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BASIS FOR CONCLUSIONS ON IFRS 2 CONSEQUENTIAL AMENDMENTS TO OTHER STANDARDS

BASIS FOR CONCLUSIONS ON IFRS 2 CONSEQUENTIAL AMENDMENTS TO OTHER STANDARDS

BASIS FOR CONCLUSIONS ON IFRS 2 CONSEQUENTIAL AMENDMENTS TO OTHER STANDARDS

Tax effects of share-based payment transactions

Whether expenses arising from share-based payment transactions are deductible, and if so, whether the amount of the tax deduction is the same as the reported expense and whether the tax deduction arises in the same accounting period, varies from country to country.

If the amount of the tax deduction is the same as the reported expense, but the tax deduction arises in a later accounting period, this will result in a deductible temporary difference under IAS 12 Income Taxes. Temporary differences usually arise from differences between the carrying amount of assets and liabilities and the amount attributed to those assets and liabilities for tax purposes. However, IAS 12 also deals with items that have a tax base but are not recognised as assets and liabilities in the balance sheet. It gives an example of research costs that are recognised as an expense in the financial statements in the period in which the costs are incurred, but are deductible for tax purposes in a later accounting period. The Standard states that the difference between the tax base of the research costs, being the amount that will be deductible in a future accounting period, and the carrying amount of nil is a deductible temporary difference that results in a deferred tax asset (IAS 12, paragraph 9).

Applying this guidance indicates that if an expense arising from a share-based payment transaction is recognised in the financial statements in one accounting period and is tax-deductible in a later accounting period, this should be accounted for as a deductible temporary difference under IAS 12. Under that Standard, a deferred tax asset is recognised for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be used (IAS 12, paragraph 24).

Whilst IAS 12 does not discuss reverse situations, the same logic applies. For example, suppose the entity is able to claim a tax deduction for the total transaction amount at the date of grant but the entity recognises an expense arising from that transaction over the vesting period. Applying the guidance in IAS 12 suggests that this should be accounted for as a taxable temporary difference, and hence a deferred tax liability should be recognised.

BASIS FOR CONCLUSIONS ON IFRS 2 CONSEQUENTIAL AMENDMENTS TO OTHER STANDARDS

However, the amount of the tax deduction might differ from the amount of the expense recognised in the financial statements. For example, the measurement basis applied for accounting purposes might not be the same as that used for tax purposes, eg intrinsic value might be used for tax purposes and fair value for accounting purposes. Similarly, the measurement date might differ. For example, US entities receive a tax deduction based on intrinsic value at the date of exercise in respect of some share options, whereas for accounting purposes an entity applying SFAS 123 would recognise an expense based on the option’s fair value, measured at the date of grant. There could also be other differences in the measurement method applied for accounting and tax purposes, eg differences in the treatment of forfeitures or different valuation methodologies applied.

SFAS 123 requires that, if the amount of the tax deduction exceeds the total expense recognised in the financial statements, the tax benefit for the excess deduction should be recognised as additional paid-in capital, ie as a direct credit to equity. Conversely, if the tax deduction is less than the total expense recognised for accounting purposes, the write-off of the related deferred tax asset in excess of the benefits of the tax deduction is recognised in the income statement, except to the extent that there is remaining additional paid-in capital from excess tax deductions from previous share-based payment transactions (SFAS 123, paragraph 44).

BASIS FOR CONCLUSIONS ON IFRS 2 CONSEQUENTIAL AMENDMENTS TO OTHER STANDARDS

At first sight, it may seem questionable to credit or debit directly to equity amounts that relate to differences between the amount of the tax deduction and the total recognised expense. The tax effects of any such differences would ordinarily flow through the income statement. However, some argue that the approach in SFAS 123 is appropriate if the reason for the difference between the amount of the tax deduction and the recognised expense is that a different measurement date is applied.

For example, suppose grant date measurement is used for accounting purposes and exercise date measurement is used for tax purposes. Under grant date measurement, any changes in the value of the equity instrument after grant date accrue to the employee (or other party) in their capacity as equity participants. Therefore, some argue that any tax effects arising from those valuation changes should be credited to equity (or debited to equity, if the value of the equity instrument declines).

