South Africa: Proposed Amendments To The Rules Dealing With The Taxation Of Employee-Based Incentive Plans

Last Updated: 19 August 2016
Article by Robert Gad and Megan McCormack

Most Read Contributor in South Africa, September 2016

The Draft Taxation Laws Amendment Bill of 2016 was released for public comment on Friday 8 July (the "2016 TLAB"). It proposes certain amendments to the rules currently contained in the Income Tax Act No. 58 of 1962 (the "Act") dealing with employee-based incentive plans.

Some of these proposed changes were foreshadowed by announcements made by the Minister of Finance in the 2016 Budget Speech, namely that:

  • section 8C of the Act will be reviewed to address schemes where restricted shares held by employees are liquidated in return for an amount qualifying as a dividend
  • certain dividends in respect of restricted equity instruments are subject to income tax. These taxable dividends will be specifically included in the definition of "remuneration" for employees' tax purposes
  • the Act will be amended to avoid possible double taxation on the acquisition of a restricted equity instrument under both the definition of "gross income" and under section 8C of the Act

Specifically, a substitution of paragraph (ii) of the proviso to section 10(1)(k)(i) has also been proposed. This paragraph of the proviso currently provides that any dividends received or accrued to a taxpayer in respect of services rendered or to be rendered, or in respect of/by virtue of employment or the holding of any office, will not be exempt from income tax, unless that dividend was received or accrued in respect of a restricted equity instrument held by that person, or in respect of a share held by that person.

If implemented as currently proposed, the substitution of paragraph (ii) to this proviso will exclude from the 10(1)(k) exemption, any dividend received or accrued to a person in respect of services rendered or to be rendered, or in respect of/by virtue of employment or the holding of any office, other than dividends accrued to that person in respect of:

  1. an equity instrument, after that equity instrument has vested in that person as contemplated in section 8C; or
  2. a marketable security, contemplated in section 8A, held by that person.

In addition, the 2016 TLAB proposes that section 8C(1A) be substituted. This section currently provides that a return of capital other than a distribution of an equity instrument received by a taxpayer in respect of a restricted equity instrument must be included in that taxpayer's income. The suggested substitution provides that any amount received by or accrued to a taxpayer in respect of a restricted equity instrument must be included in his/her income during the relevant year of assessment, with the exception of amounts that are:

  • distributed as a return of capital or foreign return of capital to that taxpayer by way of a distribution of a restricted equity instrument;
  • subject to the provisions of the Act dealing with dividends received in respect of restricted equity instruments; or
  • taken into account in terms of section 8C in determining the gain or loss in respect of that restricted equity instrument.

These amounts will constitute "remuneration" in terms of paragraph (e) of the definition contained in paragraph 1 of the Fourth Schedule to the Act, being amounts required to be included in the income of a taxpayer in terms of section 8C of the Act. As such, employees tax will be required to be withheld in respect of these amounts.

It is anticipated that the abovementioned changes will come into operation on 1 March 2017, and apply in respect of any amount received or accrued to a taxpayer on or after that date. It therefore appears that this proposed change would apply to existing, unvested restricted equity instruments.

A further proposed change, which was not announced in the 2016 Budget Speech, is the introduction of a new section 8CA of the Act.

This section would deal with expenditure incurred in respect of "restricted equity instrument schemes". A "restricted equity instrument scheme" is defined for these purposes, in relation to an employer, as a scheme in terms of which an equity instrument (as defined in section 8C), the value of which is determined directly or indirectly with reference to an equity share in that employer (or an associated institution in relation to that employer), can be acquired by an employee or director of that employer, where that equity instrument will qualify as a restricted equity instrument (as defined in section 8C) at the time of its acquisition by an employee or director, and which will be subject to the provisions of section 8C(1) upon vesting.

The proposed section 8CA(2) goes on to provide that any expenditure actually incurred and paid by an employer in respect of a restricted equity instrument scheme must be treated as expenditure incurred evenly over the longest period during which an equity instrument can qualify as a restricted equity instrument in terms of the relevant scheme. Unless it is treasury's intention that this reference is limited to issued equity instruments only, this proposed amendment may have a significant impact on schemes that are to operate for long periods of time. The amendment does not cross refer to the existing "timing" provision in section 23H of the Act.

Section 8CA(3) also permits a deduction for an employer in respect of much of the expenditure it has actually incurred and paid in respect of that scheme, as is treated as having been incurred in terms of section 8CA(2) during the relevant year of assessment. It is currently unclear whether this proposed amendment is intended to permit a deduction in respect of amounts paid by employers as dividends and redemption proceeds, in addition to the amounts incurred by employers to facilitate the acquisition of instruments in terms of the scheme.

This insertion is also proposed to come into operation on 1 March 2017 and, if section 8CA is introduced as proposed, it will apply in respect of any amount that is paid, or becomes payable by the relevant employer, on or after that date.

In addition to the above, the Draft Tax Administration Laws Amendment Bill of 2016 (the "2016 TALAB") proposes that the definition of "remuneration" be updated to include the amount of any dividend received or accrued:

  • in respect of a restricted equity instrument as defined in section 8C to the extent contemplated in paragraph (dd) of the proviso to section 10(1)(k)(i) of the Act; and
  • to a person in respect of services rendered or to be rendered, or in respect of/by virtue of employment or the holding of any office contemplated in paragraph (ii) of the proviso to section 10(1)(k)(i) of the Act.

As such, employees tax will be required to be withheld in respect of these amounts as well.

Lastly, the 2016 TLAB proposes that paragraph (c) of the definition of "gross income" contained in section 1 of the Act be amended to exclude amounts referred to in sections 8B and 8C. It is anticipated that this welcome change will come into operation on 1 March 2017, and apply in respect of years of assessment ending on or after that date.

It follows that, if the abovementioned proposals are implemented in their present form, taxpayers should carefully re-evaluate their tax position in relation to any amounts, including dividends, received or accrued to them in respect of instruments that are subject to the provisions of section 8C of the Act. Employers should also carefully consider their employees' tax withholding obligations, as well as the timing and amount of deductions to which they may be entitled in respect of expenditure incurred by them in connection with their employee incentive arrangements.

It may even be prudent for the structure of their existing employee incentive arrangements to be re-considered to ensure that these continue to meet the commercial purposes for which they were established, without resulting in an unnecessarily complex position for the various parties concerned.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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