The Benefits and Forms of an Employee Share Scheme

Employee share schemes provide opportunities for employees to own shares in the company in which they are employed. They create a means to provide employees with equity which enables a more direct incentive for growth than bonuses or general remuneration.

Share purchase plans offer eligible employees the chance to purchase shares, sometimes through a loan from their employer. The shares are often paid for through salary sacrifice over a set period (for example, 6 months), or by using the dividends received on the shares. Some share purchase plans also allow employees to pay for the shares in full, up front. Employees on higher incomes are often eligible to receive shares as a performance bonus, or as a form of remuneration, instead of receiving a higher salary.

The share schemes of larger companies usually offer employees 'ordinary shares' that provide an equity investment in the company. However, smaller companies may only offer 'pseudo' equity schemes that pay dividends but do not give employees the rights associated with traditional share ownership, such as the right to vote at annual general meetings.

With regard to Employee Share Schemes, a combination of the applicable company laws, as well as information available from the South African Institute of Chartered Accountants, provides the following useful information:

• Employee Share Schemes are traditionally constructed according to various different models, being:
• Outright Option to Purchase
• Share Options, with interposing trusts and without interposing trusts;
• Staggered Share Option;
• Share Incentive trusts (General Staff Incentive Trust, Broad Based Black Economic Empowerment Trusts, and The Selected Employee Incentive Trusts); and
•  A Cash Settled Share Plan.

The substantial differences between these options are as follows:

• An Outright Option to Purchase constitutes an agreement in terms whereof shares are offered for sale to either a single or multiple employees at either the market related value of the shares or at a discounted rate. The purchase price may even be financed by the corporation and may even be subject to certain conditions such as a minimum period of employment with the corporation or the performance of the employee. The shares will generally vest in the employee at the time of concluding the agreement.

• Share Options, in turn, constitute an agreement in terms whereof the shares will vest in the employee at a later stage. The shares will be offered to the employee at either the market related value thereof or at a discounted rate. The employee will be obliged to make payment of the purchase price, either after expiry of the period referred to, or during the period, or will be subject to certain performance requirements. This model does not make use of an interposing trust. The model can be implemented by making use of an interposing trust, where the allotted shares will be issued to a trust, which will hold the shares on behalf of the participant until the period expires and/or the other restrictive conditions have been met such as employment for at least 5 years.

• Staggered Share Options can take the form of either an outright option or a share option. The major difference lies in the fact that shares are allotted to the employee as she makes payment of the purchase price.

• Share Incentive Trusts (hereinafter referred to as a “SIT”) are based on the principle that shares are not allotted to either a selected employee (Selected Employee Incentive Trust) or all staff of a particular class (General Staff Incentive Trust or Broad Based Black Economic Empowerment Trusts), but that such shares are kept in trust on behalf of such a selective or class of employees. The employees will as a general rule be entitled to elect a representative to represent them at board meetings and will further be entitled to dividends accruing to the trust. Typically, a SIT model would involve the following steps:

• the employer would form the SIT, which in turn would subscribe for the shares in the employer;
• once the SIT has acquired the shares, the employees would be appointed as beneficiaries of the SIT to receive the benefits flowing from the shares (i.e. the dividends and voting rights) until the expiry of a specified lock-in period;
• at the expiry of the lock-in period the beneficiaries would receive the shares, either for market-related consideration, for a consideration which is less than the market value of the shares, or for no consideration depending on the circumstances;
•  the formation of the SIT and the issue and subscription of the shares in the employer do not have any tax consequences in the hands of either the employer or the SIT. However, the manner in which the SIT model is structured (i.e. for all of the employees in general or only for a select few) will determine the tax consequences in the hands of such employees.

