The future of employee share schemes seems to be in the balance if proposals in the latest draft Taxation Laws Amendment Bill go through.
Tax experts have warned that the proposed changes, where almost any amount received by a taxpayer in respect of these schemes will be taxed as ordinary income, will tear up existing financial models and sink many schemes.
From 1 March next year all distributions (all dividends and all returns of capital) on restricted equity instruments will be taxed at revenue rates.
The South African Revenue Service (SARS) believe that share schemes are, in many instances, used to convert salary into dividends and capital gains which are taxed at lower rates than income.
The overarching intention with the various anti-avoidance provisions relating to share schemes in the Income Tax Act (Sect 8C)in recent years, including the latest changes, is to ensure that amounts received by employees through their employer and employee relationship are taxed as ordinary income rather than as dividends.
Ordinary income tax rates range between 18% and 41%, but dividends are taxed at 15% and capital gains at 16.4%.
Dan Foster, head of international private clients at Webber Wentzel, says if the proposed changes were meant to be fair, then the new rules would apply only to restricted shares and other restricted equity instruments that were acquired after 1 March 2017.
“Companies who have created existing restricted equity schemes in good faith and in perfect compliance with existing laws will now face the prospect of having to tell staff, not to mention the unions and empowerment trustees, that their dividends will be taxed at marginal rates up to 41%, and not at 15% as expected.”
Lesley Isherwood, associate director at KPMG, says the fairness of the proposed change is debatable. However, National Treasury has voiced concerns on a number of occasions previously regarding the use of share schemes to disguise remuneration as dividends.
“It remains to be seen whether the legislation will be passed in its current form,” she says.
She explains that share schemes which involve restricted equity instruments would generally involve the issue of shares at less than market value to employees.
Deloitte Tax Associate Director Jaco la Grange says many of the broad based schemes have been designed so that the ownership (of the shares) is obtained through a cash payment upfront, grants and loans. Employees repay the loans with dividends received from the company.
The viability of these schemes are now in question. “The main concern is the retrospective nature of the legislation and the effect it will have on legitimate older schemes which aimed at empowering employees,” says La Grange.
Foster warns that post-tax dividends are often used to fund the scheme. “The amendments will tear up existing financial models and sink many schemes.”
He says the “crippling uncertainty” that these changes cause, for schemes which often last 10 or 20 years, cannot be underestimated.
“It has proven immensely difficult for companies to successfully fund, administer and maintain compliance in terms of their share schemes, not to mention fulfil their BEE responsibilities, in such a punitive and ever-changing environment.”
Foster says some schemes, including many black economic empowerment (BEE) trusts, did permit employees to receive dividends taxed at 15%, which was perfectly legal.
“This will be reversed. The rug has been pulled from under them. Schemes cannot be changed now, since most employees have restricted equity and that equity cannot be unrestricted without a tax charge,” he says.
South African Institute of Tax Professionals CEO Keith Engel says there are firms who have been actively pursuing ways to circumvent the act in order to disguise revenue through “share-buybacks” and “dividend stripping”.
National Treasury and SARS have introduced several anti-avoidance measures in recent years to counter ways of disguising revenue as dividends or return on capital.
La Grange says there is a tension between “smaller boutique schemes” and large schemes where participation is aimed at a broad base.
In the mind of SARS and treasury there is distinction between executive share schemes and broad based share schemes.
“The executive schemes are designed to be more tax advantageous for a small group of people. Unfortunately, although the attack is on these schemes older schemes which is aimed at benefitting deeper into the organisation is caught in the cross-fire,” says La Grange.
Engel says while government’s concerns are legitimate, the current measures are unfair to existing BEE schemes and rank and file employees, who are locked into the schemes for a period of at least five and even 10 years.
“The change undermines their legitimate expectations even where no disguised schemes exist,” he says.
A recent survey by Deloitte indicated a dramatic increase in the number of companies who are offering employee share schemes.
Matt Hart, senior manager at Deloitte, says the aim with the schemes is to increase the culture of “ownership” in an organisation. “It also tries to bridge the gap between executive share plans and everyone else,” he says.
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