IFRS 2 Taxes and share-based payments best studies

IFRS 2 Taxes and share-based payments best studies – In some countries, a share-based payment arrangement may be subject to a tax payment related either to the employee’s own tax obligations or to employee-based taxes levied on the employer. The tax is often based on the difference between the share price and the exercise price, measured at the exercise date.

Alternatively, the tax may be calculated based on the grant-date fair value of the grant.

Tax payments when employee has primary liability

In many cases, the tax obligation is a liability of the employee and not the employer, although the employer may have an obligation to collect it or withhold it.

If the employer has an obligation to collect or withhold employee taxes, then the employer is either acting as an agent for the tax authorities by collecting the taxesIFRS 2 Taxes and share-based payments best studies or acting as an agent for the employee by paying the tax authorities on the employee’s behalf.

In some cases, the tax obligation is a liability of the employee and not the employer, although the employer may be obliged to collect or withhold the tax payable by the employee and transfer it to the tax authority.

This type of transaction is classified as equity-settled in its entirety if the entire share-based payment would otherwise be classified as equity-settled without the net settlement feature. This may be referred to as ‘an exception’ to the general requirements in IFRS 2.

The amount that the entity is obliged to withhold under tax laws or regulations does not need to be a fixed amount but does need to reflect the employee’s tax obligation related to the share-based payment. Any amounts withheld in excess of the employee’s tax obligation associated with the share-based payment should be accounted for as cash-settled. (IFRS 2 33E-33H)

The employer may pay employees an amount of cash to cover social taxes and/or income taxes related to a share-based payment in addition to the share-based payment arrangement. In our view, if the cash payment is not based on the price (or value) of the entity’s shares, then this portion of the plan should be treated as an employee benefit under IAS 19.

If the cash payment is based on the value of the entity’s shares, then it may be appropriate to treat this portion of the plan as a cash-settled share-based payment transaction

Grant of share options with additional payment to cover employee’s income taxes

On 1 January Year 1, Company B grants one share option each to 100 employees, subject to a two-year service condition. The share options will be exercisable at any date in Year 3.

The employees will be subject to income taxes at 20% of the intrinsic value of the options based on the difference between the exercise price and the then-current share price, at the date of exercise. All employees are expected to and ultimately do stay in service with B. The share price increases and all employees exercise the share options on the last day in Year 3.

In addition to the grant of share options, B grants a payment to the employees to cover the employees’ income tax that results from the exercise of the share options. B’s decision to compensate the employees for the income tax consequences to them of the share-based payment is an additional benefit that B recognises as the services are provided.

B is not required to withhold amounts for the tax liability from the employees.

B accounts for the grant of share options as an equity-settled share-based payment transaction and for payment for the employees’ income tax as a cash-settled share-based payment.

The value per share option is as follows.

Fair value

Intrinsic value

1 January 20×1

20

31 December 20×1

15

4

31 December 20×2

12

8

31 December 20×3

10

10

Because the additional 20% payment is accounted for as a cash-settled share-based payment transaction (i.e. the employee services received are measured initially based on the grant-date fair value of the share options, and then at each reporting date, and ultimately at settlement date, the fair value of the recognised liability is remeasured), the expenses over time are as follows.

End of

Instruments for which it is expected that the service condition will be satisfied

Current fair value at end

Expected total tax expense (instruments x fair value x 0.2)

Cumulative tax expense at the end of period

Tax expense in current period

20×1

100

15

300

1501

150

20×2

100

12

240

2402

90

20×3

100

10

200

200

-40

Totals

200

Assume that B’s share-based payment expense is not deductible for tax purposes1 and that all of the share options are exercised on 31 December Year 3. In addition, the tax payment due to the tax authority is required to be paid after the options have been exercised. B accounts for the transactions as follows.

