Common differences related to the accounting for income tax consequences of share-based payments.
From the IFRS Institute – December 3, 2021
Share-based payments (e.g. restricted stock, stock options and warrants) are often awarded to employees or suppliers as compensation for services received. The income tax benefit to the grantor may differ in timing and amount from the expense recognized in the financial statements, which may result in the recognition of deferred taxes. Despite similar objectives, the accounting for the income tax effects of share-based payments under IFRS Standards1 and US GAAP2 may differ. This article summarizes and illustrates some of the common differences.
In many tax jurisdictions, a company may receive a tax deduction for the share-based payment awards it grants; however, the tax deduction may differ in amount and/or timing from the cumulative share-based payment expense recognized in profit or loss.3
These differences arise because compensation cost is often measured at different dates and recognized at different times for financial reporting and income taxes purposes.
| Type of award | For financial reporting purposes | For income taxes purposes |
|---|---|---|
| Equity-settled awards (equity-classified awards under US GAAP) | — Measured based on fair value of award at grant date — Recognized over service or vesting period | — Often4 measured based on fair value of award at time of exercise or vesting — Often deducted at that time |
| Cash-settled awards (liability-classified awards under US GAAP) | — Remeasured each reporting period based on fair value of award — Recognized over period from service inception date to settlement date | — Often measured based on fair value of award at time of exercise or vesting — Often deducted at settlement date |
For a deeper dive into share-based payments accounting and the difference between equity- and cash-settled awards, see KPMG Handbooks, Share-based payments (IFRS Standards) and Share-based payments (US GAAP).
Under IFRS Standards and US GAAP, deferred taxes are generally recognized for temporary differences associated with assets and liabilities. However, for equity-classified awards, neither an asset nor a liability typically exists; accordingly, each accounting framework has developed its own approach for recognizing deferred taxes for share-based payment arrangements.
Additionally, the share-based payment standards have differing views as to whether part of a tax deduction related to a share-based payment award relates to an equity item for which the related income tax benefit should be allocated directly to equity.
While this article is not intended to cover all possible differences, we have summarized common differences in the accounting for income taxes associated with share-based payments under IFRS Standards and US GAAP. Let’s start with the two most fundamental ones dealing with the measurement of deferred taxes and the intraperiod tax allocation of the tax effects, followed by an example.
| IFRS Standards | US GAAP |
|---|---|
1. Measurement of deferred taxes | |
IFRS Standards include specific guidance about current and deferred tax arising from share-based payment transactions. Under this guidance, the difference between the amount the taxation authorities will permit as a deduction in future periods for services received to date (i.e. tax base) and the carrying amount of zero is a deductible temporary difference for which a deferred tax asset is recognized. The deferred tax asset is remeasured each period to capture any change in the expected tax deduction. In many jurisdictions, tax deductions are based on the company’s share price at the date when share options are exercised or share grants vest, and therefore measurement of the deferred tax asset is based on the company’s share price at the end of the period – or estimated based on information available if the share price is not known as of the end of the period. This essentially results in the deferred tax asset being adjusted each period. | Unlike IFRS Standards, US GAAP has a special rule for share-based payments, whereby the deductible temporary difference is the cumulative amount of compensation expense for instruments that ordinarily would result in a future tax deduction. As a result, the corresponding deferred tax is measured based on the amount of compensation expense recognized in profit or loss without any adjustment for the company's current share price. |
2. Intraperiod tax allocation of the tax effects | |
Under IFRS Standards, if the amount of the tax deduction (or estimated future tax deduction) exceeds the amount of the related cumulative share-based payment expense, this indicates that the tax deduction relates not only to remuneration expense but also to an equity item. Accordingly, the tax benefit is allocated:
If the tax deduction received (or expected to be received) is less than or equal to the cumulative compensation expense, all amounts are allocated to profit or loss.6 | Unlike IFRS Standards, under US GAAP, the tax effect of any excess is allocated to profit or loss in the period in which the amount of the tax deduction is determined. Like IFRS Standards, if the tax deduction is less than the cumulative compensation expense, all amounts are allocated to profit or loss. |
Example ABC Corp. grants options for 20,000 shares on January 1, Year 1, when the grant date fair value of the options is $15 per share. The options vest on December 31, Year 1, when the intrinsic value is $18 per share. ABC recognizes $300,000 of compensation expense in Year 1. All share options are exercised on December 31, Year 2, when the intrinsic value is $20 per share. In its tax jurisdiction, ABC receives a tax deduction related to the share-based payment when the options are exercised. The deductible amount is the option’s intrinsic value at the date of exercise. The tax rate is 25%. | |
Journal entries at December 31, Year 1 To record the deferred tax benefit related to the options. | |
