Latest / Tax Break: South African tax for professionals / Pointers for share incentive schemes

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Pointers for share incentive schemes · Tax Break: South African tax for professionals

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Many companies, both large and small, use share incentives for
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key staff members. Now if we stand back a little
0:19
bit, the purpose of these incentive schemes is really to
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align the objectives of the company, which is in a lot of
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cases to, to to maximise its profitability with what the
0:33
employees would be striving for. And that would then if, if these
0:37
two things are aligned, the employees would obviously be
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compensated if they achieve the same things that they can
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influence this influence and that that would drive up the
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company's profits. Now, the design of these schemes
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could look very different depending on the type of scheme
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that you've got and depending on the type of entity that you're
0:59
looking at. So it might well be that the
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scheme implemented by a listed company and a private company
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looked very different. Now even if we stand back a bit
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and look at the think about the tax considerations, there are a
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few core tax questions or considerations that are very
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common to a lot of these schemes irrespective of whether you for
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example looking at the lesser dura private company.
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So the question is then, what are these key tax matters that
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you need to consider when you are looking at an employee share
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incentive scheme? This is what I'll be discussing
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in this episode of Tax Break, the podcast for South African
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tax professionals and practitioners.
1:44
Now before I start, I would like to ask that if you if you like
1:50
listening to the podcast, would you mind writing it on your
1:53
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would show it to, to the other potential listeners.
2:08
And then as always, I would like to ask you to consider if
2:12
there's another tax practitioner or tax professional who also
2:17
work in South African tax you think might also like to listen
2:22
to the podcast. If you don't mind forwarding the
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link to them and perhaps they can also become a listener.
2:28
Then just a reminder, my e-mail address is in the show notes.
2:33
So if you've got any ideas, suggestions for for other
2:36
episodes, questions, and of course, if you need tax advice,
2:41
please send me an e-mail. Right.
2:44
So back to our topic of share incentive schemes.
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Now the idea to speak about these things came from and to
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highlight some key pointers came from a recent ruling that's art
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issued in November last year. So binding class ruling 91, I
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would like to perhaps before I go to do what these common tax
3:08
considerations are, I would like to, I would like to few aspects
3:12
of the ruling and that would also give you a feel as to what
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do you typically and often see in these share incentive
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schemes, right. So firstly, the entity involved
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is a listed company and actually the it's the share incentive
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scheme for a whole group of companies that form part of
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this, that other subsidiaries of this listed company.
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One of the subsidiaries is the applicant, there's the
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subsidiary administers the scheme and then they are other
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entities who are the employer companies.
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And this is where the participants work.
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So the people who participate in the scheme, the key employees.
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Now from the detail that set out in the ruling document, it seems
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that the scheme and the awards are approved at the level of a
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group remunerations committee. So a group REMCO.
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And what the REMCO would do is they would determine a number of
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shares or a value of the award converted into a number of
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shares. And then practically each
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participant would receive an award letter.
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Now this award letter would set out some conditions.
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The conditions are related to employment.
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So in other words, along the, you need to work for the group
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to, to, to get the, the, the shades and some performance
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targets. And obviously from a design
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perspective, if you, we're not talking about tax necessarily,
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but if you think about a well designed incentive, these
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performance targets should be something that the individual is
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actually able to influence. Otherwise what's the point of,
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of, of trying to align the target with what the, the, the
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individual is aiming to achieve, right.
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This specific scheme works in a way that the applicant arranges
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with a stockbroker. You go into acquire the sheets
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in the market and then the sheets would be transferred to
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the employee and this is then again terminology might differ
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from scheme to scheme. In the context of this scheme,
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this is referred to as settlement.
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Now maybe just to highlight in the context of an unlisted
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company, it's highly unlikely that you'll go into the market
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and and acquire the sheets. So your your mechanism to get
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the shares to the employees might look a bit different.
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Now why the statement the the fact that settlement happens?
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So in other words the shares are transferred into the name of the
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employees. Why that's important?