IFRS 2 Taxes and share-based payments best studies IFRS 2 Taxes and share-based payments best studies

Debit

Credit

31 December 20×1 IFRS 2 Taxes and share-based payments best studies

Expenses IFRS 2 Taxes and share-based payments best studies

1,0003

Equity IFRS 2 Taxes and share-based payments best studies

1,000

To recognise share-based payment expense in 20×1 IFRS 2 Taxes and share-based payments best studies

Expenses IFRS 2 Taxes and share-based payments best studies

150

Liability for employees’ income tax IFRS 2 Taxes and share-based payments best studies

150

To recognise associated payroll tax for share-based payments in 20×1 IFRS 2 Taxes and share-based payments best studies

31 December 20×2 IFRS 2 Taxes and share-based payments best studies

Expenses IFRS 2 Taxes and share-based payments best studies

1,000

Equity IFRS 2 Taxes and share-based payments best studies

1,000

To recognise share-based payment expense in 20×2 IFRS 2 Taxes and share-based payments best studies

Expenses IFRS 2 Taxes and share-based payments best studies

90

Liability for employees’ income tax IFRS 2 Taxes and share-based payments best studies

90

To recognise associated payroll tax for share-based payments in 20×2 IFRS 2 Taxes and share-based payments best studies

31 December 20×3 IFRS 2 Taxes and share-based payments best studies

Liability for employees’ income tax IFRS 2 Taxes and share-based payments best studies

Expenses IFRS 2 Taxes and share-based payments best studies

To recognise remeasurement of payroll tax associated with share-based payments IFRS 2 Taxes and share-based payments best studies

Cash IFRS 2 Taxes and share-based payments best studies

2,0004

Equity IFRS 2 Taxes and share-based payments best studies

2,000

Liability for employees’ income tax 5

200

Payable to tax authority IFRS 2 Taxes and share-based payments best studies

200

To recognise exercise of options and liability to tax authority IFRS 2 Taxes and share-based payments best studies IFRS 2 Taxes and share-based payments best studies

This example illustrates that the tax liability is measured based on the fair value of the options during the vesting period, although the future payment will be based on the intrinsic value of the options. (IFRS 2 33)

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Tax payments when employer has primary liability

In some jurisdictions, the employer rather than the employee may have the legal obligation to pay taxes on employee awards. If the employer is the obligor for the tax, then the emploStaff retraining as a result of changes in the income tax systemyer recognises the cost and liability. In our view, an entity should choose an accounting policy, to be applied consistently, to treat the employer’s obligation to pay the taxes either under IFRS 2 or as a provision in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. IFRS 2 Taxes and share-based payments best studies

Treatment as a provision would be appropriate if the obligation is of uncertain timing or amount, because this tax is not an income tax and therefore is not in the scope of IAS 12 Income Taxes.

The other alternative is to account for the tax obligation according to IFRS 2. Under this alternative, if the amount of the tax is based on the price (or value) of the equity instruments of the entity, then it should be accounted for as a cash-settled share-based payment. However, if the amount is not based on the value of an equity instrument, then it may be appropriate to consider the tax as an incidental expense associated with granting the share-based payment; the objective of IFRS 2 notes that the standard addresses share-based payments including associated expenses.

The following example illustrates the treatment as a cash-settled share-based payment. IFRS 2 Taxes and share-based payments best studies

Tax payments with employer being obligor

On 1 January Year 1, Company C grants one share option each to 100 employees, subject to a two-year service condition. The share options will be exercisable at any date in Year 3.

C will pay payroll taxes at 20% of the intrinsic value of the options at the date of exercise. All employees are expected to and ultimately do stay in service with C. The share price increases and all of the employees exercise the share options on the last day in Year 3.

The accounting treatment for the payment of the payroll taxes is the same as the accounting in ‘Grant of share options with additional payment to cover employee’s income taxes’ above – i.e. the fair value of the liability is estimated at grant date, spread over the vesting period and remeasured at each reporting date until settlement.

Consistent with the accounting for cash-settled share-based payments, the measurement is based on the fair value of the options, although the payment is based on the intrinsic value of the share options.

