Taxation of currently exempt benefits
One of the main changes is the amendment that dividends received in respect of so-called ‘restricted equity instruments’ will no longer be exempt from normal tax, unless the restricted equity instrument is an ‘equity share’ as defined. The term ‘equity share’ is new to the Income Tax Act and is proposed to replace the previous concept of ‘equity share capital’. It has been indicated by Treasury and SARS that the change is merely to accord with the new Companies Act. We believe that the change may have unintended consequences extending beyond company law reform.
Employers should consider: "Will the restricted equity instruments in our employee share scheme satisfy the new definition of equity share?"
Section 8C restricted equity instruments are not limited to shares and can, for example, be an entitlement as trust beneficiary to dividends from shares held by the trust. The definition of equity share includes ‘any share or similar interest’, which begs the question whether the rights of trust beneficiaries will qualify as ‘equity shares’, or whether the dividends will now become taxable. There could be a need to amend the trust deed to ensure clarity.
Furthermore, the definition does not differentiate between entitlement to dividends and capital as the current definition of equity share capital does, but the definition is based on the concept of 'distribution' (purportedly borrowed from the new Companies Act). It is uncertain to what extent the definition in the Companies Act can be used as guidance in interpreting the Income Tax Act definition of equity share. Key areas that may be affected are employee share schemes that make use of shares which have unlimited rights to dividends but no rights to capital.
Casting the net wider
The other notable change to the legislation dealing with employee share schemes is the addition of a ground relating to the manner in which equity instruments contemplated in an employee share scheme are acquired. Previously, parties who did not acquire equity instruments by virtue of their employment would escape the application of the employee share scheme provisions. This requirement infers a direct/causal link to a person’s employment in order for the employee share scheme provisions to find application. The additional ground provides that in instances where a restricted equity instrument is bought from the taxpayer’s company of employment or an associated institution in relation to such employer company or fellow employee the employee share scheme provisions would find application notwithstanding a direct/causal link to the taxpayer’s employment. A possible area of application in this regard is management buy outs.
Employers ought to re-evaluate their current employee schemes in light of the amendments so as not to be caught off guard, particularly since the tax imposed on the share scheme beneficiaries results in an obligation to withhold employees’ tax.