Phantom Stock / SAR

Phantom stock and Stock Appreciation Rights (SARs) are cash-settled incentive plans that mimic the economics of equity ownership without issuing any actual shares. Because no shares change hands, there's no cap-table dilution, no Section 62(1)(b) ESOP compliance, and no ROC filing — the plan is purely a contractual promise to pay cash.

Phantom stock vs SAR — the distinction: phantom stock pays out the full value of a hypothetical share at settlement (as if the employee actually held it); a SAR pays out only the appreciation in value between grant and settlement (economically closer to an option, but cash-settled instead of share-settled).

Why Indian companies use them: LLPs, which can't easily issue employee stock options at all, are a common user. So are companies that want to extend an equity-like incentive to employees in a jurisdiction where issuing real shares would trigger cross-border securities or FEMA complications, or that simply want to avoid diluting the cap table or running an ROC-filed scheme.

Tax treatment — the part people get wrong: because no shares are ever transferred, the entire payout is taxed as salary income under the normal slab rate at the time of payment. There is no capital-gains leg at all — unlike a real ESOP, where post-exercise share-price appreciation is taxed as capital gains (often at a lower rate). This makes phantom stock/SARs meaningfully less tax-efficient for the employee than real equity, even though it feels similar on paper.

Common pitfall: assuming phantom stock sidesteps compliance entirely. It doesn't remove the need for a well-drafted plan document and a defensible valuation methodology for computing the payout — it just moves the compliance burden from company law to a straightforward income-tax/salary characterisation. Model phantom stock/SAR liabilities as a cash obligation, not equity, in your cap table planning.