Phantom Share Schemes and Share Appreciation Rights: A Guide for Business Owners

Not every business owner wants to dilute their shareholding by issuing actual shares to employees. Private company shareholders may have concerns about employees holding minority stakes, about the complexity of share registers, or about the administrative burden of approved schemes. Phantom share schemes offer an alternative: they deliver equity-linked economic rewards in cash, without the legal complexity of actual share ownership. This guide explains how they work, their tax treatment, and where they sit relative to growth shares and other equity alternatives.

What Is a Phantom Share Scheme?

A phantom share scheme is a contractual arrangement under which an employer promises to pay an employee a cash bonus in the future, calculated by reference to the value of a notional number of company shares. The employee never actually receives shares — the "phantom" element is that the reward mirrors the economics of share ownership without the legal reality.

Phantom shares are particularly common in:

• Private companies where actual share issuance would require Companies House filings and minority shareholder protections.
• Subsidiaries of international groups where the parent's listed shares are difficult to use as the reference asset for local employees.
• Professional partnerships converting to corporate structures where partners are not yet ready to issue equity to employees.
• Companies with complex shareholder agreements where adding new shareholders would trigger pre-emption or consent rights.

Share Appreciation Rights (SARs)

Share Appreciation Rights (SARs) are a variant of phantom shares. Rather than linking the cash payment to the full value of a notional number of shares, SARs pay the employee the appreciation in share value from grant date to exercise date — i.e., the increase in value above a base price. This mirrors the economics of a share option in cash form.

Example: Employee is granted 10,000 SARs with a base price of £5.00 per share. At exercise, the share price is £9.00. The employee receives a cash payment of £4.00 × 10,000 = £40,000.

SARs are particularly common in US-listed multinational groups that want to incentivise local staff in markets where actual share delivery is operationally complex (withholding, exchange controls, local securities regulations).

Valuation Methodology

Unlike statutory approved schemes (EMI, CSOP, SAYE), phantom schemes do not require HMRC-agreed valuations. However, the value formula embedded in the scheme rules must be clearly defined. Common approaches for private companies include:

• EBITDA multiple: the notional share value is calculated as a defined multiple of the company's last twelve months' EBITDA, divided by the number of fully diluted shares. This is the most common formula in private company phantom schemes, as it ties closely to the valuation methodology likely to be applied in any eventual trade sale.
• Revenue multiple: used where EBITDA is not meaningful (e.g., early-stage businesses).
• Book value or net asset value: less common, used where asset values are the primary driver.
• Third-party valuation: the scheme rules may provide that value is determined by an independent accountant at defined intervals.

The formula should be set out clearly in the phantom share plan rules and the individual grant agreement. Ambiguity in the valuation formula is a common source of dispute between employers and departing employees.

Tax Treatment

Income Tax and NIC

Phantom share awards are employment income. When the cash payment is made, the employee is subject to:

• Income tax at marginal rates (20%, 40%, or 45%) on the full amount received.
• Employee NIC at the applicable rate on the full amount.
• Employer NIC at the applicable employer rate — a significant cost compared with actual equity schemes where no employer NIC arises on capital gains.

The employer deducts PAYE and NIC at source through payroll. The employer can claim a corporation tax deduction for the phantom payment as a trading expense in the year it is paid, provided the payment is made wholly and exclusively for the purposes of the business.

This tax treatment — income tax and NIC on the full payment — is significantly less tax-efficient than EMI or other approved schemes, where the gain can be taxed as capital at CGT rates. This is the key disadvantage of phantom schemes compared with actual equity. Employers often justify the use of phantom schemes on the grounds of administrative simplicity, accepting the less favourable tax treatment.

Part 7A: Disguised Remuneration Risk

HMRC's disguised remuneration rules (Part 7A ITEPA 2003) were introduced to prevent employers from deferring employment income into offshore Employee Benefit Trusts or similar arrangements. Part 7A creates a tax charge when a "third party" makes a "relevant step" (such as earmarking or paying funds) in connection with a "disguised remuneration arrangement."

