Tax allowance for lessors limited

It is common for directors and employees of companies to participate in share based incentive schemes. The taxation of such schemes is primarily dealt with in section 8C of the Income Tax Act. The South African Revenue Service (SARS) has recently issued an interpretation note in respect of that section, as well as the associated sections dealing with employees’ tax obligations.

Section 8C applies to equity instruments that are acquired by virtue of employment or directorship. The terms “equity instrument” is quite widely defined and includes shares and options or rights to acquire shares. Section 8C does not apply to a “broad-based employee share plan” in terms of section 8B of the Income Tax Act.

The basic concept behind section 8C is that it taxes gains in respect of equity instruments, when those equity instruments vest in the employee or director. The gain is the difference between its market value at the date of vesting and any consideration that was paid for the equity instrument. The gain is subject to income tax, rather than capital gains tax.

The question as to when a particular equity instrument vests in an employee or director is then key to the tax implications. If there are no restrictions placed on an equity instrument, then the answer is straightforward, in that vesting occurs on acquisition. The answer is more complicated where there are restrictions placed on an equity instrument. These restrictions could include anything that prevents the employee or director from freely disposing of the equity instrument at market value or that could result in him forfeiting it for less than market value. A restricted equity instrument vests once all its restrictions fall away, or immediately before its disposal.

As an example, a director participates in a share scheme. He acquires a share for its market value of R100. The rules of the share scheme prohibit him from disposing of the share for a two year period. At the end of that period, the market value of the share is R250. The director will then be taxed on an amount of R150, being the difference between the R250 market value and the R100 consideration that he originally paid.

When a liability arises in terms of section 8C, there are corresponding employees’ tax obligations. There are also a number of anti-avoidance provisions to prevent the objective of section 8C being subverted through, for instance, transactions with connected persons or the use of trusts and companies to acquire shares.