Employees Share Option Schemes – Tanzanian Case
1. Defining Employees Share Option Schemes
A share option is the right to buy a certain number of shares at a fixed price, sometime in the future, within a company that is usually granted to employees of that company. This right enables employees to buy a certain number of shares at a fixed price, sometime in the future within the company. Generally, an employee is given share options in which he has rights over certain aspects of the share, in thresholds exercisable by the employee over certain periods as would be arranged by the employer’s scheme. When an employee exercises his options, it’s at the price fixed at the date of grant, i.e. when the options were given to the employee, regardless of the prevailing market price. This however shall not apply to a listed company whose prices of course, depend and are influenced according to the fluctuations of share prices at the Dar es Salaam Stock Exchange (DSE).
2. Advantages of employees share option schemes
• Remunerate employees in a tax efficient way
• Compensate for lower salaries and relieve pressure on cash flow
• Increase loyalties and reduce staff return
• Recount and retain key employees.
The first step in choosing a suitable share scheme is to decide on your objectives for introducing such a scheme such as to:-
• attract staff
• offer an incentive to retain staff across the business
• provide targeted incentives to selected employees
• conserve cash and reduce the cost of pay and/or bonuses
3. Setting up an employees share option scheme
Normally, the employer (founder or settlor) together with selected trustees create a trust under the Trustees Incorporation Act, Cap 318 R.E 2002. The trust then acquires company’s shares. The employees become the beneficiaries of the trust and the shares are held by the Trust of which the beneficial rights to the employees shall be either; the options and shares (after some time) or mere share options and after some time the shares revert back to the company. In either case, the dividends from the shares are distributed to the employees by the trust according to set options exercisable by each particular employee. The employer may decide the manner the shares are treated. For example, the shares can be redeemable, that is, they can be returned back to the company after a certain period of time and after exhaustion of rights to exercise share options. The company can setup how the employees can be eligible to join the trust and how the funds will be distributed.
4. Applicable Documentation
In setting up share option schemes employers should always satisfy themselves as regards the internal mandate to formulate such schemes. In the premise the following documents are needed:-
(a) Employer’s internal resolutions for establishment of share scheme
(b) Trust Deed and Rules
(c) Share options certificates for employees
5. Trust Obligations under the Law
In law, a Trust is a person like any other person and being an entity conducting activities it is thus regulated by law. A Trust holding shares for the benefit of employees has obligations that make the Trust liable to various accounting and notifications to regulatory bodies. Duties of the Trust include;-
(a) to the office of Administrator General of reporting in terms of Returns of the activities of the Trust
(b) Filing Tax Returns
(c) Paying Tax
6. Liability to account to the Administrator General
These are mere liabilities for accounting of the Trust Business. There are minimal fees for the record and update of the Trust existence with the Administrator General. The Trust is supposed to file annual returns with specified prescribed fee. Likewise, whenever there is a change that affects the information about the Trust, such as Change of Trustees, or change of office address of Trust, such change must be communicated to the Administrator General and registered.
7. Tax Liability to Trusts and their works
In the Income Tax Act, Cap 322 Trusts are provided for under Section 52. The Act specifically states that Trusts are taxable separately from their beneficiaries. Which means that the income of the Trust is taxable. Section 52(1) of the Act states that; “….A trust or unit trust shall be liable to tax separately from its beneficiaries and a separate calculations of total income shall be made for separate trusts regardless of whether they have the same trustees.” But in our opinion, for there being no income that the Trust is receiving in its own person, a Trust formed for purposes of carrying on employees share scheme shall not pay income. The Trust becomes more or less a conduit pipe for benefits to be enjoyed by employees. However, this shall not waive? The Trust’s duty to file returns despite there being no liability to declare.
7.1. Tax on Dividends (currently 5%)
This kind of tax is not a duty of the Trust to declare or pay since dividend tax is a final withholding tax and the one issuing the dividends is the one liable to withhold such tax. Hence the Company is liable to pay that tax by withholding the 5% of the dividends before it releases the dividends to the Trust.
7.2. Distributions to employees
S. 52 (2) of the Income Tax Act read together with section 3(c) (i) and S. 7 (3) (a) suggest that distributions made by the Trust are not subject to tax. The test here is the connection of such distribution with the employment of the employee to the company and as regards to distributions there is none.
7.3. Authority’s views towards taxing distributions
The Tanzania Revenue Authority (TRA) has been strictly keen to treat distributions from the Trusts as income from employment in the hands of the employee and hence subject the same to PAYE system. It is characteristic, for a taxing authority to try and broaden the tax base and hence, the TRA has been trying to see the schemes as a tax avoidance method by entities. The TRA has thus been treating such distributions as employment income of employees under the employees share option schemes as income from employment. In any case the laws as stated in 7.2 above provide a different picture and subject the application by the TRA into ambiguity and confusing state.