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Tax Benefits of Employee Share Ownership Plan (ESOP)

CM Advocates > Legal News  > Tax Benefits of Employee Share Ownership Plan (ESOP)

Tax Benefits of Employee Share Ownership Plan (ESOP)

Tax Benefits of Employee Share Ownership Plan (ESOP)

An ESOP is an employee stock/ share ownership plan. An ESOP grants company stock to employees, often based on the cadre and duration of their employment. Typically, it is part of a compensation package giving them a stake in the company through equity participation. It affords them an opportunity to participate in the ownership and decision making of their company.

Thus, it is safe to say that ESOPs are designed so that employees’ motivations and interests are aligned with those of the company’s shareholders. These shares vest over a period of time and if the company succeeds and the value of the shares increase, the employees gain from their own efforts. Upon exit from the Company, the Employee sells their share at a profit.

ESOPs are often taxed as benefit from employment. Tax can arise at 3 stages:

  1. At Pre-Vesting (Grant) Stage
  2. At Vesting Stage
  3. At Post-Vesting Stage

Pre Vesting Stage (Grant Stage)

At the Grant Stage, no value is pegged to the shares. An option is given to an eligible employee to exercise in the future i.e. upon vesting. As such, during this stage no taxes are triggered on the eligible employees.

Vesting Stage

At the vesting Stage, the employee makes a decision as to whether to exercise the option granted or not. As per the provisions of the Income Tax Act if the employee opts to exercise the option, this creates a benefit, similar to any other employment benefit.

The taxing of this benefit at the point of vesting is generally governed by Section 5(5) and (6) of the Income Tax Act (ITA). Section 5 provides for the benefit whilst Sub-Section 6 provides for valuation. As per Section 5(5) of the ITA the value of the benefit will be the difference between the market price per share and the offer price per share at the date an option is granted.

Section 5(6) on the other hand provides that for the benefit to be chargeable to tax, the ESOP has to be registered with the Commissioner General of the Kenya Revenue Authority (KRA) as a Collective Investment Scheme (CIS).

Recent developments have however emerged where the Finance Act 2022 has amended Section 5(5)(a) and Section 5(6)(a) of the Income Tax Act which provides for taxation of benefits accruing to an employee from a registered Employee Share Ownership Scheme(ESOP). Currently, Section 5(5)(a) of the Income Tax Act provides that the value of the benefit accruing to an employee from an ESOP registered with KRA shall be the difference between the market value, per share, and the offer price, per share, at the date the option is granted by the employer. The actproposes to determine the value of a benefit accruing from an ESOP as the difference between the offer price per share at the date the option is granted by the employer, and the market value per share on the date the employee exercises the option.

Further, the act to amended Section 5(6)(a) of the Income Tax Act which currently provides that the benefits chargeable to tax under a registered ESOP shall be deemed to have accrued to the employee at the end of the vesting period. The Finance Act 2022 amended this to provide that the benefits chargeable shall be deemed to have accrued on the date the employee exercises the option.

Post Vesting Stage

Post vesting of the shares, the employee would become an investor in the company like any other shareholder. Any distributions made on account of the units in the trust constitute dividends from the shares of the company are taxed at 5% (withholding tax).

On future disposal/redemption of the units, any gains made will be subjected to capital gains tax, unless the shares are listed on the Nairobi Stock Exchange in which case the gain realized will be exempt from tax.

How can we assist

At CM Advocates LLP, we have a team of experienced tax lawyers that offer tax law advisory and tax dispute resolution services. For more information, you can go to our website law@cmadvocates.com or email us at taxteam@cmadvocates.com

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Contact Persons & Contribuors

Jane Mugo- Partner & Head of Unit

Angela Ndolo-  Associate

Disclaimer

This article is for informational purposes only and should not be construed as legal advice.

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