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The employer may be able to require the employee to reimburse the employer for tax paid by the employer. If the employer elects to collect the tax from the employee, then this agreement with the employee may be accounted for as a reimbursement right under IAS 37.

Alternatively, the recovery can be treated as an adjustment to the exercise price because from the entity’s perspective it is a cash inflow from the employee, assuming that it is conditional on exercise of the share-based payment. If the recovery is treated as an additional exercise price, then the estimation of the actual exercise price would affect the determination of the grant-date fair value.

Differences between the estimated and the actual exercise price would not be ‘trued up’ (adjusted). If the reimbursement approach is taken, then the estimated recovery would be trued up to the actual amount recovered.

The accounting policy choice regarding the treatment of the reimbursement right is independent of the accounting policy choice regarding accounting for the employer’s obligation.

The following examples illustrate the treatments described above.

Reimbursement right for tax payments treated as adjustment to exercise price

The facts are the same as in ‘Grant of share options with additional payment to cover employee’s income taxes’ and ‘Tax payments with employer being obligor’ above, but thIAS 12 Income taxes Corporate taxese employer has a legal right (either from the arrangement or by law) to require reimbursement for the tax payment from the employee on exercise date and chooses to do so.

C elects to treat the reimbursement right as an additional exercise price in the underlying share-based payment transaction with the employee – i.e. the share option grant.

The additional exercise price reduces the grant-date fair value of the equity instruments granted. For example, the fair value of the share options before the adjustment at grant date is 20 (see Grant of share options with additional payment to cover employee’s income taxes’). The grant-date fair value of the tax reimbursement would be 4 (20% of 20). Taking the additional exercise price into account, the adjusted grant-date fair value would be 16 (20 – 4) – i.e. the expenses recognised under the share-based payment transaction are reduced.

Assume that C’s share-based payment expense is not deductible for tax purposes1 and that all of the share options are exercised as at 31 December Year 3. C accounts for the transactions as follows.

Debit

Credit

31 December 20×1

Expenses

8006

Equity

800

To recognise share-based payment expense in 20×1

31 December 20×2

Expenses

800

Equity

800

To recognise share-based payment expense in 20×2

31 December 20×3

Cash

2,2007

Equity

2,200

Expenses

200

Payable to the tax authority 8

200

To recognise exercise of options, liability to tax authority and reimbursement from employees

This example assumes that the timing of the recognition of the reimbursement from employees coincides with that of the related tax effects. Therefore, no deferred income tax has been recognised in connection with the reimbursement.

The actual reimbursement received from the employee is recognised as the consideration for the issue of the share, like a normal exercise price: debit cash and credit equity.

If the intrinsic value at the date of exercise equals the grant-date fair value – i.e. it actually is 20 – then the reduced expenses for the equity-settled share-based payment of 4 and the expenses for the tax payment of 4 (20% of 20) result in a net effect on profit or loss of zero.

If, as is likely, the intrinsic value subsequently differs from 20, then these changes are not considered in the accounting for the share-based payment – i.e. there is no true-up – but the share-based payment expense related to the employee’s tax liability will be adjusted when the options are exercised.

For example, if the actual intrinsic value at date of exercise is 25, then 5 is the reimbursement to be received and credited to equity. In this case, the net effect on profit or loss would be an expense of 1 – i.e. a fixed reduction in share-based payment expense of 4 and variable tax cost of 5.

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Reimbursement right for tax payments treated as a reimbursement right under IAS 37

The facts are the same as in ‘Reimbursement right for tax payments treated as adjustment to exercise price’ above, but C elects to treat its right to recover tax as a reimbursement right under IAS 37.

The amount of income recognised will be equal to the actual payment. Together with the expenses recognised for the tax payment under the cash-settled share-based payment transaction or under the provision in accordance with IAS 37, the total net effect on profit or loss of the payment to the tax authorities and the tax reimbursement from the employee is zero.

There is no effect on the accounting for the share-based payment.

IFRS 2 Taxes and share-based payments best studies

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