Phantom Stocks are gaining popularity all over the world. However, little are know on them. In this blog, we shall try to understand more about this and the various Indian Regulatory aspects attached to this.
What is Phantom Stock?
Phantom stock is an employee benefit where certain individual related to the company receive the monetary benefits of stock ownership without the company giving them actual stock. It is similar to real stake, and its value rises and falls with the company’s actual stake. Employees are paid out of capital reserve /profits at the end of a pre-determined length of time or execution of particular service. Employees feel invested under this scheme. It is derived from usage for SARs which are settled by way of cash entitlement.
Types of Phantom Stocks
There are two kinds of phantom stock plans that are given. These include either “full value” phantom stock, or “appreciation only” phantom stock.
- FULL VALUE – It pays the underlying value and the amount the stock increased while it was held.
For example, let’s say that Mr. X was granted 500 phantom shares on July 1, 2020. When the shares were granted, they were worth Rs. 100 each. In order to receive the benefit of these shares, Mr. X needs to stay with the company for five years. So on July 1, 2021 the shares are worth Rs. 110 each. In this case Mr. X is paid out the full Rs. 110 per share and ends up being Rs. 15,000 (Rs. 110*100). On July 1, 2025, the shares are worth Rs. 150 each. In this case Mr. X is paid out the full Rs. 150 per share and ends up being Rs. 75,000 (Rs. 150*500)
- APPRECIATION ONLY – It doesn’t include the value of the underlying shares, just the increase in stock over the amount of time the shares are held. If the value is not appreciated the employee is not eligible for any amount.
For example, let’s say that Mr. X was granted 500 phantom shares on July 1, 2020. When the shares were granted, they were worth Rs. 100 each. In order to receive the benefit of these shares, Mr. X needs to stay with the company for five years. So on July 1, 2021, the shares are worth Rs. 110 each. Mr. X will get the difference between the current value (Rs. 110) and the initial value (Rs. 100), which is Rs. 10 per share. On July 1, 2025, the shares are worth Rs. 150 each. He’ll get the difference between the current value (Rs. 150) and the initial value (Rs. 100), which is Rs. 50 per share. Mr. X ends up being Rs 25,000 (Rs. 50*500).
The existing Indian legal framework is silent on the grant and exercise of Phantom Stock Options.
It is usually taxed under the head of salary income as perquisites in the hands of the employee. No incidence of the tax arises in hands of the company at the time of making payment of the cash entitlement to the employee.
Why Phantom Stocks are preferred?
- More Flexibility – Private and public companies are both eligible for phantom stocks, which are highly flexible. One need not be a full time employee to receive phantom stocks.
- Vesting Period – Within the vesting period, there is no tax levied on the employee.
- No Dilution for Founders – As no shares are getting allotted, the Founders stake remain as it is and it results in no dilution for the existing shareholders of the Company.
- Little to no complications – A phantom stock program has fewer complications, as the employees are paid only if they meet all the conditions.
Phantom stock plans can be a good employee motivation tool for the company and a solid cash incentive plan for employees. Even if an event goes otherwise and the stock price doesn’t appreciate, neither employer nor employee loses any money directly in the deal.
If you have any query on Phantom Stocks feel free to drop a line at firstname.lastname@example.org
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