Share incentive schemes dividends
Many South African companies seek to incentivise their employees by allowing them to participate in the ownership of the company, whether directly or indirectly. Complex share incentive plans are not uncommon in South Africa.
Employers may issue shares to eligible employees either directly, or allow them to participate in the ownership of the company through participation units in a trust which, in turn, holds a fixed number of shares in the company. The latter option ensures that the ownership in the company does not change each time that an eligible employee leaves the company.
Shares issued by a company to its employees by virtue of their employment constitute equity instruments that are subject to section 8C of the Income Tax Act. Any gain determined in respect of the vesting of such a share in an employee must be included in the employee's income for the year of assessment in which vesting takes place. Depending on the specific circumstances, vesting may take place on the acquisition of the share, when the restrictions in respect of the holding or disposal of the share are lifted or on the disposal of the share.
In addition to these tax consequences on the vesting of the share, in certain circumstances dividends received from the share (subject to section 8C) are not exempt from income tax in terms of section 10.
Dividends paid by a resident company to its shareholders are generally exempt from tax in terms of section 10(1)(k). However, this exemption will not apply to any dividend in respect of a "restricted equity instrument" as defined in section 8C, to the extent that the "restricted equity instrument" was acquired in the circumstances contemplated in section 8C, unless:
- the "restricted equity instrument" constitutes an equity share other than an equity share that would have constituted a hybrid equity instrument as defined in section 8E(1) but for the three-year period requirement contemplated in that definition;
- the dividend constitutes an equity instrument as defined in that section; or
- the "restricted equity instrument" constitutes an interest in a trust and, where that trust holds shares, all of those shares constitute equity shares, other than equity shares that would have constituted hybrid equity instruments as defined in section 8E(1) but for the three-year period requirement contemplated in that definition.
The three points are exceptions to the circumstances in which the dividend exemption will not apply (that is, if one of these three circumstances is applicable, the section 10(1)(k) dividend exemption will apply).
The definition of "equity instrument" in section 8C specifically includes "any contractual right or obligation the value of which is determined directly or indirectly with reference to a share or member's interest". This would include participation rights set out in the trust deed of a trust that holds shares in a company, such as an employee share incentive trust. Whether or not the participation rights will be regarded as "restricted equity instruments" will depend on the provisions of the trust deed and the rights attaching to the shares in question.
In Binding Private Ruling 199, issued by SARS on 20 July, the question was whether the participation rights held by beneficiaries of an incentive trust are "restricted equity instruments" as contemplated in section 8C and, accordingly, whether the dividends that the beneficiaries will receive by virtue of their participation rights are to be taxed as income or as dividends.
Based on the specific facts of the matter, SARS held that the participation rights held by the beneficiaries of the incentive trust are considered to be "restricted equity instruments" as defined in section 8C.
However, SARS held that the exceptions to the section 10(1)(k) dividend exemption did not apply and that the dividends vested by the share incentive trust in the beneficiaries were exempt from income tax.
When distributing dividends from an employee share incentive trust to its beneficiaries, it remains important to confirm the tax treatment of such distributions, taking into account the terms of the trust deed and the rights attaching to the shares held by the trust. Depending on the facts of the matter, dividends tax may still have to be withheld by the company when paying the dividend to the employee share incentive trust.