“But he isn’t wearing anything at all!”Hans Christian Andersen- The Emperor’s New Clothes
The remuneration committee of the Board has implemented what they claim is a ‘market-comparable’ incentive scheme for executives. So as a shareholder / participant in such a plan you should feel comfortable that such a plan is the best way to align management with shareholders. Maybe. But, the important thing to note is that there is really only one structure these days…
Tax has made them all equal
Equity instruments acquired by virtue of employment are governed by Section 8C of the Income Tax Act. The effect is that if the equity instrument (i.e. the option or share purchase) generates a gain, the taxpayer is required to include such gain in their personal income for the tax year in which the instrument vests in their name.
The taxable gain, included in the employee’s tax return, is calculated by subtracting it from the market value of the equity instrument at the time that it vests in the taxpayer’s name, from the sum of any consideration paid by the taxpayer in respect of the equity instrument.
What this means is that any gains are effectively diluted by 45%.
This damages their effectiveness as an incentive tool, and makes them a costly and inefficient mechanism, for the companies involved. Essentially, all of the gains accruing to employees from “restricted” equity instruments are now subject to income tax.
Types of equity-based reward strategies
There are various types of incentive schemes, with each strategy characterized by a specific mechanism for rewarding employees and calculating the gain (or loss) accrued to the employee.
Like the hidden 90% of an iceberg, the complexities of designing and implementing effective share incentives, can pose significant challenges to uninformed or unprepared company executives, boards and shareholders. Many CFOs implement a share incentive structure on their own. Whilst not beyond the technical competency of Chartered Accountants, the ramifications of a share incentive structure are often not considered by most CFO’s as they are not encountered during one’s career.
When determining which strategy to implement, consideration should also be given to the changing nature of the company, financial performance and the inevitable changes in workforce which need to be accommodated by such schemes. Finally, any transactions involving the equity of a company, such as a merger or sale, would bring such an incentive plan into play, and may form an important part in the negotiation process.
Addison Inc. is a professional service firm based in Sandton, South Africa. We provide insight, advice and direction to senior executives, shareholders of emerging and established companies and individuals. Our expertise covers corporate finance, share transactions, business development, strategy and governance matters including executive compensation, incentive structuring and succession plans. The firm is supported by a team of qualified professionals and associates. Our solutions are custom designed, with an emphasis on high-impact, value enhancing services that are clearly understood and supported by our clients.
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Addison Advisory Inc.
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