New Share Scheme Ruling

Share schemes, in various forms, have been the subject of a number of Binding Private Rulings (BPR) and Binding Class Rulings (BCR) since inception of the Advance Tax Ruling (ATR) process.

This theme is continued with SARS releasing BCR 30 on 9 September 2011, which is sure to force a re-think in the way many current share schemes are structured, especially schemes based on the premise of utilising after tax money for participation.BCR 30 involves the application of section 8C of the Income Tax Act (the Act) to a Share Value Incentive Plan (SVIP) of a foreign company, registered as an external company in South Africa. The rules of the SVIP make a distinction between Bonus Invested Shares, Invested Shares and Matched Awards. Operation of the schemes is summarised below.

Bonus Invested Shares are acquired on behalf on a participant at the current listed price and funded by way of a percentage of his / her after tax annual bonus. It appears from the ruling that the acquisition of Bonus Invested Shares is compulsory for qualifying participants. The shares so acquired are then restricted for a period of three years with typical good and bad leaver scenarios generally found in schemes of this nature.

Invested Shares are acquired by a participant on invitation only, at market related prices and funded by way of the remaining portion of his / her annual after tax bonus, after deducting the portion used to acquire the Bonus Invested Shares referred to above. Invested Shares are then restricted for a period of three years with the participant entitled to dividends during that period and enjoying voting rights in relation to the Invested Shares. After acquiring the Invested Shares on behalf of the participant, the remuneration committee will procure a Matched Award based on the value of Invested Shares acquired.

On the face of it, it appears that the Invested Shares and Matched Awards are interlinked in that the participant may dispose of the

Invested Shares, but in so doing the Matched Awards will correspondingly reduce or be forfeited. Acquisition of the Matched

Awards after a period of three years from grant date is contingent upon the happening of certain events which include, inter alia,

being in employment and the meeting of certain performance targets. Matched Awards are also subject to various good and bad

leaver scenarios and carry no voting or dividend rights.

SARS ruled that the Bonus Invested Shares, Invested Shares and Matched Awards constitute "restricted equity instruments" for

purposes of section 8C of the Act and any gain would therefore be subject to the deduction of employee's tax upon vesting. SARS

also ruled that a deduction would be available for a participant to the extent that a loss arises on vesting, most likely because some,

if not all, of the aforementioned schemes could be 'under water' at time of vesting. There is nothing controversial about allowing

the deduction as section 8C(2)(b) of the Act specifically provides for same. However, the issue of whether the use of after tax funds

to acquires shares in a scheme falls within section 8C, requires closer scrutiny.

Section 8C of Act governs the taxation of "equity instruments" and is limited to "equity instruments" acquired by a taxpayer:

by virtue of employment or the office of director of any company or from any person by arrangement with the taxpayer's employer; by virtue of any restricted equity instrument held by that taxpayer in respect in respect of which section 8C will apply upon vesting thereof; and as a restricted equity instrument during the period of employment by or office of director of any company from that company or an associated institution in relation to that company.

In order for the provisions of section 8C of the Act to apply, the taxpayer must acquire the "equity instrument" "by virtue of his

or her employment or office of director". If an "equity instrument" is acquired "by virtue of his or her employment or office of

director" section 8C of the Act will be applicable and the taxpayer will be liable for income tax on the difference between the market

value of the "equity instrument" and any consideration given in respect of that "equity instrument".

Generally, section 8C of the Act will only be triggered when all the restrictions relating to the "equity instrument" cease to have

effect. The crisp issue for consideration in relation the use of after tax funds to acquire shares is whether the "by virtue of his or her

employment" criteria will be met. The phrase 'by virtue of employment' requires a causal connection between the acquisition

of the equity instrument and employment. Stated differently, section 8C does not apply to all equity instruments which an employee

acquires but only to equity instruments which the employee acquires because he is an employee. The question that one would ask under the SVIP is whether the participants will acquire "equity instruments" because they are employees or because they chose to acquire the shares and pay for them with after tax funds.

In Stander v CIR it was held that the phrase, 'by virtue of any employment' in paragraph (c) of the "gross income" definition in

section 1 of the Act means that services rendered or to be rendered must be the causa causans of the amount received and that it was

not sufficient if such services were merely the causa sine qua non for the amounts received. The court drew a distinction between an

event being a cause-in-fact, (a so-called conditio sine qua non) and a cause in law (legally relevant cause) and how that the mere fact

that the recipient would not have received the amount had he not been an employee was not sufficient to establish the causal link

required for purposes of paragraph (c). In other words, the fact that employee's employment is the conditio sine qua non for the receipt

of an amount does not per definition mean that the amount is received in respect of services rendered. That will only be the case

if the services constitute any causa causans (that is the real or proximate cause) of the receipt.

With regard to the participants in BCR 30 their employment with the applicant or its subsidiaries is certainly the factual cause of the

acquisition of the shares. For instance, when applying the "but for" test one would ask, but for the participants employment with the

applicant, would he or she have acquired the shares? The answer is most likely no and the basic causal nexus may exist.

One could certainly advance the argument that in schemes of the nature in BCR 30, ie acquisition of shares with after tax money, that the participant's employment is merely the causa sine qua non for the acquisition of the "equity instruments". In other words,

something more is required in order to establish whether their employment is in fact the real or proximate cause or the causa

causans for acquiring the shares.

The following practical example can be used to illustrate the absurd result that may arise if one accepts the basis that a participant

acquires the "equity instrument" as a result of his employment. For instance, if an employee uses his bonus to buy a car instead

of shares, would anybody contend that he obtained the car by virtue of his employment relationship? One would argue that

surely this cannot be the case, as every single thing that an employee buys with his salary and bonus are things which he would not

have had but for the fact that he was employed (ie merely the causa sine qua non of the acquisition of equity instrument).

Given the possibly wide ramifications to similar share schemes currently being implemented, or already implemented that look

to circumvent the application of section 8C of the Act, it is crucial that the terms of those schemes be scrutinised and possibly

restructured.