BASIS FOR CONCLUSIONS ON IFRS 2 CONSEQUENTIAL AMENDMENTS TO OTHER STANDARDS

Similarly, some argue that the tax deduction arises from an equity transaction (the exercise of options), and hence the tax effects should be reported in equity.It can also be argued that this treatment is consistent with the requirement in IAS 12 to account for the tax effects of transactions or events in the same way as the entity accounts for those transactions or events themselves. If the tax deduction relates to both an income statement item and an equity item, the associated tax effects should be allocated between the income statement and equity.

Others disagree, arguing that the tax deduction relates to employee remuneration expense, ie an income statement item only, and therefore all of the tax effects of the deduction should be recognised in the income statement. The fact that the taxing authority applies a different method in measuring the amount of the tax deduction does not change this conclusion. A further argument is that this treatment is consistent with the Framework, because reporting amounts directly in equity would be inappropriate, given that the government is not an owner of the entity.

BASIS FOR CONCLUSIONS ON IFRS 2 CONSEQUENTIAL AMENDMENTS TO OTHER STANDARDS

The Board noted that, if one accepts that it might be appropriate to debit/credit to equity the tax effect of the difference between the amount of the tax deduction and the total recognised expense where that difference relates to changes in the value of equity interests, there could be other reasons why the amount of the tax deduction differs from the total recognised expense. For example, grant date measurement may be used for both tax and accounting purposes, but the valuation methodology used for tax purposes might produce a higher value than the methodology used for accounting purposes (eg the effects of early exercise might be ignored when valuing an option for tax purposes). The Board saw no reason why, in this situation, the excess tax benefits should be credited to equity.
In developing ED 2, the Board concluded that the tax effects of share-based payment transactions should be recognised in the income statement by being taken into account in the determination of tax expense. It agreed that this should be explained in the form of a worked example in a consequential amendment to IAS 12.

During the Board’s redeliberation of the proposals in ED 2, the Board reconsidered the points above, and concluded that the tax effects of an equity-settled share-based payment transaction should be allocated between the income statement and equity. The Board then considered how this allocation should be made and related issues, such as the measurement of the deferred tax asset.
Under IAS 12, the deferred tax asset for a deductible temporary difference is based on the amount the taxation authorities will permit as a deduction in future periods. Therefore, the Board concluded that the measurement of the deferred tax asset should be based on an estimate of the future tax deduction. If changes in the share price affect that future tax deduction, the estimate of the expected future tax deduction should be based on the current share price.

BASIS FOR CONCLUSIONS ON IFRS 2 CONSEQUENTIAL AMENDMENTS TO OTHER STANDARDS

These conclusions are consistent with the proposals in ED 2 concerning the measurement of the deferred tax asset. However, this approach differs from SFAS 123, which measures the deferred tax asset on the basis of the cumulative recognised expense. The Board rejected the SFAS 123 method of measuring the deferred tax asset because it is inconsistent with IAS 12. As noted above, under IAS 12, the deferred tax asset for a deductible temporary difference is based on the amount the taxation authorities will permit as a deduction in future periods. If a later measurement date is applied for tax purposes, it is very unlikely that the tax deduction will ever equal the cumulative expense, except by coincidence. For example, if share options are granted to employees, and the entity receives a tax deduction measured as the difference between the share price and the exercise price at the date of exercise, it is extremely unlikely that the tax deduction will ever equal the cumulative expense. By basing the measurement of the deferred tax asset on the cumulative expense, the SFAS 123 method is likely to result in the understatement or overstatement of the deferred tax asset. In some situations, such as when share options are significantly out of the money, SFAS 123 requires the entity to continue to recognise a deferred tax asset even when the possibility of the entity recovering that asset is remote. Continuing to recognise a deferred tax asset in this situation is not only inconsistent with IAS 12, it is inconsistent with the definition of an asset in the Framework, and the requirements of other IFRSs for the recognition and measurement of assets, including requirements to assess impairment.

BASIS FOR CONCLUSIONS ON IFRS 2 CONSEQUENTIAL AMENDMENTS TO OTHER STANDARDS

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