The 2013 draft Taxation Laws Amendment Bill has introduced significant changes insofar as the taxation of dividends are concerned, specifically dividends paidin respect of unvested shares held via employee share schemes.
By way of background, the Income Tax Act, No 58 of 1962 (Act) currently contains certain anti-avoidance rules to prevent taxpayers from converting high-taxed salary into low taxed dividends. In particular, s10(1)(k)(dd) of the Act provides that a dividend derived from a restricted employee share scheme shall be taxable as normal income unless that dividend falls into one of the following three exceptions:
- the share constitutes an equity share that lacks hybrid equity share features (without having regard to the three-year carve-back);
- the dividend constitutes an equity instrument; or
- the dividend arises from a trust solely containing equity shares that lack hybrid equity share features (without having regard to the three-year carve-back).
Although these anti-avoidance rules are aimed at preventing taxpayers from converting their high-taxed salary into low-taxed dividends, it is clear that these anti-avoidance rules are targeted solely at dividends derived from restricted employee share schemes, where the underlying share does not have pure equity features. Accordingly, the current anti-avoidance rules draws a distinction between equity shares and non-equity shares in respect of restricted employee shares, with the resultant effect that only dividends derived from restricted employee share schemes, where the underlying shares do not consist of pure equity features (preference shares), are taxable as normal income.
In order to remove the distinction that exists in respect of restricted employee shares, it is proposed in paragraph 32(1)(n) of the Taxation Laws Amendment Bill that the proviso to s10(1)(k)(dd) be deleted, with the effect that dividends (restricted and unrestricted) from employee shares and share schemes essentially operate as income without regard to whether the underlying shares have a pure equity or preference-like yield.
The effect of the proposed amendment is that:
- the recipient of the dividend derived from the equity instrument will be taxed on the dividend as ordinary income, unless the equity instrument has vested (as contemplated in section 8C(3) of the Act); and
- the company declaring the dividend, in respect of the equity instrument, will be entitled to an income tax deduction equal to the amount of the inclusion (in terms of the newly proposed section 11(t) of the Act).
Accordingly, higher income earners who receive dividends from employee shares and share schemes will be subject to income tax at the marginal rate of 40% and the company declaring the dividend will effectively offset a 28% rate of tax. Similarly, lower income earners will be subject to tax at the marginal rate of between 18 to 25% and the company declaring the dividend will effectively offset a 28% rate of tax.
It is important to note that the proposed amendments seek to apply equally to senior management incentive plans as well as to broad-based Black Economic Empowerment schemes.
It is proposed that the amendments be effective as from 1 March 2014 and will be applicable in respect of dividends declared on or after that date.