Phantom Shares: in the light of recent employment case law

Versión en español

Companies are increasingly using phantom shares as a strategic tool for compensating and retaining employees and executive personnel. Phantom shares – which are virtual shares – are instruments that offer an incentive to key personnel to remain in a company. However, the holders of phantom shares do not become shareholders as such – they benefit from financial rights attaching to the capital, but not present or future voting rights as would otherwise occur were they to receive shares or stock options.

Comparison with other forms of compensation

By contrast with compensation schemes that offer shares or stock options, phantom shares require the company to pay the holder in cash when they vest. This means that, although no actual shares are transferred, granting them attaches a financial obligation, which may be reflected in the company's cash flow projections or other financial forecasts. In order to control their financial exposure, companies should establish limits to the yield of phantom shares, setting the start value and the criteria for determining the final encashment value for differences, the maximum number of phantom shares that can be granted, establishing specific terms and conditions, such as the employee remaining in the company on the vesting date, or a minimum available cash amount. In certain cases, depending on how the incentive scheme is structured, it is possible to establish that the award be settled by delivering shares rather than cash if the company understands that issuing shares is more convenient financially when the rights are acquired. This option is particularly beneficial where a company intends to reduce its cash disbursements while at the same time offering an attractive incentive to its key executives and staff.

Variable employment-related remuneration

As phantom shares are a form of compensation for employees and/or top executive personnel, it is vital to take into account how they are treated from a legal perspective. From an employment standpoint, the recent Judgment of the Spanish Supreme Court (SSC) of 25 September 2024¹, which confirms the Judgment delivered by the High Court of Justice of the Basque Country of 2023², qualifies phantom shares as employment-related variable remuneration. In particular, the SSC's Judgment considered that the phantom shares granted to the employee in question constituted variable remuneration. This was because the phantom shares derived from a nominal grant based on an agreement between the company and the employee, by means of which the worker obtained an indirect stake in the company's performance, received in the form of a bonus and materialising in the form of a cash compensation.

As for the consideration of phantom shares as salary, it could be said that they are similar to stock option plans, where the company awards the employee, whether for free or for consideration, a right to acquire shares in the company or a linked company on a specific date or within a specific time period. Subject to the specifications inherent to each phantom share plan and the agreements signed regarding the application of those plans, a number of elements suggest that this form of remuneration could be treated as salary, if: (i) their aim is to increase employees' commitment with the company and to improve financial performance and, (ii) they derive directly from an employment relationship, and/or (iii) they are linked to continued employment and the terms of termination of the employment contract. Furthermore, as the remuneration is linked to the holder's position as an employee, it adheres to articles 26.1 and 26.3 of the Spanish Workers' Statute, which establishes that all financial considerations obtained for professional services rendered, whether that be in cash or in kind, constitute salary.

In that context, on the basis that salary is the determining factor that should be taken into account to calculate the severance compensation payable for termination of an employment contract, it could be interpreted that phantom shares, given that they constitute salary, should be included in that calculation based on their accrual period and the greater value generated by them.

Work-related income from the perspective of personal income tax (IRPF)

From a tax perspective, we must look to the rulings issued by the Directorate General of Taxation (DGT), particularly rulings nos. V0784-24, V1128-24 and V1132-24, in which income obtained under phantom share plans qualify as work-related income. As for the possibility of applying the 30% reduction established by article 18.2 of the Personal Income Tax Law (LIRPF), it should be assessed whether that income can be understood to have been generated over a period exceeding two years.

In the case of phantom shares, if the plan has a maturity period exceeding two years and the benefit is received in a single fiscal year, the 30% reduction may apply provided that the fiscal conditions of periodicity and exceptionality are met. The above notwithstanding, the above rulings conclude that the 30% reduction did not apply as the plans assessed had a vesting schedule – which, according to the Directorate General of Taxation, was when calculation of the generation period started – and two years had not elapsed from that date when accrual occurred.

In conclusion, phantom shares may offer a valuable incentive tool for attracting and retaining key talent – however, implementing these plans should take into account legal, employment and tax considerations. By correctly designing and implementing these plans, it would be possible for companies to optimise their effectiveness as a form of compensation, while at the same time ensuring compliance with prevailing legislation.

¹Sentencia Tribunal Supremo (Social), sec. 1ª, A 25-09-2024, rec. 3416/2023.
²TSJ País Vasco (Social), sec. 1ª, S 14-02-2023, nº 374/2023, rec. 1741/2022.

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