Phantom Stocks, ESOPs and Sweat Equity

Phantom Stocks, ESOPs and Sweat Equity

Companies today have evolved towards hybrid reward plans for their employees, which may include SARs (Stock appreciation rights). One such stock option derived through SARs is Phantom Stocks or Shadow Stocks. Herein, the employee or non-employee is entitled to receive the underlying value of the share as a cash payment upon fulfilment of certain criteria or time period, as laid down in the agreement.

Thus, this provides for incentive-plans for employees or non-employees (such as consultants, agents, promoters, advisors, etc.) without an actual issuance of the shares as compared to an ESOP or sweat equity(explained below).

Phantom Stocks do not find a mention in any legal framework in India. In an informal guidance sought by Saregama India Ltd in 2015, SEBI clarified that such options are not governed by SEBI’s Share Based Employee Benefits (SBEB) Regulations, 2014 which specifically refer to ‘dealing in or subscribing to or purchasing securities of the company, directly or indirectly…’ under Regulation 1(4).

Thus, in the last few years, Phantom Stocks have become increasingly popular especially for start-ups to incentivize their staff as well as maintain their shareholding. The employee/non-employee too has found this beneficial however the payment received is taxable in their hands (as perquisites) unlike as capital gains and would be less advantageous for those who wish to receive actual equity in the company shares.

Companies may be familiar with Employee Stock Option Plans (ESOPs)- often part of an employee’s remuneration package providing for an equity stake or a cash payment based on the equity share. ESOP provides the right to purchase a certain amount of shares at a predetermined price in the future.

Sweat Equity on the other hand, are immediately allotted shares as a compensation for providing intangibles (in the form of knowledge, IP, etc.).

The definition of ‘employee’ for both however differs- thus unlike sweat equity shares, an unlisted company cannot give ESOP to a director (directly or indirectly holding more than 10% of equity shares), an employee who is a “promoter” or person belonging to the promoter group.


Disclaimer: The material provided herein is solely for general information purposes only and should not be relied upon for such purposes or used as a substitute for legal advice.

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