Introduction
Fairly new concepts in the Indian stock options universe are Phantom Stock Options or Shadow Stock Options (PSO).
PSO is a contractual agreement between the organization and the recipient that bestows the recipient with the right to receive payout on the basis of stock prices of the organization at a future date or on fulfilment of certain conditions. The said option helps the organization to reward its people or third party vendors and maintain the control of the existing shareholders at the same time.
Meaning
The literal meaning of the word “Phantom” can be derived as “a ghost or a figment of imagination”. Thus in terms of PSO it can be construed that while stock options are being given to the recipient these options won’t result in the allotment of stocks, rather some other rewards shall be given.
Legal Status
Since it is a legal contract between the organisation and the recipient, the discharging of the contract upon fulfilment of criteria of the contract is the obligation of the contracting parties.
Parties to PSO
The first party to the PSO is always the organisation issuing the Options while the recipient or the Second Party are generally employees but can be directors, third party vendors or others.
Objectives
The very purpose of the option being the desire to reward without dilution of equity and linking the rewarding system with the changes in the stock value of the organization.
Purpose
In case the recipient are employees, then the primary purpose is to retain the employees, give them a sense of ownership of the organization while not saddling them with the equity of company which may not be of much use to them. Most of the time, the issuing organisation are unlisted companies/ pvt ltd companies,securities of which are not easily tradable in the market, hence they don’t have any liquid benefits to the employees until and unless the company goes for buy back or liquidation. PSO on the other hand provides the employees generally 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 on the basis of payout. One being the appreciation plan and the other being the full value plan. In appreciation plan, the amount of cash payout is equivalent to the appreciation in the stock from the date of grant of option to the date of vesting of right to receive payout. In full value plan, the amount is equivalent to the value of the stock on the date of vesting.
How the options are exercised:
PSO links the value of payout with the stock value. Thus, the recipient is supposed to receive the appreciated value of stock or the full value of stock after the completion of certain fulfilment criteria or some specific period. A simple example is given below :
On 1st April 2019, Mr Prakash a Senior Employee in BCD Pvt. Ltd. has been granted 10,000 PSO (Appreciation Plan) if he continues his employment in the organisation till 31st March,2021.The value of these stock as on date is Rs 1,000 per share as per the valuation derived by a Registered Valuer. Mr Prakash fulfils the criteria. As on 31st March 2021, the value of the company is derived at Rs 1,500 per share. Thus as on 31st March 2021, Mr Prakash is supposed to receive Rs (1,500-1,000)*10000=Rs 50 Lakhs.
Types of Organisation which can issue PSO
Generally companies issue such options but the organizations which are taxed as partnership firms can also provide a plan similar to that of 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 | As the name suggests it covers only Employees | Generally it is given to employees but can be given to third parties and director also |
| 2 | Employees are generally issued Equity after exercising the options | Cash Payout is generally the preferred payout |
| 3 | Specific rules exists under Cos Act, SEBI guidelines and others statutes | No specific guidelines under 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 at the time of fulfilment of criteria and subsequent payout in the hand of Employee |
| 5 | Mandatory vesting period of 1 year | Nothing mandatory |
| 6 | Employees have the right to not exercise the options | Even though theoretically, PSO payout can be refused also but most of the time recipient shall not refuse the payout |
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 of “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. In such types of cash settled options, the liability of the entity has to be recognised 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 the Equity Instrument* No of Instrument Options issued to each employee*Cumulative Proportionate Period of vesting expired*No. of employees to whom option granted.
Example: M/s Ekta Ltd. grants 1,000 PSO each to 10 employees with a vesting period of 1 year as on 1st April 2021. Fair value of equity as on date of grant is Rs 500 per share. What will be the liability to be recognised in the books of the company? Now as on 31st March 2021 the fair value is recalculated as Rs 600 per share, then what shall be the accounting treatment?
Answer: As on date of grant, liability to be recognised:
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= Rs 50 lacs
As on date of exercise, liability to be recognised
Total liability to be paid= 600*1000*10=Rs 60 lacs
Accounting treatment
As on Grant Date,
Reserve & Surplus 50 lacs
To Prov for PSO 50 lacs
(Being liability created for PSO payment out of reserve)
As on exercise date,
By Reserve & Surplus 10 lacs
To Prov for PSO 10 lacs
(Differential between fair value of grant date and exercise date)
As on 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. Non presence of inherent requirements or restrictions by different statues makes it even more favourable as the organization can design the plan as it desires.
So, in an era where monetary as well non monetary compensations are important and high employee turnover is present, phantom stock option serves as a viable option.
Author Bio
Read. Good writing.
Thanks!