Taxing cash payments from phantom share plans
A cash-settled award is a promise to pay money, so it is treated like a bonus. That award is a phantom share. Nothing is taxable at grant or at vesting, and the whole payout is employment income in the year the cash is received, with normal payroll withholding and social security.
Worked example. An employee holds 1,000 virtual shares with a base value of 5 euros. The company sells at 25 euros per share. The payout is 20,000 euros, taxed as salary in that year and paid through the payroll, usually alongside the exit proceeds, a different result from the treatment under stock option tax.
The trade off against real equity
| Aspect | Phantom shares | Real options or shares |
|---|---|---|
| Employee tax rate | Full income tax rates | Often capital gains rates under a qualifying regime |
| Timing | Only when cash is paid | Can be earlier than cash |
| Employer social security | Applies on the payout | Often reduced or removed by qualifying regimes |
| Corporate tax | Usually a deductible employment cost | Deduction depends on the regime |
| Setup cost | Low, contract only | Higher, plan documents, valuation and register |
The employee usually pays more tax on a phantom payout than on a qualifying option gain. In exchange they carry no cost, no dry income risk and no shareholder obligations, and the company keeps a clean cap table, which is one reason phantom plans are common for employee equity in Germany.
Phantom share tax rules across European jurisdictions
- Germany: virtual share programmes are widespread, largely because they avoid notarial costs and the historic dry income problem on GmbH options.
- Netherlands: the payout is wage and runs through the payroll like a bonus.
- United Kingdom: cash settled awards are earnings, with income tax and National Insurance through PAYE, and no capital gains treatment.
- France, Spain and the Nordics: cash bonuses linked to share value fall outside the qualifying share schemes, so no favourable regime applies.
Rates, thresholds and qualifying conditions change with each national budget. Treat the figures here as orientation and confirm the current position with a local tax adviser before you grant.
Drafting points that affect tax and cost
- Define the payout event precisely: a share sale, an asset sale, or a dividend event.
- State the base value per unit, so only growth above it is paid out.
- Set out what happens to good and bad leavers, since a payout to a former employee is still payroll income.
- Provide for the employer social security cost in the exit budget, because it lands in the same period as the payout.
Accounting and provisioning
Cash settled awards are remeasured over time, so the accounting charge moves with the company valuation. Finance should model the payout and the employer charge at the current valuation each period, rather than discovering the number during exit due diligence.
Cash payout tax, answered directly
- Do phantom shares create a taxable event at grant?
- No. There is no transfer of value at grant. Tax arises when the cash payout is made.
- Can a phantom payout be taxed as a capital gain?
- Generally not. The payment comes from the employer under an employment contract, so it is salary rather than a gain on an asset.
General information for founders, not legal or tax advice. Thresholds and rates change, so confirm the current position with an adviser in the relevant country before granting.