IFRS Standards Dr. Deferred tax asset 90,000 [1] [1]ABC measures the future tax deduction based on the intrinsic value of $360,000 (20,000 shares x $18) and records a deferred tax asset of $90,000 ($360,000 intrinsic value x 25% tax rate). Because the future tax deduction of $360,000 exceeds the cumulative compensation expense of $300,000, a tax benefit is allocated to profit or loss only to the extent of the cumulative compensation expense of $75,000 ($300,000 compensation expense x 25%). The excess tax benefit of $15,000 [($360,000 – 300,000) x 25%)] is allocated to additional paid-in capital. | US GAAP Dr. Deferred tax asset 75,000 [2] [2]ABC records a deferred tax asset of $75,000 based on the cumulative compensation expense ($300,000 x 25% tax rate). The entire tax benefit is allocated to profit or loss. |
Journal entries at December 31, Year 2 To record the elimination of the deferred taxes previously recognized over the service period, and to record the current tax benefit from the exercise of the options. | |
IFRS Standards Dr. Deferred tax benefit 75,000 Dr. Current tax assets (liabilities) 100,000[3] [3]ABC measures the current tax deduction based on the intrinsic value of $400,000 ((20,000 shares x $20) and adjusts its current tax assets or liabilities by $100,000 ($400,000 x 25%). Because the tax deduction of $400,000 exceeds the cumulative compensation expense of $300,000, a current tax benefit is allocated to profit or loss only to the extent of the cumulative compensation expense of $75,000 ($300,000 x 25%). The excess tax benefit of $25,000 [($400,000 – 300,000) x 25%)] is allocated to additional paid-in capital. | US GAAP Dr. Deferred tax benefit 75,000 Dr. Current tax assets (liabilities) 100,000[4] [4]ABC measures the current tax deduction based on the intrinsic value of $400,000 and adjusts its current tax assets or liabilities by $100,000. Unlike IFRS Standards, the entire tax benefit is allocated to profit or loss. |
| IFRS Standards | US GAAP |
|---|---|
| 3. Measurement of deferred tax assets for cash-settled stock appreciation rights (SARs) | |
For a cash-settled share-based payment arrangement, where a tax deduction is received for the ultimate payment when it is made, in our view, a company should choose an accounting policy, to be applied consistently, for the temporary difference to reflect either:
Determining the temporary difference with reference to fair value would be consistent with general practice for calculating deferred tax on revalued items. Conversely, the guidance in IAS 12 refers explicitly to intrinsic value in the case of equity-settled share-based payments. | Unlike IFRS Standards, the deductible temporary difference is the cumulative amount of compensation expense recognized for financial reporting purposes for liability-classified awards (including cash-settled SARs and many other liability-classified awards). |
4. Measurement of deferred tax assets for instruments that ordinarily do not result in a future tax deduction | |
| No specific guidance. | Unlike IFRS Standards, US GAAP states that compensation costs for instruments that ordinarily do not result in tax deductions do not result in a deductible temporary difference. |
| 5. Measurement of deferred tax assets for equity-settled replacement awards issued in a business combination | |
The tax effects of recognizing equity-settled replacement share-based payment awards attributed to pre-combination service are recognized in acquisition accounting, consistent with the recognition of such awards. If the jurisdiction provides a deduction based on intrinsic value, the related deferred tax asset is measured based on the company’s current share price (intrinsic value) at acquisition. | Like IFRS Standards, the tax effects of the recognition of such awards are recognized in acquisition accounting, consistent with the recognition of such awards. However, unlike IFRS Standards, the related deferred tax asset is measured based on the amount included in measuring the consideration transferred in the business combination (generally at fair value) at acquisition. |
| 6. Intraperiod tax allocation of tax effects of equity-settled replacement awards issued in a business combination | |
IAS 12 does not specify how changes in the deferred tax asset recognized in acquisition accounting and the expected tax deduction should be allocated. In our view, a company should choose an accounting policy, to be applied consistently, to allocate:
| Unlike IFRS Standards, the acquirer allocates any resulting excess tax benefits and tax deficiencies as income tax expense (benefit) in profit or loss. |
| 7. Intraperiod tax allocation of tax benefits from employee share ownership plans (ESOPs) | |
| No specific guidance. The general allocation principle applies. | Unlike IFRS Standards, tax benefits associated with tax deductible dividends paid on unallocated shares of an ESOP are required to be allocated to profit or loss. |
| 8. Recognition, allocation and disclosure of deferred taxes where a tax deduction is allowed at grant date | |
If current tax deductions are available based on the intrinsic value of a share-based payment award at grant date, in our view, a company should choose an accounting policy, to be applied consistently, to recognize:
| Unlike IFRS Standards, if a tax deduction taken at grant date results in a current tax benefit at the intrinsic value of the award, a deferred tax liability is recognized at grant date and reversed over the service period. All entries are allocated to income tax expense (benefit) in profit or loss. |
| 9. Disclosure of the tax effects of share-based payments | |
| IFRS Standards require the aggregate current and deferred tax relating to items that are charged or credited directly to equity, including the tax effects of share-based payments, to be disclosed. | Unlike IFRS Standards, US GAAP requires companies to disclose:
|
Income tax effects of share-based payments may be significant to a company’s profit or loss. Accounting for such arrangement is also complex, requiring combined knowledge from tax, valuation and accounting professionals including a good understanding of the applicable tax law and terms of the share-based payment plan. The differences in measuring and allocating tax benefits between IAS 12 and ASC 718-740 add to those complexities for dual reporters. Although calculations may be run on Excel, companies should also ensure that appropriate controls and processes are in place. In doubt? Start the conversation now with your KPMG representatives.
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