Amendments to the taxation of Employee Incentive Schemes
Employee incentive scheme legislation seeks to ensure that employees and directors are taxed when they are able to liquidate share scheme awards so as to realise cash to pay their tax liabilities. The legislation is complex and the latest amendments impact existing schemes.
Not applicable to all types of share incentive schemes
Some share incentive schemes did not fall within the ambit of section 8C and were still taxed in terms of general tax principles. For example, employees who acquire the right to the value of a share held by a trust, established by the employee’s employer, without a right to acquire the underlying share. Another example is phantom share schemes in terms of which employees obtain a contractual right to a bonus, the quantum of which is based on the increase in value of a share in a company.
Certain legislative amendments to section 8C have recently been introduced. These amendments are geared toward widening the scope and application of section 8C.
Wider application of the employee incentive scheme legislation
In terms of the latest amendments the ambit of section 8C has been widened so as to include “any contractual right or obligation the value of which is determined directly or indirectly with reference to a share or member’s interest” as an “equity instrument” for section 8C purposes. This amendment is aimed at applying the same taxation principles to schemes where employees acquire rights associated with the value of shares without acquiring the underlying shares themselves.
Deferring the taxing event
Certain schemes are devised specifically to allow for an early tax event when the share price is lower.
In addition to the above the amendments, section 8C now also defers the taxing event where the taxpayer can be penalised financially for not complying with the terms of the share acquisition agreement. For example, an obligation to pay a cash penalty when employment ceases (instead of forfeiture of shares) could result in the taxing event being deferred until the employee is no longer subject to such penalty provision. Unfortunately, neither the amendments nor the Explanatory Memorandum expand on what would be regarded as a financial penalty for purposes of section 8C.
Taxation of share distributions
Whilst dividends (essentially distributions from profits) are exempt from normal tax, capital share distributions are not. The amendments seek to bring clarity as to the treatment of “capital distributions”. The amended section 8C provides that capital distributions received by or that accrues to a taxpayer in respect of a section 8C instrument which has not yet been taxed, the taxpayer must include the amount of the capital distribution in his or her income. Capital distributions so included in income do not trigger CGT as a result of the part-disposal of the shares. However, no provision is made for the withholding by employers of PAYE in respect of capital distributions.
Effective date of the amendments
The amendments apply in respect of section 8C instruments acquired by a taxpayer on or after 21 October 2008, except for the taxation of capital distribution, which are now taxed in respect of both prior and new awards as from 21 October 2008.
Conclusion
The legislature’s attempts at casting its net as wide as possible to include as many share and other incentive schemes within the provisions of section 8C will surely be bolstered by the latest amendments. This, coupled with the current global economic downturn in which many share based incentive schemes are out of the money, a review of existing schemes would be useful to ensure compliance with tax and to incentivise and retain key employees.
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