Many companies (listed and non-listed) offer employee share incentive schemes as a form of further remuneration. It can also be utilised as an employee retention tool. This month we want to unpack* the complicated tax rules governing share incentive schemes to help employees better understand the potential tax consequences. This post was inspired by a question we answered in this episode of The Fat Wallet Show.
Let’s use an example to see how these schemes usually work:
- 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 of time (usually every three years). It 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, i.e. you cannot elect when to sell or to whom. Also, the value at which the shares can be disposed of is usually pre-determined. In other words, you can’t sell them at market price.
- Only when you’re allowed to freely dispose of the shares to anyone and at market value, do the shares truly 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 even if you still hold the shares.
- After vesting, you sell the shares for R55 per share.
The above illustrates when shares vest for tax purposes. We will try to explain this in as simple terms as possible, but these tax rules have been subject to many a dispute with SARS in the past and can get extremely complicated.
Vesting date = income tax trigger event
In short, the Income Tax Act seeks to tax the difference between the grant price paid (R15) and the vesting price (R35) as salaried income and not as capital gains tax. In this instance, R20 will be added to your salary and taxed accordingly. This effectively means that you have a tax trigger event without any 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.
Capital gains tax on growth after vesting
Should the share, after vesting, grow in value to R55 and you decide to dispose of the share, the gain now made (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. It’s therefore important to have sight of and understand these rules as the tax treatment is often determined by the wording of these rules.
*This is, in fact, an understatement because we’ve barely scratched the surface.
Being tax efficient is an important part of great financial management. In this blog, a group of South African tax experts share their tips and explanations on tax issues. Learn everything you need to know about tax, from deductions you never knew about to retirement savings and capital gains. The first Tuesday of every month is Tax Tuesday. Don’t miss it!