Chapter 6: Tax on share-based payment awards

Income tax accounting for share-based payment awards

IAS 12 provides guidance on where an item has a tax base (the amount that the tax authorities will permit as a deduction in future periods with respect to goods or services consumed to date) but is not recognised as an asset or liability in the entity’s balance sheet. For equity-settled awards under IFRS 2, employee services are expensed. Their carrying amount is, therefore, zero.

If the employer will be entitled to a tax deduction equal to the options’ intrinsic value (that is, the difference between the fair value of the share at exercise date and the exercise price) on the exercise date, an estimate of the value of the tax base at the end of each reporting period is determined by multiplying the options’ current intrinsic value by the proportion of the total vesting period that has elapsed.

The difference between the tax base of the employee services received to date and the carrying amount of zero is a temporary difference that results in a deferred tax asset, if the entity has sufficient future taxable profit against which the deferred tax asset can be utilised. The income tax accounting for awards exchanged in a business combination will differ between :-

(1) the portion included in the consideration transferred for the acquiree and

(2) the portion of the award for which the expense will be recognised in the post-combination financial statements.

A deferred tax asset is set up, based on the intrinsic value at the acquisition date for the portion of the replacement award included in consideration, subject to the deferred tax asset recognition criteria. The deferred tax asset will reduce the net assets acquired (for example, goodwill).

Any change in the intrinsic value of the award (and, therefore, the deferred tax asset) will be reflected, in the post-combination financial statements, through an adjustment to the deferred tax asset for the period in which the change arises. There is diversity in practice as to where the movement in the deferred tax asset is recognised.

There is no expense in the income statement, which suggests that the deferred tax movement should be reflected directly in equity in a manner similar to that used for deferred tax movements relating to a share-based payment that exceed the total share-based payment expense. One possible approach is for some or all of the movement to be presented in the income statement, because the amounts treated as purchase consideration represent benefits earned before the acquisition, that are analogous to book expenses.

The guidance is not specific; and so, given the diversity in practice, management should make a policy choice and apply it consistently. A deferred tax asset is recorded equal to the tax benefit related to the estimated future tax deduction. For the portion of the replacement award accounted for in the post-combination financial statements (as employee costs), this deferred tax asset is multiplied by the proportion of the total vesting period that has elapsed. Because none of the vesting period for this portion of the award has elapsed as of the acquisition date, no deferred tax asset is recorded at the acquisition date. The deferred tax asset balance is based on the tax benefit related to the estimated tax deduction at the end of each period (measured using the current share price).

 The following example illustrates the deferred tax guidance.

Example – Deferred tax accounting for a vested equity-settled option

Entity A (the acquirer) exchanges replacement awards with a fair value of C500 at the acquisition date for awards by entity B (the acquiree) with a fair value of C500 at the same date. Entity A was obliged to issue replacement awards under the terms of the acquisition agreement. When originally granted, entity B’s awards had a vesting period of four years. The replacement awards have the same terms as the original awards. The replacement awards are fully vested and require no further service. A tax deduction for the replacement awards will not arise until the options are exercised. The tax deduction will be based on the options’ intrinsic value at the exercise date.

The exercise price of the awards is C400. At the acquisition date, the market price of entity A’s shares is C600. The intrinsic value at the acquisition date is C200 (market price of entity A’s shares of C600 less the exercise price of C400). Entity A’s applicable tax rate is 40%. How are the replacement awards accounted for as part of the business combination? The entire C500 is included in the consideration transferred for the acquiree, because the replacement awards have no excess fair value, and no post combination service is required.

Entity A records a deferred tax asset equal to C80 (C200 intrinsic value × 40% tax rate) because, at the time of the acquisition, the awards are expected to result in a tax deduction based on intrinsic value. The deferred tax asset will be recorded by entity A as follows:

Dr Deferred tax assets 80

Cr Goodwill (as residual) 80

Any subsequent change in the intrinsic value (and, hence, the deferred tax asset) will be reflected in the post-combination financial statements. The deferred tax asset replaces the deferred tax asset that was recorded by entity B in its own financial statements before the business combination and before its awards were replaced.