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From the date the of settlement the employees are entitled to
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vote and they are entitled to the dividends in respect of the
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issues, but they are not entitled to dispose of the
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shares or encumber the shades until a future date.
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Now this future date is the date when the conditions are made.
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So the employment requirement has been satisfied and we know
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which of the performance conditions or to what extent the
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performance conditions have been complied with.
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Then we also see some detail about what's referred to as good
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and bad leaver provisions. So what is essentially mean is
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that a good lever may retain some of the shares if they leave
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the employment of the company some all of the shares, whereas
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a bad leaver could forfeit the shares for no consideration.
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So in other words, if you leave, for example, due to misconduct
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or having been involved in fraud, then you could fall for
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the chase for no consideration. What is in my mind Niko not
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common to other schemes that I've worked with is that in this
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case, the bad leavers would forfeit their shares to A/B O
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trust that would then acquire the shares and would use that to
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to to try to achieve its public benefit objectives.
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Now, what is the the detail of the scheme that set out in the
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ruling all set alls us is that once the conditions have been
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made, some of the shares will be sold back to into the market or
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to the company to settle the tax and the employees tax.
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So again, it may be that in the private company intakes you
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needed a different mechanism to give you the cash flow to pay
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the tax because there is no market necessarily for the
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chase, you know, larger public company context with the shoes
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are perhaps traded over the counter.
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They might be a a different way again.
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So in this way, the the small mechanics and how you design the
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scheme could would look a bit different between different
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schemes and entities, right? So let's get into what the
8:13
episode is really intended to deal with.
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Hopefully you've got a bit of a picture in your mind as to what
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the scheme that we are looking at, how it works and what it
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looks like. So in my view, there's a few
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things that nothing is new, nothing is unique, but there are
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a few things that this ruling highlight that are that would
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give you a good indication of what the tax issues are that you
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normally need to consider. The first thing that the ruling
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highlights is that the employer companies must withhold pay as
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you earn. So by implication, the other
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side of having to withhold because you earn is that the
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employee would be taxed on an amount.
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So these two are one is the tax implication, the other one is
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the collection of the recovery mechanism.
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So there's a few things that the ruling then highlight for us
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that if you are dealing with a scheme like this, you need to
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consider the question is when does the obligation for pays you
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earn and the employee to be taxed?
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Where, when does that happen? The ruling highlights it's at
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wasting. It's not when the grant is made,
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it's not when the water is made to when their ward later is
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given and it's also not when settlement is made.
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Now wasting in itself, they said it's got a very specific meaning
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in the context of Section 8C. That's the provision of the
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Income Tax Act dealing with these types of, of, of awards,
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share incentive or share awards. And there's a very detailed
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definition of restricted equity instrument that would guide you
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to determine when wasting happens.
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So factors such as the conditions, the good and bad
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leaver provisions all impact when wasting my happen.
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Now that's the, the, the, the when it happens the how much the
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tax implication could be. I think that we can also say
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it's not something that comes from the ruling, but from
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experience I know that the for different companies, determining
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the value may look a bit different.
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So if you've got a listed company where the shares are
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listed and traded on an exchange, it might be fairly
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easy to value the shares. Whereas for a private company,
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the the rules may need to have some sort of a formula to to
10:34
determine the value, right? So that is the taxability of the
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chase. Now what this ruling also
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highlights for us that I think it's quite a useful reminder is
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that after settlement. So in other words, we've got the
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event of settlement, but then we also have the event of wasting
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that would happen sometime after settlement if the the the
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employee received dividends between settlement and wasting
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diet. The ruling highlights for us and
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it reminds us that these dividends are not necessarily
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exempt from normal tax. So there are quite a few complex
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provisions that could have the effect that the dividends are
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not exempt from normal tax. In other words, they become
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taxable as income, and that would be on the basis that they
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are really part of the person's remuneration package.
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So if you've got these dividends flowing before vesting, be
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careful and look carefully at those complex provisions.
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That's something 1 needs to consider.
