Deferred taxes and Share-based payments IAS 12 accurate accounted for

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This narrative looks at two particular issues that arise in accounting for deferred tax arising on share-based payments, specifically:

how to calculate the amount to be recognised in other comprehensive income / equity and the amount to be recognised in profit or loss
how to account for deferred tax on share based payments not caught by the measurement provisions of IFRS 2 ‘Share-based Payment’.

Calculating the credit to equity

IAS 12 requires a deferred tax asset to be recognised for deductible temporary differences associated with equity-settled share-based payments. In certain jurisdictions, tax law provides for a deduction against corporation tax when share options are exercised. The deduction can be equal to the intrinsic value (market price less exercise price) of the share options at the date they are exercised or computed on another basis specified by the tax law.

IAS 12.68C requires any deferred tax credit arising on equity-settled share-based payments to be allocated between profit or loss and equity.

What amount should be credited in profit or loss?

Simple case – Tax credit in profit or loss

On 1 January 20X1, Company A issued share options to its employees with a one year vesting period. At 31 December 20X1, an IFRS 2 charge of CU15,000 had been recognised. At 31 December 20X1, the share options expected to be exercised had a total intrinsic value of CU25,000. In the year, a deferred tax credit of CU5,750 should be recognised, based on a tax rate of 23% (assumed tax rate) (CU25,000 × 23%).

At 31 December 20X1, the expected tax deduction of CU25,000 exceeds the cumulative IFRS 2 charge recognised to date of CU15,000 by CU10,000. Therefore, of the tax credit of CU5,750, CU3,450 should be recognised in profit or loss (CU15,000 × 23%) and CU2,300 should be recognised directly in equity (CU10,000 × 23%).

In the above simple case, the amount of the deferred tax credit to be taken to profit or loss was simply the current year’s share-based payment charge multiplied by the effective tax rate. However, this will not always be the case. Whether any amount should be taken to equity in a given year depends on whether or not there is an ‘excess tax deduction’.

To see whether there is an excess tax deduction, the total expected tax deduction to date should be compared to the cumulative IFRS 2 expense to date. If the expected tax deduction is greater, then there is an excess tax deduction. As noted above, the computation of tax deduction may be different for each jurisdiction and is dictated by the tax law.

Something else – Deferred tax assets

For example, in a jurisdiction where deduction for share-based payments is based on the intrinsic value of the share options at the date of exercise, the total expected tax deduction to date is calculated as the number of options expected to be exercised multiplied by their intrinsic value at the reporting date multiplied by the proportion of the vesting period completed.

In such a case, the cumulative amount of deferred tax that should be taken to other comprehensive income / equity is the excess tax deduction multiplied by the effective tax rate. The amount to be taken to other comprehensive income / equity each period is the difference between this cumulative total and the amounts already recognised directly in equity in previous periods (if any). The amount that should be recognised in profit or loss is then the difference between the total deferred tax credit or debit for the period and the amount taken to other comprehensive income / equity in that same period.

The number of options expected to be exercised might not necessarily be the same as the number of options expected to vest under IFRS 2.

Case – Tax in other comprehensive income / equity and profit or loss

On 1 January 20X1, Company A issues 1,000,000 options. These share options vest three years after the date of Deferred taxes and Share-based payments grant and have an exercise price of CU2.50. In the country where A is domiciled, corporation tax rate of 23% applies and the tax deduction allowed for share-based payments is the intrinsic value of the share options at the date they are exercised.

Year 1

At 31 December 20X1, the market value of Company A’s shares is CU3.25, therefore the share options have an intrinsic value of CU0.75 (CU3.25 – CU2.50). At year end, the company estimates that only 595,000 options will vest and will also be exercised. The share-based payment charge recognised in profit or loss for the year is CU69,417.

The total expected tax deduction to date is CU148,750 (595,000 × 0.75 × 1/3). The cumulative share-based payment charge to date is CU69,417. There is therefore an excess tax deduction of CU79,333 (CU148,750 – CU69,417).

The amount of deferred tax that should be recognised directly in other comprehensive income / equity is therefore CU18,247 (CU79,333 × 23%), and the amount that should be recognised in profit or loss is CU15,966 ((CU148,750 × 23%) – CU18,247).

