Employee share incentive schemes

Employer companies generally implement employee share incentive schemes to retain and incentivise their employees by enabling the latter to receive indirect benefits from the appreciation in the growth of the company. This is an effective way to offer benefits to employees and encourage their participation and loyalty of employees.

Even though these schemes are generally equity-settled, an employer can also elect to implement a cash-settled scheme or even a hybrid scheme wherein the directors are afforded the discretion to award either shares or cash. It is important to determine what benefits should be received when considering these schemes.

In terms of an equity-settled scheme, employees will either receive shares upfront (subject to certain restrictions), or they can receive a right to shares upon vesting (i.e. when the restrictions have been complied with). In both instances, the employees will receive (unrestricted) shares in the employer (or holding company) when the restrictions (e.g. a three year employment period) have been complied with.

Section 8C of the Income Tax Act No 58 of 1962 seeks to tax the gain in respect of the “vesting” in a year of assessment of an “equity instrument” acquired by an employee if the employee acquired such an equity instrument:

• by virtue of his employment or the office of a director of any company or from any person by arrangement with the employee’s employer; or
• by virtue of any “restricted equity instrument” held by that employee.

In general, section 8C seeks to include any gain or loss made upon the vesting of an equity instrument in a taxpayer’s taxable income provided that the share is acquired by virtue of employment or holding of any office of director. A further distinction is drawn in section 8C between unrestricted and restricted equity instruments. The former is deemed to vest on the acquisition date, whilst the latter is deemed to vest in a taxpayer when all the restrictions in respect of the equity instrument cease to have an effect, or immediately prior to a disposal thereof by the taxpayer, whichever is the earliest

Depending on whether the rights granted under the scheme are restricted or not, the tax consequences arising for the employee will become due when the shares are granted to the employee and no restrictions apply anymore. Accordingly, the gain to be taxed is calculated as the value of the benefits which the employee received in terms of the underlying scheme, less the consideration given by the employee (if any) to acquire those benefits.