The use of share incentive schemes as a tool to retain staff, align the behaviour of employees with the objectives of the shareholders and to assist with achieving board based empowerment are common place in the market. Employees can participate in these schemes either through a direct shareholding or indirectly through an interest a share trust. In terms of most of these schemes, employees are taxed on the difference between the amount paid by them for the shares or trust interest acquired and the value of that instrument at the time that the employee that all ‘restrictions’ in relation to the shares cease to have any effect and the employee can cash in on the instrument. Examples of restrictions are the requirement to forfeit the shares for less than market value in the case of dismissal and prohibitions on the disposal of the shares for a period of time. Dividends on the shares are generally exempt from income tax in the hands of the employee and / or the share trust unless those shares limit the holders participation to profits and to the capital of the company and carry some restrictions on the shares.
In terms of the proposed legislation, the rules in so far as the tax treatment of dividends paid on all shares acquired pursuant to these share incentive scheme and which carry restrictions will change. From 1 March 2014 dividends declared will:
- Be taxed in the hands of the recipient as gross income;
- Be deductible in the hands of the company;
- Will not be subject to dividends withholding tax.
As the proposed changes affect dividends declared on or after 1 March 2014, the changes would impact schemes already in existence.
In prior years, National Treasury has sought to tax the dividends paid to employee share trusts and on distributed to employees but withdrew the proposals as it impacted negatively on these schemes, the use of which is common place where the scheme is intended to benefit a large number of employees and hence to benefit lower paid employees. From a labour relations point of view, advising the employees that they will now receive less than originally promised as a result of the dividends being taxed could be problematic. However, National Treasury may not be sympathetic to this plight for a number of reasons. Firstly the dividends would have been subject to a 15% dividends withholding tax which will not be charged under the new provisions. Secondly, the employer is obtaining a tax deduction for the amount of the dividend paid and could therefore, in theory, afford to increase the dividend by an amount necessary to place, at least the lower income earners, in the same after tax position.
Maths aside, this could be an overly simplistic view as the amounts paid to the employees would remain a dividend for Companies Act purposes and would therefore be subject to inter alia the solvency and liquidity requirements of that Act. It may therefore not be possible to simply increase the amount of the dividend declared. Companies may therefore be forced to pay higher salaries or additional bonuses to compensate employees for the income tax payable on the share scheme dividends.