBI clarified that phantom stock plans fall outside its purview for listed companies. [1637066501879.pdf]

2. There are so provisions regulating phantom shares under Companies Act, 2013:

   Since phantom shares do not involve actual share issuance, provisions like Section 62 (issue of shares to employees) do not apply. However, companies must ensure proper board and shareholder approvals if the plan is linked to remuneration policies.

3. Tax Treatment of phantom shares:

   Taxable as salary income at the time of payout (redemption), under the head “Income from Salaries”. The amount received is treated as a perquisite, and companies must deduct TDS. No capital gains tax applies because no actual shares are transferred.

Key Compliance Points while issuing Phantom Shares

• Draft a clear contractual agreement specifying:

  i. Vesting conditions

  ii. Valuation methodology

  iii. Payout triggers

• Ensure accounting compliance under IND-AS 102 for share-based payments.

• For foreign companies granting phantom shares to Indian employees, FEMA compliance may apply if linked to foreign securities.

Phantom Shares vs ESOPs vs SARs:

Feature	Phantom Shares	ESOPs (Employee Stock Option Plans)	SARs (Stock Appreciation Rights)
Nature	Cash-settled; no actual shares issued	Equity-settled; actual shares allotted	Can be cash-settled or equity-settled
Ownership Rights	No ownership or voting rights	Ownership after exercise	Depends on settlement type
Regulation	Contractual; not covered by SEBI SBEB Regulations	Governed by SEBI SBEB Regulations (for listed cos)	SEBI SBEB applies if equity-settled
Tax Treatment	Taxed as salary at payout; TDS applicable	Taxed as perquisite on exercise; capital gains on sale	Similar to ESOP if equity-settled; salary if cash-settled
Accounting Standard	IND-AS 102 (Share-based payments)	IND-AS 102	IND-AS 102
Best for	Private/unlisted companies; retention bonuses	Listed companies; long-term wealth creation	Flexible incentive structures
Complexity	Low (no share issuance)	High (Requires approvals, compliance)	Medium

Conclusion

In essence, phantom shares offer companies a flexible way to reward and retain talent without diluting ownership or navigating complex regulatory hurdles. By mirroring the financial benefits of equity through cash payouts, they strike a balance between employee motivation and corporate control. For businesses—especially private and unlisted ones—phantom stock plans can be a strategic tool to align employee interests with long-term growth, while keeping governance simple and transparent.