Share Scheme Pitfalls
12 November 2013
Posted by: Author: BDO
The recently released Taxation Laws Amendment Bill of 2013 (the TLAB) contains a provision (a new proviso (ii) to section 10(1)(k)(i) of the Income Tax Act) whereby dividends received by employees or directors of companies in circumstances where the shares are not held by the employees or directors directly (for example if the shares are held by a share trust), will no longer be exempt from income tax. In terms of the wording of the provision, it makes no difference whether the shares are ‘restricted equity instruments' or ‘unrestricted equity instruments', although in terms of the Explanatory Memorandum the intention was to exclude restricted equity instruments from this treatment. It is not clear whether this is an oversight. The intention appears to be to attack schemes whereby the employees do not receive shares but participate in dividends as a form of disguised remuneration.
The provision applies where the dividend arises ‘in respect of services rendered… or in respect of or by virtue of employment or the holding of any office'. It gives rise to possible provisional tax registration and reporting implications as well as the possibility of the dividends tax arising in addition to the loss of exemption from income tax. The provision, if enacted, will most likely apply to dividends received or accrued on or after 1 March 2014.
The initial proposal included an income tax deduction for the company declaring the dividend. This appears to have been scrapped.
The example given in the Explanatory Memorandum to the Bill, with adaptation, is as follows:
A discretionary trust holds equity shares in EmployerCo. EmployerCo declares and pays a dividend (R100) to Trust. In the same year of assessment, trustees decide to distribute the dividend to the employees of EmployerCo as beneficiaries.
The dividend (R100) is taxable in the hands of the employees as normal income (without exemption). In order to avoid Dividends Tax withholding, the trust must make a declaration to the relevant CSDP (if listed shares) or EmployerCo (if unlisted shares) that the employees are the beneficial owners of the dividend. The employees need to take the dividend into account for provisional tax purposes.
If the trust had only distributed the dividend in year 2, R85 (net of dividends tax) would have been received by the trust in year 1. The R85 would be subject to income tax in the hands of the employees as normal income in year 2. In these circumstances, the dividends tax adds to the overall tax burden.
This article was first published on bdo.co.za