PHANTOM STOCK OPTION
Neeraj Agarwal
I Neeraj Agarwal, am a Fellow Member of ICAI, practicing under the banner of M/s AAN & Associates LLP, a firm based out of Banglore Mumbai.
I am also registered under Insolvency and Bankruptcy Board of India as a Registered Valuer for valuation of Security or Financial Assets (Passed in Feb 2020)
I am also holding Bachelor of Commerce (B. Com) degree from Calcutta University (Passed in 2011).
I have corporate working experience in Wipro. After working in Wipro for a short period I started my practice in late 2013 and have been in practice so far for the last 10 years. I have also completed a Certificate Course by ICAI on IND-AS in 2020. I have also cleared Social Auditor Exam conducted by NISM.
I have been inducted as a Special Invitee to the Sustainability Reporting Standard Board, ICAI for the FY 2023-24.
Introduction
Phantom Stock Options (PSOs), also known as Shadow Stock Options, are relatively new concepts in the Indian stock options landscape.
A PSO is a contractual agreement between the organization and the recipient, granting them the right to receive a payout with the right to receive a payout based on the stock prices of the organization at a future date or on fulfillment of certain conditions. This option allows the organization to reward its employees or third-party vendors while retaining control with the existing shareholders.
Meaning
The literal meaning of the word “phantom” is “a ghost or a figment of imagination”. Thus, in the context of PSOs, it can be inferred that while the recipient is granted stock-linked options, these do not result in the allotment of actual shares but rather in other forms of compensation.
Legal Status
Since it is a legal contract between the organization and the recipient, the obligation to discharge it upon fulfillment of its conditions rests with the contracting parties.
Parties to PSO
The first party to the PSO is always the organization issuing the options, while the recipient, or the second party, is generally an employee but can also be a director, third-party vendor, or another stakeholder.
Objectives
The primary objective of the option is to provide rewards without diluting equity while aligning compensation with changes in the organization’s stock value.
Purpose
If the recipients are employees, the primary purpose is to retain them and give them a sense of ownership of the organization while not saddling them with the equity of the company which may not be of much use to them. Most often, issuing organizations are unlisted or private limited companies, the securities of which are not easily tradable in the market. Hence, they do not provide employees with liquid benefits until and unless the company goes for buyback or liquidation. PSOs, on the other hand, generally provide employees with liquid cash which is beneficial to them, especially, to middle-level and lower-level employees.
Basis of Payout:
Phantom stock options are divided into two types based on payout. These include the appreciation plan and the full value plan. Under the appreciation plan, the cash payout is equivalent to the increase in stock value from the grant date to the date of vesting of the right to receive payout. In a full-value plan, the amount is equivalent to the value of the stock on the date of vesting.
How the Options Are Exercised?
A PSO links the value of the payout to the stock value. Accordingly, the recipient receives either the appreciated or the full stock value upon meeting certain criteria or after a specified period.
A simple example is provided below:
On 1st April 2019, Mr Prakash, a Senior Employee in BCD Pvt. Ltd. was granted 10,000 PSO (Appreciation Plan) if he continues his employment in the organization till 31st March 2021. The value of these stocks on the grant date was ₹1,000 per share as per the valuation derived by a Registered Valuer. Mr Prakash fulfills the criteria. As of 31st March 2021, the value of the company is derived at ₹1,500 per share. Therefore, as of 31st March 2021, Mr. Prakash is entitled to receive ₹(1,500 – 1,000) × 10,000 = ₹50 lakhs.
Types of Organisations that can issue PSO
Generally, companies issue such options; however, organizations taxed as partnership firms can also provide a plan similar to that of a phantom plan where the amount of payout is tied to the partnership equity value.
Difference between traditional Employees Stock Option Plan (ESOP) and PSO
While both ESOP and PSO are incentive schemes, there are certain differences between the two:
Serial No | ESOP | PSO |
1 | Applicable only to employees | Generally, it is given to employees but can be given to third parties and directors also |
2 | Employees are generally issued equity shares upon exercising their options. | Cash Payout is generally the preferred payout |
3 | Specific rules exist under the OS Act, SEBI guidelines, and other statutes | No specific guidelines under the Cos Act or other statutes. |
4 | Taxability in the hands of Employees at the time of Exercise and at the time of sale of shares | Taxable upon fulfillment of the criteria and subsequent payout in the hands of the employee.
|
5 | Mandatory vesting period of 1 year | Nothing mandatory |
6 | Employees have the right to not exercise the options | Although recipients may theoretically refuse the PSO payout, in practice, this is rarely done. |
Taxability
While there is no taxability in the hands of the entity issuing the PSO, the employees receiving the same are taxed under the head “Salary” as perquisites at the time of exercising the option i.e., at the time of actual payout and not at the time of granting. Standard rules of tax deduction (TDS) are to be applied while the payout is being done. The entity issuing the PSO can claim this as expenses in their books just like normal salary (perquisites) expenses.
Accounting Treatment
Ind AS 102 “Share-based Payments” deals with accounting for such types of options. For such cash-settled options, the liability of the entity has to be recognized at the grant date itself with valuation to be done for the same at the end of each reporting period. The calculation of the said liability will be done by the following formula:
Fair Value of Equity Instrument × Number of Options Issued per Employee × Cumulative Proportion of Vesting Period Expired × Number of Employees Granted Options
Example: M/s Ekta Ltd. grants 1,000 PSO each to 10 employees with a vesting period of 1 year as of 1st April 2021. The fair value of equity as of the date of the grant is ₹500 per share. What will be the liability to be recognized in the books of the company? Now as of 31st March 2021 the fair value is recalculated as ₹600 per share, then what shall be the accounting treatment?
Answer: As of the date of grant, liability to be recognized:
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 option granted.
Or
₹500*1000*1*10= ₹50 lacs
As of the date of exercise, liability to be recognized
Total liability to be paid= 600*1000*10=₹ 60 lacs
Accounting treatment
As of the Grant Date,
Reserve & Surplus 50 lacs
To Prov for PSO 50 lacs
(Being liability created for PSO payment out of reserve)
As of the exercise date,
Reserve & Surplus A/c Dr. 10 lakhs
To Provision for PSO A/c 10 lakhs
(Differential between fair value of grant date and exercise date)
As of the Payment date,
Salary A/c (P/L) 60 lacs
To Bank 54 lacs
To TDS 6 lacs
(Assuming TDS @10 percent straight)
Concluding Thoughts
Concepts like PSO are here to stay. The absence of statutory requirements or restrictions makes PSOs even more favorable, as organizations can design plans according to their specific needs.
In an era where both monetary and non-monetary compensation are crucial, phantom stock options serve as a viable solution to attract and retain talent. Given the importance of effective compensation strategies and the prevalence of high employee turnover, phantom stock options serve as a viable and strategic solution.
Declaration
I, Neeraj Agarwal, residing in Bangalore, hereby declare that the article titled “Phantom Stock Options” has been written by me based on legal facts and contents have not been copied from anywhere except legal provisions under various enactments. I further declare that this is my ‘original work’. Any resemblance to any other work/article/book/blog is purely coincidental. Although I have made every effort to ensure that the information in this article was correct at press time, I do not assume and hereby disclaim any liability to any party for any loss, damage, or disruption caused by errors or omissions, whether such errors or omissions result from negligence, accident, or any other cause.
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