Employee share incentive schemes new anti-avoidance measures

income tax 1By Douglas Gaul, Tax Manager Grant Thornton Johannesburg
Prior to 1 March 2014, dividends received from equity shares that were acquired by an employee as part of a share incentive scheme, were exempt from income tax (with some exceptions), even if these shares were held by a share trust on behalf of the employees. This situation has changed, and share incentive schemes must be reviewed to determine whether they still achieve the outcomes they were originally setup to deliver.
Treasury has recognised that avoidance schemes were being implemented whereby share trusts held equity shares on behalf of employees with the sole intention of generating dividends for employees as compensation for past or future services rendered to the employer, without the employees ever taking ownership of the shares.
This means that, because ownership of the shares is never transferred to the employee, the employee enjoyed the benefit of receiving tax-free dividends.
As set out in the Explanatory Memorandum to the Taxation Laws Amendment Act, 2013, the dividend yield in these instances effectively operates as disguised salary for employees (that is not deductible by employers) even though these dividends arise from equity shares.
In order to shut down such anti-avoidance schemes, a new proviso has been inserted to section 10(1)(k), which is the section that provides for a general exemption of dividends received by, or accrued to, any person (subject to certain provisos).
In terms of the new amendments proviso, any dividend received by, or accrued to a person in respect of services rendered, or to be rendered, or in respect of, or by virtue of employment or the holding of any office, will generally be taxable. However, an exemption remains in respect any dividend received or accrued in respect of a restricted equity instrument as defined in section 8C held by that person, or in respect of a share held by that person (our emphasis).
This has the effect of taxing any payment made by an employer to an employee for services rendered even if such payment is facilitated indirectly in the form of dividends through an employee share trust.
In other words, in order for the employee to obtain an exemption from dividends received in respect of equity shares that form part of share incentive scheme, it will be necessary for the employee to directly hold the shares himself, as opposed to an employee trust holding the shares on his behalf.
Where the dividend is subject to normal tax, it will not be subjected to dividends withholding tax (DWT) as this would result in a double taxation.
Measures have been implemented whereby, in circumstances where the dividend is subject to normal tax in the employees hands, the trust can make a declaration to the relevant Central Securities Depository Participant (CSDP) if the shares are listed, or to the distributing company in the case of non-listed shares, not to withhold dividends tax.
If dividends tax was withheld on dividends that will be distributed by the trust and included in the employees income, the trust may make a declaration to the relevant CSDP or company in order to receive a refund and distribute the full dividend to the employee.