Phantom Share Option Plans – 6 Things You Need To Know

Structuring your business and finding ways to incentivise your employees can be a challenging process. One of your options for an incentivisation scheme is implementing a Phantom Share Scheme. If you’re looking for ways to motivate and retain your employees without relinquishing equity, this option might be suitable for you. 

Keep reading to find out:

1. What is a Phantom Share Scheme?
2. When are they offered? 
3. What are the different types? 
4. How are they different from an Employee Share Scheme?
5. How are they taxed in New Zealand? 
6. How are they implemented?

What Is A Phantom Share? 

A Phantom Share Scheme is offered by an employer to their employees. It is one of the types of schemes that offer incentives to employees as a reward for their hard work and loyalty to the company. With a Phantom Share Scheme, no actual shares in the company are transferred. 

Instead, the company offering the scheme provides ‘notional’ shares. These shares are pegged to the value of the actual company shares. Depending on the type of phantom share scheme, your employees will receive a payout when the real shares of the company increase in value or pay a dividend. 

It’s useful to consider the purpose of phantom shares. When an employer wishes to offer incentives to their employees in the form of shares, but does not want to dilute their equity in the company, what options do they have? Employers in the United States addressed this issue by creating the phantom share. It still encourages employees to work diligently by linking their benefits to the company’s success. At the same time, no equity is diluted while creating this incentive. It is an ingenious solution to a complex issue! 

When Are Phantom Share Schemes Offered? 

As mentioned earlier, Phantom Share Schemes are a way to incentivise employees without losing equity. However, there are certain situations where Phantom Share Schemes are more suitable than others.

Firstly, Phantom Share Schemes require a significant amount of cash. This is because the payout for a Phantom Share Scheme is akin to an annual bonus. You need to pay the employee the equivalent dividend or agreed rewards that are due to them in cash. If your company’s value increases significantly or you have many employees on the scheme, you will need a robust cash reserve to fulfil your obligations. 

Secondly, perhaps because they are such a cash-intensive venture, Phantom Share Schemes are typically offered only to senior or high-performing employees. This is due to the highly competitive market for talented employees. If your business faces a lot of direct competition and you need to encourage your employees to stay, this could be an excellent reason to offer a Phantom Share Scheme.  

Thirdly, Phantom Share Schemes do not involve real shares. This means they are less expensive to implement, simpler to set up, and alleviate concerns over company equity that you may have with an alternative incentive program. 

What Are The Different Types Of Phantom Share Schemes? 

There are two main types of Phantom Share Plans: an ‘Appreciation Only’ plan and a ‘Full Value’ plan. Both plans are linked to the performance of the company’s shares. 

However, they differ in how the behaviour of the stock affects the employees’ payout. 

Appreciation Plan 

An appreciation plan is a more restricted version of the Phantom Share Scheme. It assigns ‘notional stock’ that is tied to real stocks to the individual. However, it only compensates the individual when the stock increases in value. Moreover, it only pays the amount by which the stock has appreciated from its base level. It does not include the value of the actual stock, only the appreciation. The base price of the stock is typically set from the date the plan is operational. 

Full Value 

A full value Phantom Share Scheme compensates employees with the value of the stock, as well as any appreciation that occurs while the Phantom Share Scheme is active. This option will cost more than an Appreciation Plan but may also serve as a stronger incentive for employees. 

Phantom Share Schemes vs Employee Share Schemes 

Employee Share Schemes are a more commonly used employee incentivisation scheme. Indeed, Phantom Share Schemes and Employee Share Schemes share many similarities. 

The key difference is that Employee Share Schemes offer employees actual shares, whereas a Phantom Share Scheme is a contractual agreement tied to the performance of shares. 

With Employee Share Schemes, the employer must determine the value of these shares and decide if the employees receive shareholder voting rights in the company. This requires more legal and financial groundwork, which in turn incurs significant costs in terms of time and money.

Additionally, as will be explained below, these schemes are taxed differently. The taxation of Phantom Share Schemes in New Zealand is discussed below. However, it’s worth noting that changes to tax laws can impact the treatment of Employee Share Schemes, potentially offering tax advantages. This benefit may include the ability for employees to defer their tax liability.

Employee Share Schemes, like Phantom Share Schemes, have their advantages and disadvantages. But it’s crucial to understand the differences in their operation when deciding how to structure your business incentives. 

How Are Phantom Share Schemes Taxed in New Zealand? 

In New Zealand, the taxation of Phantom Share Schemes is treated similarly to income. The Inland Revenue Department (IRD) views these schemes as part of an employee’s remuneration package, and therefore, they are subject to income tax. Payments from the Phantom Share Scheme are considered part of the employee’s income for that pay period and are taxed at their marginal tax rate. 

However, a Phantom Share Scheme will only be taxed when it is paid out. This can be annually, akin to a bonus, when dividend payments are made to regular shareholders, or at a later date as stipulated in the contract. If the company is listed on the stock exchange or is acquired, the benefits from the Scheme will be paid out and taxed at that time. 

How Are Phantom Share Schemes Implemented?

Phantom Share Schemes are a contractual agreement. This is one of the factors that make them simpler than other employee incentivisation schemes. The agreement is between you and your employees, with no other parties involved. Implementing your Phantom Share Scheme can be done at the beginning of the employee’s tenure at your business, by including the scheme in the original contract. Alternatively, if you wish to introduce the scheme at some point after the signing of the initial contract, a standalone agreement between the employer and the employee can be established. 

Still Unsure? 

Structuring your business to effectively incentivise and retain talented employees is a stressful and complex task! The lawyers at Sprintlaw have experience in this area and can guide you through the process. Get in contact now for an obligation-free chat. You can reach out to us at [email protected] or contact us on 0800 002 184.

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