Ilke Meissner examines the requirements of broad-based employee share plans and their comparison to the proposed terms for shares to be held under trust in terms of the Companies Act
The provisions regulating broad-based employee share schemes in the Income Tax Act 58 of 1962 play an important role in encouraging employee participation in companies.1 The envisaged tax relief is two-fold: first, provision is made for the exemption of the market value of shares received on date of grant2 and second, deductions are provided to employers of the said market value less the consideration paid by the employee to allow “a tax free transfer of shares by an employer to employees”.3 The purpose of this brief analysis is not the detailed interpretation of the tax relief provisions but rather to evaluate when these provisions apply and the impact of the Companies Act 71 of 2008, if any, on such share schemes. Furthermore, it will be assessed whether shares held in trust in terms of section 40 of the Companies Act meet the requirements of section 8B of the Income Tax Act.
THE INCOME TAX ACT
The precondition for the application of sections 8B, 10(1)(nC) and 11(lA) is that the share concerned must be a “qualifying equity share”. This term is broadly defined in section 8B as an equity share acquired in terms of a broad-based employee share plan, where the market value of all equity shares (as determined on date of grant) so acquired does not exceed R50 000 in a five year period.4 A broad-based employee share plan is in turn defined with reference to four requirements:
- The equity shares must be acquired “for consideration which does not exceed the minimum consideration”. According to Interpretation Note No 62 this means that “the shares must be offered to employees for free or at a minimum consideration, which does not exceed the par value of the shares”.
- Eighty per cent of all employees (not participating in another equity share scheme and permanently employed) must be entitled to participate.
- Employees must be fully entitled to receive dividends and exercise all voting rights.
- No restrictions may be imposed regarding the disposal of such shares, except where, amongst others, the restrictions are imposed by legislation or the restriction constitutes a lock-in period of no longer than five years from the date of grant.
A failure to meet the above requirements means that it is not a qualifying share and thus is not eligible for tax relief as provided for by the Income Tax Act.
THE COMPANIES ACT
A preliminary issue that requires mention is the treatment of par value shares in the Companies Act. In contrast to the Companies Act 61 of 1973, the new Companies Act stipulates in section 35(1) that “a share does not have a nominal or par value”. The purpose is therefore to do away with par value shares completely, subject to some transitional and conversion arrangements in Schedule 5 and Regulation 31.6
This change may cause problems pertaining to the first requirement of broad-based employee share plans as set out above. How should the requirement of “consideration which does not exceed the minimum consideration” be interpreted? If the shares are not offered for free and no longer have a par value, the determination of minimum consideration needs revision.7
Furthermore, section 40(1)(a) of the Companies Act provides that shares must be issued for “adequate consideration”. Consideration is defined in section 1 and broadly speaking covers “anything of value given and accepted”.8 It is therefore doubtful whether the Companies Act allows shares to be issued for free as set out in Interpretation Note No 62.
Finally, the “minimum consideration” debate is significantly complicated by the fact that the Companies Act provides for a broad definition of compensation, covering not only money, but also labour, an undertaking, promise, agreement or assurance, amongst others. When is the minimum consideration exceeded if it is in any other form apart from money or property?9
Shares held in trust in terms of section 40 of the
The Companies Act introduces certain changes pertaining to the consideration for shares. Before shares can be issued, the board must determine the consideration.10 Consideration is given a wide definition in section 1 and apart from money, property and securities it includes labour or an undertaking or promise.11
Once such consideration has been determined and received by the company, section 40(4) provides that the shares are fully paid and the company must issue the shares. In the particular context of employee share schemes where shares are provided to employees for future services, future benefits or future payments it means that the compensation would not be received by the company and the shares would not be fully paid and issued.
This position is however expressly changed by section 40(5), which stipulates that although compensation for shares issued for future services, benefits or payments must only be regarded as having been received by the company to the extent that such services, benefits or payments have actually been delivered or paid by the employee,12 the company must issue the shares immediately and transfer them to a trust.13 Such shares are therefore not considered fully paid, but must be issued nonetheless.
Section 40(6) continues by setting out the proposed provisions of the trust agreement under which the shares are held, although the company can determine otherwise in the trust deed.14
The provisions include:
- A restriction of voting rights and appraisal rights
- A restriction of pre-emptive rights
- Distributions may only be credited to the holder of the shares to the extent that the shares have become negotiable and distributions may be credited against the outstanding consideration, and
- A limitation of the transferability of shares
The general scheme of this section is therefore to permit the “holder” of the shares to enjoy the benefits flowing from the shares only to the extent that the consideration has actually been received by the company.15
SECTION 40 “TRUST SCHEMES” AND SECTION 8B “BROAD-BASED EMPLOYEE SHARE PLANS”
Employee share plans are aimed at encouraging employee participation in the company and ensuring employee empowerment. In general, shares are made available to employees under such plans for no up-front compensation. Rather, these shares form part of the remuneration of employees and are thus paid for with services rendered to the company.
