Section 8C of the Income Tax Act acts as an anti-avoidance mechanism that prevents employees from treating what is essentially fully taxable salary or bonus income at reduced tax rates through the use of restricted shares and other incentive schemes. Essentially, s8C delays taxation in respect of the receipt or accrual until such time that the employee becomes entitled to the full value of the share or rights under the relevant scheme. Dividends received or accrued on the underlying shares are also generally not exempt under s10(1)(k) of the Income Tax Act unless the shares are equity shares as defined.
However, schemes have been developed that circumvent the application of s8C, by effectively transferring the value of the underlying shares to the relevant employees as exempt dividends under s10(1)(k) of the Income Tax Act. This is achieved, inter alia, by ensuring that the underlying shares technically meet the definitional requirements of an ‘equity share’. There are different permutations, and in terms of some schemes the underlying shares are repurchased or redeemed for an amount that technically constitutes a dividend. In terms of other schemes, the value is first transferred to the employee by paying dividends in terms of special dividend rights attaching to the shares, and by the time the shares ultimately vest, they no longer have any value that could be subject to tax.
It is now proposed that the applicable rules in the Income Tax Act be reviewed so as to treat the value received as remuneration for purposes of employees’ tax. It is, however, not clear whether existing schemes will be affected, and taxpayers who are party to such schemes should consider that they may end up paying more tax than they may have initially anticipated.
On the positive side, it was also proposed that amendments will be made to the Income Tax Act to avoid possible double taxation in circumstances where taxpayers receive certain valuable restricted equity instruments. Technically, and in certain circumstances, the value of such restricted instruments can be included in the gross income of a taxpayer in terms of paragraph (c) of the definition of ‘gross income’ upon receipt, while the same amount can again be included in terms of paragraph (n) upon vesting in terms of s8C. The value of such instruments will now be excluded from paragraph (n) of the definition of ‘gross income’.