Are Phantom Shares Legal in India? Meaning, Rules, Taxation and Compliance for Companies

Yes, companies in India can generally offer the cash-settled phantom shares through properly structured, well-organised contractual incentive plans. These arrangements reward the participants by linking cash payments to the share value without issuing the actual equity. Their legality and compliance basically depend on the scheme’s terms, corporate approvals, taxation and applicable accounting requirements.

Phantom shares can help founders to retain employees without diluting ownership. However, the company must still meet its payment obligations under the plan.

Quick Summary

• Phantom shares represent the contractual benefits, not ownership.
• Plans may reward full share value or only appreciation.
• Pure cash settlement differs from an ESOP involving actual shares.
• Employee payouts usually attract the salary taxation and TDS.
• Companies must assess the approvals, documentation, accounting and future cash requirements.

What Are Phantom Shares?

Phantom shares are notional units whose value tracks the company’s shares. Participants receive cash when the conditions specified in the scheme are satisfied.

Two common structures are: -

For example, an employee is granted 1,000 appreciation-only phantom units with a base value of ₹100 per unit. If the value rises to ₹160 per unit at settlement, the employee’s gross payout would be ₹60,000, subject to the vesting requirements, plan terms and various applicable taxes.

Phantom units do not themselves provide voting rights, shareholder dividends or membership rights. Any dividend-equivalent benefit must arise from the contract.

Which Rules Apply to Phantom Shares in India?

There is no single standalone phantom-share registration framework. Companies must examine the arrangement under contract law, company law, tax law and applicable accounting standards.

Contractual enforceability

A phantom-share scheme should satisfy the requirements of a valid contract, including competent parties, free consent, lawful consideration and the lawful objects. Section 10 of the Indian Contract Act, 1872 provides the general contractual foundation. Clear and proper terms reduce the disputes over entitlement and payment.

Companies Act requirements

A genuinely cash-only plan does not issue the shares. Consequently, the share-issue requirements applicable to an ESOP under section 62(1)(b) are not automatically triggered simply because the benefit tracks the share value. If the actual equity issuance becomes possible, then the applicable share-issue framework must be reassessed.

Companies should obtain appropriate corporate authorisation and check their articles, shareholder agreements and remuneration policies. Shareholder approval should be assessed against the company’s circumstances rather than assumed universally necessary or unnecessary.

Director and managerial awards require the additional scrutiny under applicable remuneration and conflict-of-interest provisions.

SEBI position for listed companies

SEBI’s published FAQs explain that phantom stock options settled in cash, without actual purchase or sale of the listed company’s equity shares, fall outside the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021.

This is a structure-specific position. A scheme involving securities directly or indirectly requires fresh assessment. Listed companies must also examine their other applicable governance and disclosure obligations.

Phantom Shares vs ESOPs: What Is the Difference?

The choice should reflect retention objectives, employee expectations and the company’s ability to fund future benefits.

How Are Phantom Shares Taxed in India?

Cash payments arising from the employment generally constitute salary income rather than capital gains. A share-linked calculation does not, by itself, turn employee remuneration into the investment income.

The Income-tax Act, 2025 came into force on 1 April 2026. Companies must use the framework applicable to the relevant tax period, including transitional provisions where necessary.

For employees, the key considerations are: -

• Timing: Salary taxation usually follows the earlier of becoming due or receipt. Grant or vesting should not automatically be treated as the taxable event without examining when an enforceable payment entitlement arises.
• TDS: Employers must apply the salary withholding requirements when making taxable payments.
• Classification: Consultant, non-employee director and the cross-border arrangements require separate analysis.

Section 392 of the Income-tax Act, 2025 addresses the salary withholding at payment. The plan should explain the deductions without promising a fixed post-tax benefit.

Employer deductibility also requires a separate review; an accounting expense does not automatically establish a tax deduction.

What Compliance Should Companies Complete?

Before granting the phantom units, companies should: -

• Identify participants: Distinguish employees, directors, consultants and the overseas recipients.
• Document approvals: Record the scheme’s approval and any required committee, shareholder or contractual consents.
• Define valuation: Specify the methodology, valuation date, base value and adjustments.
• Set entitlement rules: Address vesting, performance conditions, resignation, termination, death and disability.
• Define settlement: Explain payment triggers, deadlines, caps and treatment on an acquisition or IPO.
• Maintain records: Preserve grant letters, acceptances, calculations, approvals and withholding records.

Overseas participation or foreign-group payments also warrant FEMA, remittance and tax review.

How Should Companies Account for Phantom Shares?

Where Ind AS applies, cash-settled share-based payments fall within Ind AS 102. The company recognises the relevant services and liability, remeasures the liability at each reporting date and settlement and generally recognises valuation changes in profit or loss. Companies outside Ind AS must assess their applicable accounting framework.

Conclusion

Phantom shares can reward the employees without issuing equity, but they create the real contractual and various financial commitments. A suitable scheme needs clear and proper valuation, appropriate approvals, correct taxation and reliable accounting. Reviewing these elements before grants helps companies to easily manage expectations and future settlement costs.

Get a Phantom Share Scheme Assessment from Remind Legal to review your proposed structure, documentation and compliance requirements.