Introduction and Overview

Now more than ever, companies are looking to incentivise and align key employees to a common long-term growth objective. Employee incentive schemes allow key management and staff the ability to participate, on a medium to long-term basis, in the growth and profitability of the company. We briefly set out below the different types of employee incentive schemes generally implemented in South Africa together with common queries raised by clients.

What is an employee share scheme?

Employee schemes are defined in the Companies Act, 2008 (“Companies Act”) as “a scheme established by a company, whether by means of a trust or otherwise, for the purpose of offering participation therein solely to employees, officers and other persons closely involved in the business of the company or a subsidiary of the company, either (i) by means of the issue of shares in the company; or (ii) by the grant of options for shares in the company”.

An employee scheme allows the participant employees to benefit from the growth in value of the shares of the company either by offering them actual shares or entitlements associated with those shares.

It is important to ensure that the company’s scheme falls within the abovementioned definition to avoid the scheme constituting an “offer to the public”, which involves the issuing of a prospectus, more stringent regulatory approvals etc.

What are the types of employee incentive schemes commonly implemented?

  • Share Option Plans/Performance Stock Plans: under this scheme, the employee is given the option to acquire a specific number of shares at a pre-determined price (generally the trading value of the shares at the date of being granted the option). The exercising of the option can be linked to the employee satisfying certain conditions (i.e.: performance targets) with the delivery of the shares, and payment thereof, only occurring on the date of exercise. In this scenario, vesting of the shares will occur once the employee validly exercises the option.
  • Share Acquisition Plans/Restricted Stock Plans: commonly seen under long term incentive plans, share acquisition plans result in the employee being delivered, and paying for, the shares at the commencement of his/her participation in the plan (vesting occurs at this stage). The employee will then be required to meet certain criteria (i.e.: remaining employed with the company for a specified period or achieving performance targets) or a portion of the shares will be returned/bought back by the company at a predetermined price (generally a nominal amount).
  • Phantom Share Schemes, Performance Stock Units or Cash Settled Schemes: although not strictly falling within the definition of an employee share scheme under the Companies Act, under this scheme employees are given an entitlement to a benefit equal to value of the growth of the company’s shares at various points in time. Under this option, no shares are transferred to the employee but rather a cash amount equal to the growth of the shares is paid to the employee. To the extent that the shares may be issued rather than cash, the provisions of the Companies Act in relation to employee share schemes will apply.

Can shares in a foreign parent company be issued to employees in South Africa?

The Companies Act includes shares issued by foreign parent companies in the definition of employee share schemes. Accordingly, participation by South African resident employees in a foreign based employee share scheme is permissible subject to certain South African exchange control restrictions.

Does the company need to make any filings/applications?

In addition to any further requirements set out in the constitutional documents of the company:

  • a company must appoint a compliance officer to ensure the administration of the scheme. The compliance officer is not required to be based in South Africa; however, the compliance officer is responsible for the following:
    • administration of the scheme;
    • ensuring that the company states, in its annual financial statements, the number of shares that it has allotted during that financial year under the scheme;
    • providing written statements to any employee that receives an award setting out:
  • full particulars of the nature of the transaction, including the risks associated with it;
  • information relating to the company, including its latest annual financial statements, the general nature of its business and its profit history over the last three years;
  • full particulars of any material changes, if any, that occur in respect of any information provided in terms of the above two requirements;
    • ensuring that copies of the documents containing the information referred to above are filed with the Companies and Intellectual Property Commission (“CIPC”) within 20 business days after the employee scheme has been established; and
    • file a certificate with the CIPC within 60 business days after the end of each financial year, certifying that the compliance officer complied with his or her obligations during the past financial year.

To the extent that the shares are being offered in an offshore company, the company will be required to notify the South African Reserve Bank of the scheme by way of lodging a copy of the scheme documents. The individual employees will be required to apply for exchange control approval to participate in the offshore scheme, subject at all times to the individual foreign capital allowances contained in the exchange control guidelines.

Are there any tax, social security or other liabilities?

There should be no income or social taxes which arise on the award of the shares to employees under a scheme. Ordinarily, the disposal of shares will result in capital gains tax, however, the Income Tax Act 58 of 1962 (“ITA”) provides at section 8B and 8C for different tax consequences in relation to employee share schemes.

Section 8C of the ITA provides for shares acquired by virtue of a person’s employment to be dealt with as income, taxable at a higher rate than that of the capital gains rate, at the time the shares are vested or realised (not at the time of granting the shares). A company shall be obliged to withhold the employee’s tax as Pay As You Earn (PAYE). Examples of this type of structure include the issuing of shares, equities, rights determined with reference to the shares (i.e. unit-based plans) or share option schemes.

To incentive the use of broad-based share schemes, section 8B of the ITA was introduced. Should a share scheme meet the requirements of section 8B, being that the shares are equity shares, available for acquisition by 80% of employees, which confer all dividend and voting rights to the holders of the shares and where the shares are held for at least 5 years, upon disposal of the shares, the gain will be taxed as a capital gain (not income).

Where the employee share scheme is taxed as income, the company is obliged to withhold the relevant taxes and will need to submit an application to the South African Revenue Service (“SARS”) to obtain a directive on the amount to be withheld. The employee will be required to indicate that he/she has been granted an award in his/her annual tax return.

In terms of social taxes, the company is liable for the following amounts:

  • a skills development levy at a rate of 1% of the gain, which must be remitted, together with the income tax withholdings, to the SARS on the 7th day of the month following the month in which the relevant gain vests; and
  • unemployment insurance fund on the gain realised by the relevant employee. The contribution will amount to 1% of the gain, but only to the extent that the gain added to the employee’s other “remuneration” does not exceed the UIF ceiling (currently ZAR178 464 per year). Such amount must also be remitted to SARS on the 7th day of the month following the month in which the relevant gain vests.

Do the local scheme documents need to be translated to be legally enforceable?

No, the rules of the scheme will not need to be translated if they are provided to the employees in plain language that the employees can understand.

Other considerations?

Certain provisions of the Protection of Personal Information Act, 2013 (POPI) have recently come into effect which regulate the collection, processing and storage of personal information. Companies utilising employee share schemes will be required to adhere to these principles when administering the scheme, especially to process and transfer any personal information of the employee.