The judgment raised the question whether such capital contributions would henceforth always be considered non-deductible or rather whether it was a case of considering the merits and specific facts and circumstances of each case. Many taxpayers would thus have been relieved when reading SARS Binding Class Ruling 78 issued on 24 January 2022 (BCR 78) which, amongst others, determined the income tax consequences of an employee share incentive scheme. We discuss the SARS ruling in this article.
The applicants in BCR 78 (being resident companies forming part of the same group of companies) proposed implementing an employee share scheme. Importantly, the purpose of the employee share incentive scheme was to incentivise all the participating employees by affording them the opportunity to participate in the economic benefits and appreciation in value in the shares held by the share incentive trust that would be driven by their endeavours. Critically, this would be expected to be achieved by the participating employees being entitled to on-going dividends and indirectly the capital appreciation of the scheme shares by virtue of being entitled to so-called milestone distributions and leaver distributions as defined in the scheme rules and trust deed.
The proposed transaction steps of BCR 78 envisaged a typical share incentive scheme. In particular –
- The applicants (being the relevant employers of the group of companies in question) would make cash contributions to the co-applicant (being a share incentive trust).
- The co-applicant trust would use the proceeds of the contributions to acquire shares in the ultimate holding company of the group of companies in question (Holdco).
- The trustees of the co-applicant would allocate units in the co-applicant to the participating employees.
- A participating employee would be entitled to the following benefits in terms of the trust deed of the co-applicant:
- proportionate share of 50% of any dividends received in respect of the scheme shares;
- milestone distributions after an initial period of four years participation in the scheme and thereafter every five years of completed participation in the scheme; and
- leaver distributions, being equivalent to milestone payments (and essentially determined on the same basis) payable to a participating employee that ceases employment with an applicant.
- The co-applicant would receive the gross foreign dividends that vest in the participating employees and would pass on the net amount (foreign dividend less the dividends withholding tax (DWT) at the applicable reduced rate) to the participating employees.
- The co-applicant would annually issue a certificate to participating employees certifying the amount of Holdco dividends derived by them and the amount of DWT accounted for by the trust on their behalf.
SARS ruled, amongst others, as follows:
The contributions to be made by the applicants to the co-applicant (share incentive trust) would constitute expenditure deductible under section 11(a) read with section 23(g), subject to the application of section 23(h).
BCR 78 thus reaffirms the principle that a contribution to a share incentive trust may well be deductible for income tax purposes depending on the specific facts and circumstances. On the back of the SCA judgment in C:SARS v Spur Group, this is welcome clarification for taxpayers implementing share incentive schemes although taxpayers would be well advised to consider existing and future arrangements given the recent spotlight on such share incentive schemes. In particular, one should bear in mind that SARS rulings are not binding between SARS and all taxpayers and are based on specific sets of facts.