A phantom share scheme is not, strictly speaking, a share scheme.
Usually, it is in fact a cash bonus scheme. However, the amount of the cash bonus is determined by the performance of the company’s shares and hence the name of ‘phantom share’ scheme.
Such schemes are often used where it is inappropriate to give employees shares or share options.
For example, private companies sometimes prefer to use phantom share schemes, because there is no impact on the ownership/control of the company. There are ways in which phantom share schemes can be made attractive to groups of employees and there are ways in which employers can improve the tax-/NIC-efficiency of such schemes.
Phantom Share Option Plan
A phantom share option plan is a cash bonus plan under which the amount of the bonus is determined by reference to the increase in value of the shares subject to the option. No shares are actually issued or transferred to the option-holder on the exercise of the phantom share option.
Operation of the Plan
The phantom share option plan works in the same way as an Inland Revenue approved company share option plan. The executive is granted an option over a number of shares at an option price which is usually (but not necessarily so) equal to the market value of a share at the date of grant of the option. When the executive exercises the option he simply gets a cash bonus which, subject to the rules of the plan, is equivalent to the difference between the market value of the shares at exercise and the option price.
Other Considerations
The company must always consider whether it should grant options with an open-ended commitment as to the amount of bonus which may become payable when the options are exercised. It is fairly common to place a cap on the amount of bonus which is payable. There are several ways to cap the payment.
The company should also establish a policy in connection with the grant of options. The policy should cover matters as to whether options should normally only be granted to those executives who by their own efforts can increase the value of the company and whether the exercise of options should be subject to performance targets.
Main Advantages
- There is no dilution of the issued share capital as no share is transferred to the executive on exercise of the option;
- As the amount of the bonus is linked to the increase in the share price the executives interest and that of the shareholders are aligned and their common objective becomes the addition of value to the company;
- There are no regulatory requirements to be met and the plan is extremely flexible;
- Administration cost of the plan is minimal; and
- The company is entitled to a corporation tax deduction for the full cost of payments under the plan.
Main Disadvantages
- As the company makes a cash payment, the timing of which is at the individuals discretion and not the company, there will be a cash flow cost;
- National insurance contributions are payable; and
- The bonus is chargeable to income tax in the hands of the executive.