The journal to record this deferred tax asset will be:

Amounts in CU	Debit	Credit
Deferred tax asset	34,213
Deferred tax income (profit or loss)		15,966
Deferred tax income (other comprehensive income / equity)		18,247

The deferred tax asset of CU34,213 that will be recognised in the statement of financial position is subject to there being sufficient future taxable profits against which this deferred tax asset can be recovered.

Year 2

At 31 December 20X2, the market value of the shares is CU3.50, therefore the share options have an intrinsic value of CU1 (CU3.50 – CU2.50). At year end, the company estimates that 600,000 options will vest and that all of the options that vest will be exercised. The share based payment charge recognised in profit or loss in the year is CU70,583.

The total expected tax deduction to date is CU400,000 (600,000 × 1 × 2/3). The cumulative share based payment charge to date is CU140,000 (CU70,583 + CU69,417). There is therefore an excess tax deduction of CU260,000 (CU400,000 – CU140,000).

The cumulative amount of deferred tax that should be recognised directly in equity is therefore CU59,800 (CU260,000 × 23%). The amount that has previously been recognised directly in equity is CU18,247, therefore the amount that should be recognised directly in equity this year is CU41,553 (CU59,800 – CU18,247).

The deferred tax asset at the end of the previous year was CU34,213. The deferred tax asset that should be recognised at the end of 20X2 is CU92,000 (CU400,000 × 23%), this gives an increase in the deferred tax asset of CU57,787 (CU92,000 – CU34,213). The amount that should be recognised in profit or loss is CU16,234 (CU57,787 – CU41,553).

The journal to record this deferred tax asset will therefore be:

Amounts in CU	Debit	Credit
Deferred tax asset	57,787
Deferred tax income (profit or loss)		16,234
Deferred tax income (other comprehensive income / equity)		41,553

Year 3

At 31 December 20X3, the market value of the shares is CU3.15, therefore the share options have an intrinsic value of CU0.65 (CU3.15 – CU2.50). At year end, the company estimates all of the 750,000 options that have vested will be exercised. The share-based payment charge recognised in profit or loss in the year is CU122,500.

The total expected tax deduction to date is CU487,500 (750,000 × 0.65). The cumulative share-based payment charge to date is CU262,500 (CU140,000 + CU122,500). There is therefore an excess tax deduction of CU225,000 (CU487,500 – CU262,500).

The cumulative amount of deferred tax that should be recognised directly in equity is therefore CU51,750 (CU225,000 × 23%). The amount that has previously been recognised directly in equity is CU59,800, therefore the amount that should be recognised in equity is in fact a debit of CU8,050 (CU51,750 – CU59,800), ie a reversal of part of the credit already taken to equity.

The deferred tax asset at the end of the previous year was CU92,000. The deferred tax asset that should be recognised at the end of 20X3 is CU112,125 (CU487,500 × 23%), this gives an increase in the deferred tax asset of CU20,125. The amount that should be recognised in profit or loss is CU28,175 (CU20,125 + CU8,050).

The journal to record this deferred tax asset will therefore be:

Amounts in CU	Debit	Credit
Deferred tax asset	20,125
Deferred tax income (profit or loss)		28,175
Deferred tax income (other comprehensive income / equity)	8,050

Something else – Valuing deferred tax assets – How 2 best account it in IAS 12

IFRS 1.D2 ‘First-time Adoption of International Financial Reporting Standards’ provides an exemption from recognising the IFRS 2 expense relating to equity-settled share-based payments granted on or prior to 7 November 2002, or equity-settled share-based payments granted after this date but which vest prior to the later of 1 January 2005 and the date of transition to IFRSs. As set out above, IAS 12.68C requires that where the expected tax deduction exceeds the related cumulative IFRS 2 remuneration expense the tax effect of that excess should be recognised in equity.

Where, in accordance with the transitional provisions of IFRS 1, there is no cumulative remuneration expense, a question arises as to where the deferred tax associated with these equity-settled share-based payments should be recognised. IFRS 1 contains no similar exemption from recognising the deferred tax on options which:

were granted on or before 7 November 2002 or
vested before the later of date of transition to IFRSs and 1 January 2005.

As no expense is recognised in profit or loss in relation to these grants then, arguably, the entire deferred tax relating to these grants should be taken direct to equity. This includes both the deferred tax on such grants recognised on transition to IFRSs and subsequent movements in the deferred tax relating to these share-based payments.

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Something else – Determine Tax base under IAS 12

Something else – Deferred tax liabilities

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