Amendments affecting share incentive schemes

Previous amendments to the Income Tax Act (the Act) may have brought about unintended tax consequences for both employees and participants in certain share incentive schemes involving trusts (the Scheme). Depending on how the Scheme was implemented, we have previously raised two concerns were that, as a result of amendments to the Act, dividends declared to participants may no longer be exempt and the disposal of shares from the share incentive trust to a participant may trigger tax implications for the trust.

On the issue of whether dividends declared to participants of the Scheme will be exempt, amendments have been proposed to section 10(1)(k)(i)(dd) in the Taxation Laws Amendment Bill (the Bill), released on 25 October 2011, such that dividends declared in respect of a "restricted equity instrument" as defined in section 8C will no longer be exempt unless:

"(A)the restricted equity instrument constitutes an equity share, other than an equity share that would have constituted a hybrid equity instrument as defined in section 8E(1) but for the three year period required contemplated in that definition;

(B) the dividend constitutes an equity instrument as defined in that section; or

(C) the restricted equity instrument constitutes and interest and a trust and, where that trust holds shares, all of those shares constitute equity shares, other than equity share that would have constituted hybrid equity instruments as defined in section 8E(1) but for the three-year period contemplated in that definition."

It follows that dividends declared to vested beneficiaries of a trust will now be exempt for so long as the trust holds shares, and all

of those shares constitute equity shares. The "equity share" definition is also amended in the Bill to mean any share in a company, excluding any share that, neither as respects to dividends nor as respects returns of capital, carries any right to participate beyond a specified amount in a distribution. In order to ensure that the dividends received by the participants are exempt, one must therefore be satisfied that the shares held by the trust are in fact "equity shares".

The amendments to section 10(1)(k)(i)(dd) should come into operation retrospectively on 1 January 2011 However, our concern that the deletion of paragraph 38(2)(d) of the Eighth Schedule to the Act in the Taxation Laws Amendment Act, 2010, may result in a share being deemed to be transferred by the trust to a participant at its market value and potentially trigger a substantial tax liability in the trust had not been addressed in the Bill.

Consultants generally raise the argument that there is no "disposal" for so long as one is dealing with a "restricted equity instrument" (as contemplated in paragraph 11(2)(j) of the Eighth Schedule to the Act) and therefore the taxing event is not triggered.

However, the wording of the Act is not entirely clear for whose benefit paragraph 11(2)(j) is applicable. The proposed amendments in the Bill have clarified some, but not necessarily all, of the issues in relation to share incentive schemes.