• Cash Settled Share Plan is not a true share incentive plan because no actual shares are issued to the employees. Units or “hypothetical” shares are allocated to employees by the company or by a share trust. These are not actual shares, and do not entitle the employee to any rights as equity holders. Instead, the scheme amounts to a contract between the company or share trust and each employee whereby the employee receives what is, effectively, a bonus. In most cases, each unit entitles the employee to receive an amount equal to the dividend declared in respect of an actual share. On the expiry of certain time periods, the holder of the unit is paid an amount equal to the market value of an actual share or the growth in the market value since the allocation date of the unit. A cash settled share scheme cannot be structured with a tax treatment more beneficial than simple payment of tax on the benefit at the employee’s marginal income tax rate.

Any share option scheme whereby an employee or a director acquires an option to purchase shares in the employer company by virtue of his employment, falls within the ambit of section 8C of the Income Tax Act. The effect of section 8C is that if the equity instrument generates any gains, the taxpayer is required to include such gain in his income for the tax year in which the instrument vests in him. The gain is calculated by subtracting from the market value of the equity instrument at the time that it vests in the taxpayer the sum of any consideration paid by the taxpayer in respect of the equity instrument.

Employees should further note that the acquisitions of shares at discounted rates may have certain tax implications especially in as far as Capital Gains Taxes are concerned, as is the case in 8B. In essence, what section 8B does is allow for the tax-free treatment of “qualifying equity shares” acquired by employees, even though these shares may be acquired at no cost or at a discount. In order for a share to be a “qualifying equity share” for purposes of section 8B it must satisfy two requirements:

• the employee must receive the share in terms of a broad-based employee share plan; and
• the market value of all the shares acquired by the employee in terms of that broad-based employee share plan in that year and the four immediate preceding years of assessment cannot in aggregate exceed R50 000.00 (Present amount).

In order to qualify as a “broad-based employee share plan” the following conditions must be met:

• the employer must offer the shares to the employees for no consideration or at par value;
• employees may not participate in the broad-based employee share plan if they participate in another equity share plan;
• the employer must offer the plan to at least 80% of those other employees who have been permanent employees on a full-time basis for at least 1 year;
• the employees must receive full voting rights and be entitled to all dividends; and
• the plan may contain no disposal restrictions other than a restriction imposed by legislation, a right to acquire the shares at market value and a restriction on the employee to dispose of the share for a period of 5 years. 

The effect of section 8B is the following:

• the receipt of the qualifying equity shares is exempt from income tax in the hands of the employee;
•  the receipt of the qualifying equity shares is exempt from fringe benefits tax in the hands of the employee;
• any loans by the employer to the employee to acquire the qualifying equity shares are free of fringe benefits tax; and
• if the employee sells the shares after the 5-year period, the gains on the disposal would generally be capital in nature and be subject to CGT in the hands of the employee.

The previous Companies Act prevented any company to assist any person financially to obtain or acquire any interest in the company. The provisions of the New Companies Act alleviated this restriction by allowing such incentive schemes, subject thereto that:

• The board of the company may only authorise the financial assistance if:
• the board is satisfied that the solvency and liquidity test will be satisfied;
• the terms of the loans are fair and reasonable to the company; and
• the share scheme complies with Section 97 or the loans have been authorised by a recent special resolution of the shareholders.

To qualify as an employee share plan and claim the exemption from publishing a prospectus, the company whose shares are subject to the scheme must:

• Appoint a compliance officer.
• State in the company's financial statements the number of the shares that it has allotted during any financial year to the employee share plan.

The compliance officer, accordingly, must:

• Be responsible for the administration of the plan.
• Provide a written statement to any employee who receives an offer to purchase shares, setting out;
• the nature of the transaction, together with the associated risks;
• information relating to the company, including the latest annual financial statements, nature of the company’s business and its profit history for the last three years; and
• full particulars of any material changes which occur in relation to any information provided in respect of the above.

Ensure that copies of the documents containing this information are filed with CIPC within 20 business days of the establishment of the employee share scheme. File a certificate within 60 business days after the end of each financial year certifying that the compliance officer has complied with the obligations set out above in the previous financial year.

These share schemes provide a powerful way to incentivise growth in your company, as it provides your employees with a direct connection to the company's success. Share Schemes also provide BEE benefits and provide numerous benefits in a transformative South Africa.

Prepared by Alexander VD Laan