Should an employer implement an employee share plan in terms of which shares will be issued to employees for future services, future benefits or future payments, compliance with the ambit of section 40(5) and (6) of the Companies Act would necessitate the holding of these shares in trust with certain restrictions until the services are fully rendered or the benefits paid. The question therefore arises whether such a scheme envisaged by section 40 would fall within the ambit of a “broad-based employee share plan” and therefore qualify for tax relief under the Income Tax Act.
Under the first requirement of “broad-based employee share plans”, there is clearly compensation in the above scenario. Where the future compensation is however not in the form of money, the question whether the compensation did not exceed the “minimum consideration” becomes more complex, as set out under “The Companies Act: consideration” above.
The most problematic aspects are however the third and fourth requirements under a “broad-based employee share plan”. Under the Income Tax Act no restrictions may be imposed on the disposal of such shares, save for some exceptions including a restriction imposed by legislation and a five year lock-in period. Under the Companies Act, however, the trust agreement should provide for exactly such a restriction on the transferability of shares. Since the restriction on the disposal is imposed by the Companies Act, it could be argued that it is a restriction imposed by legislation as envisaged by section 8B. The fact that the trust deed is alterable may however have an impact on this interpretation.
Under the Companies Act, the trust deed should further provide for restrictions on voting rights and distributions. “Broad-based employee share plans” under section 8B however require full entitlement to dividends and full exercise of voting rights. Since the two provisions are not reconcilable on this point, a trust structure as envisaged by section 40(6) of the Companies Act therefore does not qualify as a “broad-based employee share plan” under section 8B of the Income Tax Act. As a result the employee does not qualify for the exemption in section 10(1)(nC) of the Income Tax Act. On the other hand, the employer will not be able to deduct the market value of the shares (less consideration received) from its income as provided for in section 11(lA) of the Income Tax Act.
As an alternative, the employee may qualify for an exemption of the market value of the shares received, provided the shares represent equity shares as envisaged by section 8C of the Income Tax Act.16 However, such a designation (that is, equity shares as envisaged by section 8C) would not result in deductions for the employer.
The above analysis shows that issuing shares directly to employees when consideration has not been received fully by the company does not satisfy the requirements of a “broad-based employee share plan” under the Income Tax Act if the terms of the trust deed as provided for by section 40(6) of the Companies Act are followed. Since these terms are alterable, it is possible to change the terms to such an extent that they comply with the requirements of 8B of the Income Tax Act. It is not advisable to completely disregard the terms as set out in section 40(6) of the Companies Act.17 To minimise the risks, it would be advisable to at least retain the restriction on the disposal of shares. Since this could qualify as a restriction imposed by legislation, such a limitation could be reconcilable with the requirements of s 8B of the Income Tax Act. The restrictions on voting rights and distributions will however have to be removed. An alteration of the terms of the trust agreement as set out above should enable both the employer and employees to maximise tax relief. ❐
- See South African Revenue Service Interpretation Note No 62, paragraphs 1–2.
- See Income Tax Act 58 of 1962 section 10(1)(nC) as read with section 8B.
- See section 11(lA).
- The requirements pertaining to the maximum value of shares that may be issued are not relevant to the present analysis.
- SARS Interpretation Note 62 paragraph 3.1.1.
- See Companies Act 71 of 2008 Schedule 6 Item 6; GN R 351 in GG 34239 of 26-04-2011.
- The definition of “broad-based share plan” in section 8B of the Income Tax Act still makes reference to the old Companies Act with regard to the minimum consideration requirement. It is submitted that Treasury neglected to consider the effect of the Companies Act on the working of section 8B of the Income Tax Act.
- Section 1 of the Companies Act 71 of 2008:
- In contrast, the definition of “gain” in section 8B of the Income Tax Act excludes “services rendered or to be rendered or anything done or to be done” from the ambit of “consideration”.
- Companies Act 71 of 2008 section 40(2).
- See note 6 above.
- Companies Act 71 of 2008 section 40(5)(a)(ii).
- \Section 40(5)(b)(i)–(ii).
- The alterable nature of this provision may create significant risks for the company. If performance is not made or payments are not received by the company, section 40(6)(d)(iv) stipulates that the shares must be cancelled and returned to the company. If the trust deed is however altered to such an extent that shares which are not fully paid-up are issued and the shares are sold to a third party in the meantime, risks are created.
- F H I Cassim, M F Cassim, R Cassim, R Jooste, J Shev & J Yeats, Contemporary Company Law, 2nd ed, Juta, 2012, p 227.
- See section 10(1)(nD) as read with section 8C of the Income Tax Act 58 of 1962.
- This would for example be where the only term of the trust deed is that the shares should be issued to the employees immediately.
Author: Ilke Meissner is currently in her fifth year of the BAccLLB course at the University of Stellenbosch