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Tax changes affecting share incentive structures

Did you know?

Since 2016, all gains arising under employment-linked share incentives (whether options or share purchase schemes) are taxable as income? This damages their effectiveness as an incentive tool, and makes them a costly and inefficient mechanism, for the companies involved.

What has changed?

Senior executives at listed and unlisted companies generally belong to share purchase or share option schemes. Once the primary mechanism for management to accumulate wealth, such structures have become a tax minefield.

The South African tax legislation related to share incentives has changed dramatically in recent years. Essentially, all of the gains accruing to employees from “restricted” equity instruments are now subject to income tax.

In summary, the following taxes are applicable to share incentive schemes:

  • Deemed interest on loans to executives for share purchase schemes is taxed as a fringe benefit.

  • All gains on restricted instruments are taxed at personal income tax rates – this applies to all restricted structures such as phantom, share purchase and share option schemes.

  • Capital Gains Tax applies to gains made after shares are transferred or vest as unrestricted instruments.

Taxation of Vesting of Equity Instruments (Section 8C)

According to paragraph 11A of the Fourth Schedule, an employer must apply for a directive on the gain made from the vesting of any equity instrument or any accrual or receipt of a return of capital, according to section 8C. These equity instruments would have been acquired on or after 26 October 2004.

The gain/return of capital must be processed against IRP5 code 3718, and the tax according to the directive against IRP5 code 4102. From March 2017, certain dividends in respect of section 8C equity instruments are seen as remuneration from which PAYE must be withheld according to the directive.

New Changes

The profit arising under a share option scheme has always been taxable as income in the hands of an employee, but until recently (2016), the profit arising from a share purchase scheme was treated as a capital gain, taxable at a lower rate.

As indicated above, this has since changed, with the result that even gains made on share purchase schemes are now taxable as income. The taxable gain, included in the employee’s tax return, is calculated by subtracting it from the market value of the equity instrument at the time that it vests in the taxpayer’s name, from the sum of any consideration paid by the taxpayer in respect of the equity instrument.

The impact on share incentives

What this means is that gains on shares for employee shareholders are generally considered as income, and taxed at one’s marginal income tax rate, which can be as high as 45%!

What can be done

AC Corporate Transaction Services is a professional service firm based in Sandton, South Africa. We provide insight, advice and direction to senior executives, shareholders of emerging and established companies and individuals.

Our expertise covers corporate finance, share transactions, business development, strategy and governance matters including executive alignment structures and succession plans. With an emphasis on high-impact, value enhancing work that is clearly understood and supported by our clients.

We enjoy helping clients achieve their business and financial goals and can often unlock seemingly insurmountable challenges. If we can help you make sense of your share incentives, please make contact.

If you wish to explore this topic in more detail, please contact us.


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