Do phantom schemes trigger Part 7A? Not in their basic form. If the phantom scheme is simply a contractual promise by the employing company to pay a cash bonus, with no funding vehicle or trust, Part 7A does not apply. The risk arises where:

• The employer pre-funds the obligation by contributing to an EBT or similar intermediary.
• The terms of the scheme defer payment substantially beyond the year of vesting (the loan charge provisions under Part 7A targeted arrangements where loans were used to defer income indefinitely).
• An offshore funding vehicle is used for a UK employer's phantom scheme obligations.

Employers structuring phantom schemes should ensure they do not inadvertently create a "relevant step" by setting up an offshore trust or similar vehicle to hold funds designated for the phantom payment. Payment directly from the employer's trading account at the point of crystallisation avoids Part 7A complications.

Vesting and Leaver Provisions

Like actual equity schemes, phantom schemes should have vesting schedules and leaver provisions:

• Vesting: commonly three to five years, with cliff vesting (100% at end of period) or graded vesting (pro-rated monthly or annually).
• Good leavers: departing employees who leave for permitted reasons (redundancy, retirement, death, serious illness) typically receive their vested phantom award promptly. Unvested awards may be paid on a pro-rata basis.
• Bad leavers: employees who resign or are dismissed for cause forfeit unvested awards; some schemes also require forfeiture or repayment of recent payments under clawback provisions.
• Change of control: most phantom schemes accelerate payment on a change of control (acquisition of the company), ensuring employees receive their reward from the exit event that ultimately validates the business's value.

Acceleration on change of control is important to align the incentive with the exit event — without it, the phantom scheme may not serve its motivational purpose in the critical months before and after a sale.

Phantom Schemes and Non-UK Companies with UK Employees

For non-UK businesses that employ UK-resident staff, a phantom scheme is often the simplest way to provide equity-linked incentives without the complexity of registering foreign shares in the UK, obtaining HMRC approval for non-UK schemes, or dealing with securities regulations in two jurisdictions. The phantom payment, being cash, is straightforwardly subject to PAYE and NIC in the UK.

A purely cash-settled phantom scheme does not involve employment-related securities, so it generally falls outside the ERS (Employment Related Securities) registration and annual return regime — the cash award is simply taxed as earnings through PAYE and NIC. However, where a scheme is structured so that it can deliver actual shares or securities (or rights over them), an ERS reporting obligation can arise, so the precise terms should be checked.

Growth Shares: The CGT-Efficient Alternative

For business owners who are willing to issue actual shares but want to limit dilution, growth shares offer a more tax-efficient alternative to phantom schemes. Growth shares are a class of shares that only participate in value above a defined hurdle (typically the current enterprise value). If issued at a price reflecting their nil initial economic value, they can be acquired by employees with minimal upfront payment.

Key differences from phantom shares:

Feature	Phantom Scheme	Growth Shares
Actual shares issued	No	Yes
Tax on receipt/payment	Income tax + NIC	CGT (if correctly structured)
Employer NIC on exit	Yes	No
BADR available	No	Yes (after 2 years, if conditions met)
Part 7A risk	If deferred offshore	No
Administrative complexity	Low	Medium
Minority shareholder rights	No	Yes (may need managing)

Where the company is approaching a potential sale and the management team has a multi-year horizon, growth shares — particularly if issued through an EMI arrangement — will generally deliver significantly better after-tax outcomes than phantom shares. The analysis turns on how long the employee is likely to remain, the anticipated exit valuation, and the employer's appetite for share register complexity.

Compliance Caveat

Income tax, NIC, and Part 7A rules are subject to legislative amendment. The employer NIC rates applicable to phantom scheme payments are particularly vulnerable to rate changes in annual Budgets. The interaction between phantom schemes and Part 7A requires specialist analysis if any element of the arrangement involves a third party or deferred funding. This guide reflects the law as at June 2026. Professional employment tax advice is essential before establishing or amending any phantom scheme.

How Global Investments Can Help

Global Investments advises owner-managed businesses on the design of incentive arrangements that align employee and owner interests efficiently. Whether the right solution is a phantom scheme, growth shares, EMI options, or a combination, our advisers can model the after-tax outcomes for both employer and employee and introduce you to the specialist employment tax lawyers who will implement the chosen structure. Contact us for a confidential discussion.