Employee share schemes are often introduced to reward, retain, or align employees with long-term business growth. However, under section 8C of the Income Tax Act 58 of 1962 (the “Income Tax Act”), these arrangements can create significant and unexpected tax liabilities for employees when equity instruments vest. This article explains how section 8C operates, what qualifies as an “equity instrument,” and why careful structuring of share schemes is essential to avoid punitive tax outcomes.

There are numerous reasons why employers may choose to offer shares to their employees. Employee share schemes are powerful tools for growth and continuity and can be used for several purposes, ranging from succession planning and long-term value alignment to rewarding key talent or retaining top performers. By giving employees shares in the company, employers aim to foster loyalty, incentivise performance, and ensure stability during key transitions.

However, despite these well-meaning intentions, transferring or issuing shares to employees can trigger significant tax consequences, primarily for the employee. What may seem like a generous reward or strategic move can result in unexpected and sometimes burdensome tax liabilities. This is where Section 8C of the Income Tax Act becomes highly relevant.

In essence, section 8C of the Income Tax Act applies where there is a vesting of an equity instrument (such as shares, options, or similar rights) which was acquired by the taxpayer by virtue of their employment.

The term “equity instrument” under section 8C is broadly defined, capturing far more than just ordinary shares in a company. This wide definition is deliberate and ensures that a variety of employee-related share-based arrangements fall within the scope of the provision.

An equity instrument includes, without limitation:

• shares in a company;
• an option to acquire shares; 
• any financial instrument that is convertible to a share; and
• any contractual right or obligation the value of which is determined directly or indirectly with reference to a share.

The last category is particularly important because it potentially includes phantom share schemes, which are arrangements where no actual shares are transferred, but the employee is compensated based on the value or performance of shares. Even though no ownership is involved, the value being derived from the company’s share performance is enough to bring it within the ambit of section 8C of the Income Tax Act.

The concept of vesting is central to how this provision operates. A gain is not taxed when the instrument is granted or acquired, but rather when it vests, meaning when the employee becomes unconditionally entitled to the equity instrument, free of any restrictions that could result in forfeiture.

At the point of vesting, the difference between –

• the market value of the instrument on the vesting date, and
• the amount paid (if any) by the employee to acquire it is included in the employee’s gross income and taxed at their marginal tax rate, not the capital gains tax rate.

This can create a significant and unexpected tax liability, particularly where the employee has not received any cash to fund the tax, or where the market value of the shares has increased substantially by the time of vesting.

While the decision to introduce employees as shareholders is usually made with the best intentions, it can lead to serious and unexpected tax consequences if not carefully managed. What starts as a strategic or generous move may end up creating a significant tax burden for the employee, particularly when the structure is flawed or vesting events are poorly timed. To avoid these pitfalls, it’s essential to design employee share schemes with expert guidance. With proper structuring, whether by aligning vesting with liquidity events or providing funding mechanisms for tax, employers can achieve their objectives while protecting employees from unintended tax burdens.

For assistance with structuring your employee share scheme, talk to the tax experts in our Tax Advisory Team.