ACCA Advanced Taxation (ATX) Practice Exam

What happens to the dividends received from SIP shares if reinvested?

1. They become taxable income

2. They are tax-free

3. They are subject to a capital gains tax

4. They are subject to employee benefit tax

The correct answer is: They are tax-free

When dividends received from shares in a Share Incentive Plan (SIP) are reinvested, they are typically considered tax-free at the point of reinvestment. This is because SIP schemes are designed to encourage long-term holding of company shares by allowing employees to receive shares or acquire them at a discounted rate without immediate tax implications. In many jurisdictions, the reinvestment of dividends does not trigger immediate taxation, allowing employees to effectively accumulate value through further investment in the company's shares without an upfront tax burden. This treatment aligns with the government’s intent to promote employee share ownership and incentivize loyalty and investment in the company. Tax implications may arise later when the shares are sold or if there are other realizations of gain, at which point capital gains tax could be considered. However, the initial reinvestment of dividends does not result in taxable income under the rules governing SIPs, making tax-free status the correct choice in this scenario.