Proposed tax changes for share schemes: Double tax for no good reason?
20 July 2016
Posted by: Author: Patricia Williams
Author: Patricia Williams (Bowman Gilfillan)
The 2016 Draft Taxation Laws Amendment Bill (TLAB) and 2016 Draft Taxation Laws Amendment Bill (TALAB) propose certain share scheme changes. According to the National Treasury Media Statement of 8 July 2016, these changes are aimed at "addressing the circumvention of rules dealing with employee share incentive schemes”.
What is the "normal” effective tax rate for employee income?
As a background to tax on share schemes, one should not lose focus on the tax treatment of ordinary remuneration (salary or bonus payments). Let’s assume an employer pays an employee R100. Assuming that the employee is at the maximum marginal income tax rate of 41%, the tax treatment can be shown as follows:
Employer tax deduction – tax amount
Employee income tax – maximum tax amount
The "proper” net tax collection for the fiscus, in a normal cash salary situation, is therefore a maximum 13% tax rate.
What is the current and proposed effective tax rate in the "circumvention of rules” identified by SARS?
In the Draft Explanatory Memorandum on the Taxation Laws Amendment Bill, 2016, SARS identifies two examples of the "circumvention of rules”, which would be addressed by the proposed changes. Here is example 1, with the associated tax flows, to understand what all the fuss is about.
Mr Eager, with shares with a value of approximately R2 million, has 90% of his effective equity ownership value settled by means of a dividend of R1.8 million.
The Explanatory Memorandum refers to this as an "exempt” dividend, but does not consider the income tax paid by the underlying company on the income from which the dividend is paid, and the dividends tax.
Current tax rules
Proposed tax rules
Taxable income in underlying company
Company tax @ 28%
After tax cash available for dividend
Dividends tax @ 15%
Income tax on dividend @ 41%
Tax rate (tax as percentage of original taxable income of R2.5 million
Round about now, you are imagining that you have misunderstood the whole issue. Because didn’t you just read that the normal effective tax rate for cash remuneration is a net 13%? And now it looks like the "circumvention of rules” example in the Explanatory Memorandum has a net tax rate of 38.8%, which is already a much higher rate, so it does not look at all like "circumvention” of taxes.
If this were making sense to you, there would be a problem.
Tax rates comparison
To be clear, here is a tax rates comparison:
Effective maximum net tax rate for normal cash remuneration
(Employee 41% - Company deduction 28%)
Dividends tax rate (no offsetting deduction)
Example 1 in the Explanatory Memorandum (Circumvention of rules)
Example 1 in the Explanatory Memorandum – after proposed changes
Normal cash remuneration has a maximum net tax rate of 13%, but because of share incentive schemes that result in 38.8% tax, SARS is of the view that the tax rules have to change. This change results in double taxation, and increases the effective tax rate to 57.5%, which is more than 4 times the "base case” effective rate of 13% for normal cash remuneration.
Who will be hit?
Many of these employee share incentive schemes have been used as part of BEE structures. Share schemes for BEE purposes need to ensure that black employee beneficiaries don’t immediately sell their shares to other parties, resulting in the loss of empowerment credentials. While share schemes for the benefit of individual employees can fairly easily be amended (for example if tax changes result in punitive tax treatment), BEE share schemes are not easily changed, and the change itself might result in punitive tax treatment.
In summary, as to who will be hit:
- Normal employee share schemes, if they don’t restructure.
- BEE share schemes (will either be subject to punitive tax treatment as a result of this proposal, or will have to find another way to structure the BEE credentials, experiencing negative tax consequences in the restructuring process).
Is this definitely going to happen?
Submissions on the draft tax bills are due by 8 August 2016. If this seems as unfair to you as it does to me, then make submissions to SARS and National Treasury. Perhaps the powers that be will see reason, and abandon this proposal.