The Treasury has once again proposed to tax share ownership plans (ESOPs) for start-up workers, a move that is likely to dampen the prospect of growth for these firms through attraction and retention of talent.
ESOP is an employee benefit plan that gives workers ownership interest in the company in the form of shares of stock. The scheme is used to encourage employees to give their all as the company’s success translates into financial rewards.
Through the Finance Bill 2025, the government wants to amend the Income Tax Act by scrapping the delayed taxation on cash benefits for start-up employees, which are converted into shares.
Currently, such shares are not taxed until either after five years, when they are disposed of, or when the worker leaves the eligible start-up.
This tax relief is offered under Section 8(1) of the Income Tax Act, shielding employees of start-ups from the taxes that are normally levied on the ESOPs.
This amendment was also contained in the Finance Bill 2024 that President William Ruto rejected following the violent youth-led protests due to what some termed as its many ‘punitive’ clauses.
The provision was introduced by the Finance Act 2023 to help startups to attract better talent.
“Where an employee is offered company shares in lieu of cash emoluments by an eligible start-up, the taxation of the benefit from the shares allocated to that person by virtue of employment shall be deferred and taxed within 30 days of the earlier of—… (a) the expiry of five years from the end of the year of the award of the shares,” reads part of the Income Tax Act.
The shares are also taxed at the time of disposal when the owner stops being an employee of the eligible start-up.
However, the draft Finance Bill 2025 proposes to do away with this provision, a move that is likely to deal a blow to start-ups.
ESOPs— a way of giving employees a stake in the company—is one of the strategies used to retain employees. The idea is that if the company does well, the employees also benefit because the value of their shares goes up.
Employees are first given the option to purchase shares in the company in the future. It is not until they take those shares that they are taxed.
The tax is now based on the difference between the price the company first offered the shares and the price the shares are worth when the employee takes them.
Once the employee has the shares, they are like any other shareholder and are expected to pay a withholding tax of five percent on the dividend they receive from the company’s profits.
And unless the shares are traded on the Nairobi Securities Exchange, they might also pay capital gains tax when they later sell their shares.
These changes also come at a time when start-ups in Kenya have been going through a rough patch, diminishing the vibrancy of the start-up culture.
In 2022, at least six Kenya-based start-ups closed shop due to several threats, including the lack of financing, pandemic woes, and a tough economic environment.
Most of the closures were on tech companies, hurting the country’s status as the Silicon Savanah, a version of America’s Silicon Valley that has given birth to such tech giants as Facebook, Twitter, and Uber.
