The South African Revenue Service (SARS) issued Binding Private Ruling 174 (Ruling) on 29 July 2014.
The applicant was a share incentive trust established by a local company for the benefit of its employees in senior management. It was proposed that the company would make cash contributions to the trust and the trust would use the cash to purchase shares in the company on the open market.
In terms of the incentive scheme, the trust would award the shares in tranches to the employees over a period. When the shares vest, the trust would transfer the shares to the employees.
In this regard, SARS made two interesting rulings.
Firstly, SARS ruled that the receipt of the cash contribution by the trust would not constitute gross income for the trust. SARS does not provide any reasons for its conclusion, but it is assumed that the cash contributions are received as capital amounts by the trust and therefore cannot be included in the trust’s gross income. This would also be in accordance with CIR v Pick ‘n Pay Employee Share Purchase Trust 54 SATC 271 where the court held that contributions to an incentive trust were capital in nature as opposed to having been solicited for purposes of making a profit. No ruling was made as to whether the company would be entitled to a deduction in respect of the cash contributions.
Secondly, SARS ruled that the vesting of the shares by the trust in the employees would constitute a disposal for capital gains tax purposes, and specifically in terms of paragraph 11(1)(d) of the Eighth Schedule to the Income Tax Act, No 58 of 1962 (Act).
Paragraph 11(d) provides that a disposal includes “the vesting of an interest in an asset of a trust in a beneficiary”.
However, SARS ruled that no capital gain would arise for the trust or employees because of the application of paragraph 20(1)(h)(i) of the Eighth Schedule to the Act, as well as paragraph 80(1).
Essentially paragraph 20(1)(h)(i) provides that, in respect of an equity instrument where the vesting of that instrument results in a gain or loss in terms of s8C of the Act, the value used to determine the gain or loss must be used to determine the base cost of that equity instrument.
For example, where there is a gain for an employee in terms of s8C, that gain must be used to determine the base cost of the equity instrument.
Paragraph 80(1) provides that where a capital gain is determined in respect of the vesting (for trust law purposes) of an asset by a trust in a beneficiary, that gain must be disregarded in the hands of the trust and attributed to the beneficiary.
It is not clear from the Ruling whether the reason why no gain would result for the trust is because of the determination of the base cost of the shares in the hands of the trust in terms of paragraph 20(1)(h)(i) or the application of paragraph 80(1).
Paragraph 20(1)(h)(1) of the Eighth Schedule to the Act is generally understood to only be applicable to the determination of the base cost of the equity instrument in the hands of the employee after it has vested in terms of s8C of the Act, and to not apply to the determination of the base cost of the equity instrument in the hands of the share incentive trust.
Ordinarily, and in accordance with SARS’s Comprehensive Guide on Capital Gains Tax, share incentive schemes are structured on the basis that paragraph 11(2)(j) of the Eighth Schedule to the Act would apply. Paragraph 11(2)(j) provides that there would be no disposal for capital gains tax purposes to the extent that the asset disposed of constitutes an equity instrument as contemplated in s8C of the Act which has not yet vested (for purposes of that section).
In other words, care is taken that the equity instrument does not vest until after it has been disposed of by the share incentive trust, as this would guarantee a non- disposal for capital gains tax purposes by the trust.
However, it appears from this Ruling that where an equity instrument is disposed of by a share incentive trust after it has vested in an employee beneficiary, there would be a disposal for capital gains tax purposes, but such disposal would not result in any capital gain for the trust and the employee because of the application of paragraph 20(1)(h)(i) and/or paragraph 80(1) of the Eighth Schedule to the Act.
- DLA Cliffe Dekker Hofmeyr
- South Africa