Amendments to the tax treatment of disposals by incentive trusts

Generally, where an employer establishes a trust to hold certain shares for future distribution to its employees as part of a share incentive scheme, the scheme is structured in such a manner that there are no capital gains or losses for the trust upon distribution.

In this regard, reliance is usually placed on paragraph 11(2)(j) of the Eighth Schedule of the Income Tax Act, No 58 of 1962 (Act), which provides that:

“(2) There is no disposal of an asset:

…

(j) which constitutes an equity instrument contemplated in section 8C, which has not yet vested as contemplated in that section…”

However, according to the explanatory memorandum to the Taxation Laws Amendment Bill 2015 (Bill), it is indicated that “paragraph 11(2)(j) of the Eighth Schedule has been misinterpreted to mean that there is no disposal event at all by the trust in respect of an equity instrument”.

Accordingly, the Bill proposes to make five amendments to the Eighth Schedule of the Act in order to ‘clarify’ the tax treatment of disposals by incentive trusts.

Firstly, it is proposed that paragraph 11(2)(j) of the Eighth Schedule be deleted.

Secondly, a new paragraph 13(1)(a)(iiB) will be inserted to deal with the time of disposal of equity instruments by trusts:

“13(1) The time of disposal of an asset by means of:

(a) a change of ownership effected or to be effected from one person to another because of an event, act forbearance or by operation of law is, in the case of:

…

(iiB) the granting by a trust to a beneficiary of an equity instrument contemplated in section 8C, the time that equity instrument vests in that beneficiary as contemplated in that section…”

Accordingly, the granting of an equity instrument by a trust will constitute a ‘disposal’, but the ‘time of disposal’, and therefore any capital gains tax effect, is postponed until such time as the equity instrument vests.

Thirdly, a new paragraph 64C will be inserted to deal with instances where an employee exchanges an equity instrument that has not yet vested for another instrument, as contemplated in s8C(4)(a) of the Act, or where the employee disposes of the equity instrument to a connected party as contemplated in s8C(5)(a) of the Act. In these circumstances any capital gain or loss must be disregarded, because the tax consequences will be rolled over to the new instrument, or the connected party.

Fourthly, an amendment will be introduced to paragraph 80(1) of the Eighth Schedule, which will effectively exclude the disposal by a trust of a s8C equity instrument to an employee beneficiary from the flow-through principle, and capital gains or losses will not be attributed to the employee.

However, the flow-through principle as contained in paragraph 80(2) will still apply where the trust disposes of the shares and then makes a cash distribution of any capital gain to the employee.

Lastly, a new paragraph 80(2A) will be inserted in the Eighth Schedule of the Act, which will exclude the operation of paragraph 80(2) as mentioned above to the extent that the capital gain is distributed to the employee by reason of the vesting of an equity instrument in that employee in terms of s8C of the Act. Gains resulting from a share exchange or forfeiture in terms of s8C(4)(a) or s8C(5)(c) respectively will also be excluded from the operation of paragraph 80(2) of the Eighth Schedule of the Act.