Firstly, it is important to understand that a shareholder is the owner of equity in a company and is by virtue of being such a holder entitled to enjoy certain rights, with such rights associated with the class of shares held and the rights associated with classes of shares typically set out in the memorandum of incorporation (MOI) of the company.
With increasing competition for quality employees and employers looking at new ways to incentivise and retain staff, it has become a regular occurrence for employers to offer shareholding to key employees of the company. That said, as a shareholder there are also risks and responsibilities that accompany the ownership of the shares, and as much as employees may appreciate the benefits of shareholding the downside of also carrying risk, would not be palatable to many employees.
Enter “phantom share schemes” as a popular option by employers to incentivise their staff. A phantom share scheme is defined in Regulation 81(s) of the Companies Act as a company plan or scheme in terms of which employees are granted a right to receive an amount of cash at a certain time, based on the performance of the share price of the company. With a phantom share scheme, no actual shares are issued to an employee in the way that they are issued to a shareholder of a company. With phantom share schemes a company issues units to an employee which are usually linked to the market value or growth of specific shares in the company. The allocation of the units to the employee is commonly regulated by way of a contractual arrangement between an employer and the employee with the provision that the employee will be entitled to receive a cash payment equivalent to the market value of the actual shares of the company when the company declares its dividends or at any other event which may be specified in the contract.
The payment from a phantom share scheme can be equated to a cash bonus that is received by an employee at the time specified in the contract and will thus be treated as normal income in the employee’s hands and taxable at the employee’s taxable rate. The value of the units is however linked to the value and growth of the actual shares of the company. So as the value of the company grows, the units grow simultaneously. In this way the employees who benefit are also incentivised to contribute towards the growth of the company.
Phantom share schemes grant employees the sense of sharing in the company’s growth just like shareholders without being shareholders and without being burdened with all the complexities that may accompany being a shareholder. Phantom share schemes are flexible and easily manageable as they are regulated by way of an agreement between the employer and the employee which may include any type of conditions as agreed upon between the employer and employee such as that the vesting of a unit (or further units) may be linked to performance or be time based e.g. after five years of service. Phantom share schemes are therefore an effective mechanism to consider for employees who associate their personal success to their financial goals and in turn also to the success of their employer.
Should you consider the phantom share scheme option, it would be advisable to consult with your commercial advisor regarding the setting up of the scheme to ensure that it is correctly done and that the contractual and tax arrangements in respect of your employees is appropriately addressed.