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The Third Point that the ruling touches on, that's a good
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reminder of what to consider is that they might be a deduction
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for this award that's being made by the employer or whoever
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settles this transaction. Now the questions here would be
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who incurred the expense, um, and is there even an expense?
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So the Supreme Court of Appeal a few years ago in the Labatt
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Africa case ruled that if a company issues its own chase,
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that's not necessarily expenditure.
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So the the courts reasoning was that if if the company issues
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its own chase, it's actually the other shareholders whose
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interests are being diluted, who become poorer, it's not the
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company. So depending on how the award is
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being settled, there may or may not be an expense or expenditure
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to deduct. And importantly, even though I
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freeze do might show an experience that doesn't tell you
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you've got your expenditure for Section 11A purposes, it's a bit
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more complex than that. So in this specific case, the,
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the, the the company's didn't issue their own shares.
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They paid a cash amount to acquire the shares to settle.
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So there was a, the, The ruling confirmed that there was a AN11A
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deduction. Our Ava.
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What it also highlights for us is that timing might be an
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issue. So if you look at these types of
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awards where the service and the, the, the performance
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conditions run over a number of years, the in section 23-H code
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would come often come into play. And that provision really says
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that if you've incurred an expense qualifies for
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deductibility, but the service or the benefit that you get from
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that expense will only be received in a subsequent year of
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assessment, then you need to align your deduction with when
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that service or benefit is received.
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The last one, no, the last point that I would like to, to, to
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touch on and I'm, I think I'm going a bit off the script of
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the ruling here. So the ruling highlights the
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fact that there could be a trust involved.
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As I've said, I've never really dealt with this structure where
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the shades are forfeited to a baby out trust.
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Might be that it's common that I've just not come across it,
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but I think the the point that I want to then carry on and build
14:18
on a bit is that you may often see trusts in these structures
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in different roles. So for example, the trust might
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be holding vehicle off the chase until wasting takes place, and
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it could give you a mechanism to flow dividends through to the
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participants. So there would be some tax
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implications from the as a result of the involvement of the
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trust that you need to consider. They could also be that the
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trust has got a very even a different role in the sense that
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it holds the chase and instead of having to transfer shares to
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participants, transfer it back to the company when the
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participant leaves. What's being allocated is
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actually a unit or an interest in the trust and that interest
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in the trust is awarded and forfeited when the person would
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if the person leaves employment. So that the the involvement of a
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trust. In that case, the interest and
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the trust would perhaps be your equity instrument that you need
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to look at. So let's conclude what are the
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few take home points as far as key areas that you need to
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consider when you are dealing with in employment incentive
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schemes that this ruling perhaps highlighted for us.
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Firstly, is that this and an income tax implication for the
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employee. Closely related to this, the
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employer there needs to consider when and how much tax to
15:47
withhold exposure. And secondly, if they are
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dividends that's flowing as part of this scheme, you need to
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consider the treatment of those dividends very carefully.
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They are not necessarily taxed as normal dividends would be.
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Thirdly, you need to carefully look at the reductions that the
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pair would be entitled to or the whoever settles the scheme.
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And fourthly, if you've got a vehicle like a trust that's
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involved as the holding vehicle, that becomes the vehicle in
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which the interests are are allocated and and forfeited.
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All that in this case becomes the vehicle to which the shares
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are forfeited. That does add a bit of a another
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layer to the scheme that you would have to look at very
16:35
carefully. Okay, so maybe final thoughts.
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I don't want to create the impression that these are the
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only considerations that you need to think of.
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They are. My experience is that the
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soonest companies start working on these things and they make
16:52
the scheme their own. They design A scheme for their
16:54
needs. They are often finer, no answers
16:57
that they come up with to solve specific issues in their
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context. And these things would obviously
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have tax consequences that one would need to look at.
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But the four things that I've spoken about today are some of
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the more common aspects that you are likely to encounter when you
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are dealing with these schemes. As always, I would just like to
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remind you that the podcast is not intended to be tax advice.
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It's for information purposes only, so I hope that you've
17:28
enjoyed the podcast and until next time, goodbye.