Companies issue stock options (also called share options) to key employees in order to attract and retain talent.
A stock option is different from a share – a stock option is the right to acquire a share at a specific date in the future at a set price.
For example, when John joins Company A, he is granted 5000 stock options at a price of R55 per stock option. Assume that Company A’s share price rises to R75, he will make a profit of R20 per option when he is allowed to ‘exercise’ them.
Most schemes prescribe that stock options ‘vest’ in tranches to incentivise employees over a period of time (usually 3-5 years). Employees are legally entitled to exercise the options and purchase the shares only when they vest. Should employees leave the company before the end of a vesting period, they will lose the options which have not yet vested.
Following on from our example, let’s assume that John’s stock options vest at 20% per year over 5 years i.e., 1000 options vest per year. Should John leave Company A after three years, 3000 of his stock options would have vested, but he will lose or forfeit the remaining 2000 options. We say that John’s options are ‘restricted’. This means he is not free to exercise and purchase them when he chooses. Instead, there is a ‘lock-in’ period (i.e., 5 years) and he needs to adhere to the conditions of the vesting schedule set out in the share option contract.
What many employees (and employers!) don’t realise is that stock options carry a significant tax burden, particularly if there are restrictions attached to them, just like in John’s case. The Tax Act treats the gain on stock options, in exactly the same way as a bonus you would receive from your employer i.e., it is added to the rest of your income and taxed according to the normal tax tables for individuals.
Read on for our FAQ on the taxing of stock options:
1. I received stock options from my employer – when will they be taxed?
The stock options will be taxed when they vest, which is the time that you are legally entitled to exercise the options and purchase the shares.
This amount is the profit/gain on the employee share options which you have exercised. Your employer would have had to apply for a tax directive from SARS to find out how much tax to withhold on your options. The tax directive will indicate how much tax (PAYE) your employer needs to withhold. The PAYE on your IRP5 (source code 4102) should include the tax on share options; the relevant tax directive number should reflect on it too.
3. How is the amount next to source code 3707 calculated?
You will be taxed on the gain you make on the share options. This can be worked out by taking the market value of the shares at vesting date less the cost of the share options (i.e. what you paid for them).
4. Are share options taxed as capital gains or are they included in normal income?
If you were granted share options from your employer, these fall into s8C of the Income tax Act which prescribes that the gain on these options fall into normal taxable income. The gain is the amount by which the market value (when they vest) exceeds the cost of the options. Therefore, the gain on the share options is taxed as normal income (not capital gains) when they vest.
5. I received 10 000 share options from my company 8 years ago at a cost of R3 per option. They vested 3 years ago when the market value was R4.50 per share and I paid some tax. I am now planning on selling my shares (current market value R6 per share) – do I pay tax again?
Yes, unfortunately you would need to pay more tax. The tax payable would be on the profit you made since vest date, which is effectively, the increase in market value of the shares from vesting date until now.
Because your share options have already vested, the tax treatment on the gain is treated as a capital gain. The profit on your share sale would be included in your income and taxed as a capital gain. (This is different to the tax treatment of the gain on vest date which falls into s8C and is taxed as normal income).
The capital gain is calculated as follows: 10 000 X (R6-R4.50) = R15 000
The R40 000 annual exclusion would be applied to this capital gain. Assuming you have no other capital gains for the year, total capital gains tax payable would be nil.
6.I exercised share options during the year and these are included on my IRP5 which I submitted to SARS. I have filed my tax return and owe money to SARS. Could it be related to the share options?
Yes, in the absence of anything else obvious, it is very likely that your tax debt is due to too little tax being paid on your share options. Your employer would have requested a tax directive from SARS for your share options. SARS would have calculated the PAYE for your employer to withhold based on your remuneration. However, if you earned other income in the year (e.g. rental or sole proprietor income) the tax rate that SARS applied to your share options may end up being be too low, based on your total annual taxable income – this would mean that you would have to pay in tax on assessment.
7. How do I treat the loss that I made on the vesting of my employee share options?
You can deduct this loss from your taxable income. There is a special field in the ‘Other Deductions’ section of your tax return for 8C losses (source code 4031) – you would include the amount here. You would need to be able to provide the relevant proof/calculation to SARS of the loss you made.