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Companies, particularly listed companies, offer employees so-called share options (also referred to as share incentive schemes or employee share ownership plans (ESOPs)) as a form of further remuneration and even as an employee retention mechanism. In unpacking and understanding the tax consequences linked to ESOPs, the provisions of section 8C of the Income Tax Act need to be considered. Section 8C replaced section 8A, which was previously the taxing provision in relation to ESOPs, in 2004. This article considers some of the more practical challenges when dealing with share schemes.

Section 8C seeks to tax the gain with regard to the vesting in a year of assessment of an equity instrument acquired by an employee if such an equity instrument was acquired by the employee by virtue of his employment or the office of a director.

Section 8C defines an “equity instrument” as:

… a share or a member’s interest in a company, and includes—

(a) an option to acquire such a share, part of a share or member’s interest;

(b) any financial instrument that is convertible to a share or member’s interest; and

(c) any contractual right or obligation, the value of which is determined directly or indirectly with reference to a share or member’s interest;”

In most instances, the equity instrument which is the subject matter of section 8C (i.e. share options) would be the right of an employee to acquire shares in the company, subject to certain requirements being met, which are typically catered for in the ESOP Rules of the Company. This would typically include the employee staying in the employment of the company for a fixed period of time and not breaching any of the conduct policies of the company. Typically companies allow equity instruments to vest every 3 years.

The equity instruments can also be so-called phantom share options, where the rights are purely contractual and will only ever grant the employee the right to receive the after-tax gain in relation to the equity instrument, with the price of the equity instrument, pegged to the value of the shares in the company, and never the actual shares in the company.

The concept of vesting, for section 8C purposes, envisages that the equity instrument (as defined) in question is restricted, and refers to an equity instrument which is, amongst others:
  • subject to restrictions that prevent the employee from freely disposing of the shares at market value. (This envisages that the employee should have the right to dispose of the shares to any party at market value.); or
  • subject to restrictions which could result in the employee forfeiting ownership or the right to acquire, other than at market value.
Since the tax trigger for section 8C is “vesting”, which is defined for purposes of that section, it is only these defined section 8C vesting events which will trigger the inclusion of a gain (or loss).

In terms of Section 8C, instruments vest when a “restricted equity instrument” becomes an “unrestricted equity instrument”, which occurs on the earliest of, amongst others, the following events:

  • when all restrictions cease to have effect; or
  • immediately before the hold of the share options disposes of the restricted equity instrument, unless certain equity instrument swap exclusions find application; or
  • immediately after that equity instrument, which is an option or a financial instrument, terminates (otherwise than by the exercise or conversion of that equity instrument); or
  • immediately before the holder of the share options dies, if all the restrictions relating to that equity instrument are or may be lifted on or after death.
The result of the above is that in most circumstances a holder of share options will be taxed as soon as all restrictions are lifted, even though he/she may not have actually disposed of the equity instrument (being the subject matter of the share option) at that time. This could potentially lead to a liquidity problem for the employees. Practically, companies granting these share options should inform their employees of section 8C’s workings and the practical difficulties pertaining to liquidity.

ESOPs can have complicated and sometimes unintended tax consequences and it is advisable to get professional assistance prior to the implementation of ESOPs.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)