Treasury Plans to Tax Dividends Paid to Employees as Income

Changes proposed by the Treasury in the Taxation Laws Amendment Bill follow international trends in tightening the net on the use of salaries disguised as dividends.

According to the explanatory memorandum published by the Treasury recently, many share schemes hold pure equity shares where the sole intent of the scheme is to generate dividends for employees as compensation for past or future services rendered, without the employees ever obtaining ownership of the shares.

The Treasury says it has become apparent that the anti-avoidance rules in the conversion of salary to dividends in the South African context have been “too narrow”, as they have only targeted dividends for non-equity shares.

The Treasurys legal tax design director Beatrie Gouws said this week that policy dictates that if an employer pays an employee for services rendered, the amount should be included in gross income and taxed at marginal rates, irrespective of how the employer has funded the payment.

“An anti-avoidance rule was required to ensure that salary disguised as a dividend would be taxable at marginal rates in the hands of the employee,” she said.

Werksmans Attorneys tax director Ernest Mazansky said the purpose of the changes, coming into effect in March next year, was to deal with situations where a trust is established for employees, with the trust holding shares in the employer company and the dividends being distributed to the employees.

“The government considers this to be just another form of remuneration, and therefore the dividends should be fully taxable as income, so instead of paying 15% on the dividend income it will be taxed as income at the taxpayers rate.”

Mr Mazansky said the wording of the new rule has wider consequences. If an employee has obtained the shares years ago, placed it in a family trust and retired since, then the anti-avoidance rule will apply to the dividends derived from the shares in the family trust and it will be taxed as income and not dividends.

Ms Gouws said that the provision does not apply to dividends paid in respect of a restricted equity share scheme or in respect of a share held by the employee.

The new anti-avoidance measure will not apply if the share fully vests in the hands of the employee, or the employee has paid in full and taken ownership of the share and then transfers it to a different entity. Ms Gouws added that it would also not apply if an employee purchases shares in his employer on the open market, pays in full for the shares and subsequently receives dividends in respect of the shares.

According to the Treasurys explanatory memorandum the changes will be applicable in respect of dividends accrued on or after March 1 next year.