Employee Share Schemes: South African tax Considerations

Employee Share Schemes: South African tax Considerations

• 02 November 2023
• Individuals Tax
• Pieter van der Zwan

Companies often set up employee share schemes that incentivise and align key staff members with the company’s broader objectives. As with any remuneration, these schemes have tax implications for the employer and employee.

This article provides a high-level overview of the South African tax rules for these awards. I also highlight some instances in which their application can be complex.

South African tax on employee share schemes

Section 8C of the Income Tax Act governs the tax implications for the recipient. Broadly, two aspects determine whether this provision applies:

• Did the person acquire an equity instrument(s)? This concept includes shares but is broader than that. It also includes options and contractual rights (for example, as a beneficiary of a trust) that derive their value from shares. 
• Did the person acquire these instruments from a relationship or arrangement to which section 8C applies? The provision applies where the person acquires the instruments by virtue of employment or holding office as director of a company or, in some instances, while employed or being a director of a company. The person should not necessarily acquire instruments from an employer; the provision also caters for arrangements involving other persons and instruments.

If section 8C applies to an instrument, the acquirer is taxed on the instrument’s value upon vesting, as opposed to the grant or award date. This amount is taxed as income (rather than capital gains, which many assume in the case of shares). An instrument’s vesting date depends on the instrument’s terms and those of any arrangement affecting the instruments, for example, the acquisition agreement or shareholders agreements. An employer should generally withhold employees’ tax in respect of the amount at the time of vesting.

Areas of potential complexity

The tax consequences of employee share schemes are often more complex if:

• A trust holds the instruments until vesting or the employee’s right consists of an interest in a trust that owns shares. In these structures, it is often necessary to consider the transactions that occur in or flow through the trust, which is a taxpayer in its own right.
• Instruments are granted to or held by a related person, for example, a family trust, rather than the employee. These types of arrangements could be subject to various anti-avoidance rules.
• A group entity that does not employ the recipient makes the awards. For example, this introduces complexity in identifying the entity that should withhold employees’ tax. 
• The employee share scheme involves an international group.
• The employee who acquires the instrument is only temporarily in South Africa or moves abroad during the term of the award. In such cases, the interaction between section 8C and the relevant tax treaty comes into play.  

Source: Pieter van der Zwan & Associates

FAQs

1. What is an employee share scheme in South Africa?

An employee share scheme is a program where employees receive company shares or options, often at a discounted rate, as part of their remuneration package.

2. How are employee share schemes taxed in South Africa?

Employee share schemes are generally taxed as income, not capital gains, when employees acquire or exercise rights to shares. Tax is based on the difference between the market value and the price paid.

3. Which section of the Income Tax Act applies to employee share schemes?

Section 8C of the Income Tax Act governs the taxation of employee share schemes in South Africa, setting out when and how gains are taxed.

4. When is tax triggered on employee share schemes?

Tax is triggered at the vesting date, which is when employees gain unrestricted rights to the shares or options, regardless of whether they sell them.

5. Are gains from employee share schemes subject to PAYE?

Yes. Employers must deduct PAYE tax on the taxable gain at vesting and reflect it on the employee’s IRP5.

6. Do capital gains tax (CGT) rules apply to employee share schemes?

Yes, but only after the shares have vested. If an employee later sells the shares, CGT may apply on any increase in value from the vesting date to the disposal date.

7. What is the difference between restricted and unrestricted shares?

Restricted shares are subject to conditions (e.g., lock-in periods or performance targets), while unrestricted shares give the employee immediate ownership and disposal rights.

8. Can foreign employee share schemes be taxed in South Africa?

Yes. If a South African tax resident participates in a foreign employer’s share scheme, the gains are still taxable in South Africa, although double taxation relief may apply.

9. Are there tax planning strategies for employee share schemes?

Yes. Employees and employers can structure schemes to align with vesting rules, holding periods, and potential CGT treatment to minimise overall tax exposure.

10. Should employees seek professional advice on share scheme taxation?

Absolutely. Employee share scheme taxation is complex, and consulting a tax advisor or accountant helps ensure compliance with SARS rules and maximises tax efficiency.

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