On January 24 2018 the South African Revenue Service (SARS) published Binding Private Ruling 290, which deals with the application of Paragraph 38(1) of the Eighth Schedule to the Income Tax Act (58/1962) to the distribution of shares by a trust to certain beneficiaries in the context of an employee share scheme.
The applicant, a local trust, held shares in a certain special purpose vehicle (SPV), which was a local company. The SPV in turn held certain shares in a locally listed company (ListCo).
As part of a scheme to facilitate the participation of historically disadvantaged employees in owning shares in ListCo, the beneficiaries of the trust were employees of ListCo and its subsidiaries.
After the expiry of a certain lock-up period and the repayment of the acquisition funding, the SPV distributed shares in ListCo to the trust. Under the scheme, the trust had to distribute the ListCo shares to the beneficiaries on certain vesting dates. It appears to have been accepted that, on the trust's distribution of the ListCo shares to the beneficiaries, their market value would be included in the beneficiaries' income under Section 8C of the act.
Without providing any specific details about the nature of the trust and the rights of the beneficiaries in respect of its income, assets or gains, the trust appears to have been concerned about the possible application of Paragraph 38(1) of the Eighth Schedule to the act to the distribution of the ListCo shares to the beneficiaries.
Paragraph 38 of the Eighth Schedule to the act applies to disposals:
- which are made by way of a donation;
- which are made between connected persons and do not reflect an arm's-length price; and
- where the consideration is not measurable financially.
Essentially, Paragraph 38 deems the proceeds on disposal in these circumstances to be equal to the market value of the asset.
Under general principles, and specifically under Paragraph 11(1)(d) of the Eighth Schedule, a trust's vesting of an asset in a beneficiary constitutes a disposal. Further, trusts and their beneficiaries are 'connected persons' under the definition provided in Section 1 of the act. It is therefore possible, in principle, for Paragraph 38 to apply where assets are distributed by a trust to its beneficiaries.
In this ruling, SARS unequivocally stated that Paragraph 38(1) was not applicable to the trust's distribution of shares to its beneficiaries.
However, this matter is complicated by the interaction between Section 8C of the act and the rules contained in the Eighth Schedule (specifically Paragraph 80). In recent years, a number of changes have been made to the act in order to provide for the interaction between Section 8C and the capital gains tax rules in the context of employee share schemes.
Companies wanting to set up employee share schemes should seek expert advice in order to reduce the risk of incurring taxes at multiple levels of the structure.
For further information on this topic please contact Heinrich Louw or Louise Kotze at Cliffe Dekker Hofmeyr by telephone (+27 115 621 000) or email ([email protected] or [email protected]). The Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.
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