Tax changes affecting share incentive structures

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.

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.

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%!

Should you require further information or wish to make use of our complementary review and analysis of your LTI, please find our contact details below.

Guy Addison is a corporate finance professional. He works with  high-potential businesses on share transactions and structuring investments.   

Addison Advisory Inc.

Telephone +27 (0) 10 005 3277