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Incentivise your team: A quick guide to employee share schemes and phantom share schemes

Monday, 1 July 2013 | By Ursula Hogben

Earlier this year, the team at LegalVision gave us some helpful tips on the legal basics of starting a new business.


Over the coming weeks, we’ll look at legal matters that can arise for a new business once it’s up and running.


For the first article in the series, the managing director of Hogben Group and lawyer in the LegalVision network, Ursula Hogben, will look at ownership schemes to incentivise your staff.


The right team can make the difference between your businesses failing or achieving your vision. Financiers, including private investors and banks, look at your team as an important factor in deciding whether to fund your business.


How can a start-up with limited cash attract and retain outstanding employees? This article looks at two key methods: employee share schemes and phantom share schemes.


Employee share scheme (ESS)


An ESS, also known as an Employee Share Option Plan, provides employees with shares, stapled securities or options to acquire shares or stapled securities in the employer company (interests).


A key benefit is that an ESS is a non-cash, flexible way to attract and retain employees, and align their interests with the medium and long-term interests of your company.


A key disadvantage is that the interests are treated as compensation under Australian tax. This means employees are generally required to pay tax in the year that they receive the interests, not when they sell the interests and receive cash.


This is problematic because employees pay tax up-front on a relatively illiquid asset. If the company does not succeed, the interests may not realise value for the employee in the future.


In June, the government announced it is reviewing the tax treatment of ESS. The aim is to simplify ESSs to promote participation and business growth, particularly for small business. To promote participation in ESSs, the tax treatment needs to change so that rather than be taxed in the year that they receive the interests, employees are taxed in the year that they sell the interests when cash is received, as a capital gain. 


Phantom Share Plan (PSS)


An alternative is a PSS which is a cash bonus arrangement designed to mimic the income yield and capital growth of shares in the company. Unlike ESSs, employees do not receive interests. Instead, the PSS gives employees a right to receive cash from the employer in the future. Two common types of PSS are:


1. Profit share: employee receives a certain percentage of the annual profits, and a share of profit if business is sold; or


2. Improvement share: employee receives a percentage of the improvement in the company’s profits and capital value above an agreed base.


Like an ESS, a PSS is treated as compensation for tax purposes. A key benefit of a PSS compared to an ESS is that the employee receives cash, part of which can be used to pay the tax. A key disadvantage is that employees do not own shares in the company.


Employee Share Schemes 

Phantom Share Schemes

Attract, retain and reward employees, without competing on salary alone. 



Align the interests of the employee with the company, for greater success for the company, the employee and the economy.



A flexible cash management tool to enable companies to have lower salary costs (fixed cost), and link remuneration to company performance (variable cost).


Employees remunerated with:

(i) Annual Dividends.

(ii) Capital growth.


Employees can be remunerated with:

(i) Annual bonus like a dividend.

(ii) A lump sum bonus, representing the employee’s share of the increase in the capital value of the company.

Option (ii) is generally payable only if the company is sold, the employee retires, or leaves as a ‘good leaver’.


Complex to set up.

Requires several set-up documents including ESS Rules, Letter of offer, ESS Summary and information about tax implications.

Easy to set up.

Can be set up as an addendum to the employee’s terms of employment.



Higher administration costs.

Employer ongoing documentation and reporting requirements.

Employees have reporting and withholding obligations.

Low administrative costs.

Payments create employment costs such as payroll tax.


Employees pay tax on vesting, not when they sell their interests.

Granting equity under a standard ESS is non-deductible to the employer.


No additional regulatory requirements as no equity interests are issued or transferred.

When the employee receives a payment, tax is deducted under the PAYG system.

Bonus payments to employees (whether annual bonuses or cashed out capital entitlements) are tax effective because they are fully deductible to the employer.

Ease of valuing the interests


Easy - cash


Low. Private company interests can be hard to sell until the company lists or is acquired.

High - cash


Employees own shares in their employer



Existing shareholders are diluted 



Ursula Hogben, managing director of Hogben Group: Business Law & Consulting, is a lawyer in the LegalVision network. (This information is a summary and an overview. It is not intended to be comprehensive and it is not legal advice. Your use of this information is not intended to create and does not create a solicitor-client relationship between you and Hogben Group.)