Tax consequences of share incentive schemes

Many companies, listed and nonlisted, offer employee share incentive schemes as a form of further remuneration. It can also be utilised as an employee retention tool.

We unpack the complicated tax rules governing share incentive schemes to help employees better understand the potential tax consequences.

As an employee, you are granted certain rights to acquire shares in the company or are given shares at a discounted price. The day on which this transaction takes place is called the grant date. Let’s assume you paid R15 per share.

These rights or shares normally vest over a period (usually every three years). They can be revoked if you’re dismissed from the company due to improper conduct.

Employees are usually not allowed to freely dispose of the shares – you cannot elect when to sell or to whom. Also, the value at which the shares can be disposed of is usually pre-determined and not necessarily market price.

When you’re allowed to freely dispose of the shares, the shares vest in you for tax purposes. This is your vesting date.

Let’s assume the price at this point is R35 per share. Vesting does not necessarily mean you sold the shares. It only means the restrictions have lifted.

After vesting, you sell the shares for R55 per share.

These tax rules have been subject to many a dispute with the SA Revenue Service in the past and can get complicated.

The Income Tax Act seeks to tax the difference between the grant price (R15) and the vesting price (R35) as salaried income – and not as capital gains tax.

In this instance, R20 per share will be added to your salary and taxed accordingly.

You have a tax trigger event without actual cash flow.

You will have to either have money on hand to pay this tax or sell other assets in order to pay the tax.

The vesting price (R35) now becomes your base cost for capital gains tax purposes.

Should the share, after vesting, grow in value to R55 and you decide to sell, the gain (R55 – R35 = R20) will be subject to capital gains tax.

When shares vest for tax purposes it’s normally regulated by the rules of the share incentive scheme and the tax treatment is often determined by the wording of these rules.

This article was first published on Just One Lap