It has become popular commercial practice for many employers to design employment incentive schemes whereby employees are remunerated for services rendered over a period of time by allowing them to participate in share incentive schemes. Typically, these schemes take the form of either cash-based settled schemes or share-based settled schemes. The former involves participating employees receiving a cash payment after a certain period at the exercise of their share appreciation rights equal to the increase in value of the underlying share value to which the scheme is linked. Share-based payments, on the other hand, involve the employees receiving actual shares in the employer company and which would (ideally) have increased in value over the period of time, due in part to the employees’ endeavours and involvement in the company’s activities.
In terms of section 8C of the Income Tax Act, these benefits received by employees through participation in such schemes are taxed on income tax account, in other words, on the same basis as though these benefits had been a salary earned.
Depending on whether the rights granted under the scheme are restricted or not, the tax consequences arising for the employee will fall due either when the options are granted to the employees (in the case where no restrictions in relation to the options exist), or only once they are exercised or vest for purposes of section 8C (typically when the restrictions linked to the rights granted falls away). At that stage, the gain to be taxed is calculated as being the value of the benefits received in terms of the scheme minus the amount paid (if any) to acquire those benefits.
Restrictions for section 8C’s purposes typically take the form of a restriction on when the rights acquired may be exercised (typically linked to an employee remaining in service of the company for a number of years), or a prohibition on the employee transferring or selling those rights at market value to other persons (the rights granted are often not permitted to be sold to another).
Take the following as an example: Company A grants an employee the right to receive shares in it worth R10 by paying an amount of R1 only. If that right to take up shares may be exercised immediately, and no restriction linked to transferability thereof for example exists, that “unrestricted equity instrument” will give rise to a taxable gain of R9 when the option is received. Where the right to subscribe for shares in Company A for R1 may however only be exercised if the employee is still in employment of Company A within 3 years’ time, or may be exercised at any point in time but may not be sold to another, then the gain realised for section 8C’s purposes will only be calculated when and at the value of the shares when these are eventually acquired. In such an instance, the gain calculated should be reduced by the subscription price of R1 paid for the shares. Similarly, if the reward does not involve the subscription of shares, but rather a payment to the employee of the increased value of shares over a predetermined period in time, the value of the shares minus the R1 paid to acquire the options will be the amount of the gain subject to income tax.
Section 8C has been the focus of many legislative amendments over the past few years and involves arguably one of the most complex provisions of the Income Tax Act. Employees and employers alike would therefore be well-advised to take detailed tax advice prior to entering into, and exercising, rights provided for in terms of employment incentive schemes such as these described above.
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE).