Share-based payment arrangements, governed by IFRS 2, are a common feature in employee compensation. While IFRS 2 dictates how the expense of these schemes is recognized in the financial statements, the tax implications, specifically deferred tax assets and liabilities, fall under IAS 12 Income Taxes. This interaction often presents a nuanced challenge for finance professionals, as the accounting expense recognition frequently differs from the timing and amount of the tax deduction. Understanding this specific aspect is key to accurate financial reporting.
The Core Principle of Temporary Differences
The need for deferred tax arises from a 'temporary difference' between the carrying amount of an asset or liability in the financial statements and its 'tax base.' For share-based payments, the carrying amount is typically the cumulative expense recognized under IFRS 2, or a liability for cash-settled schemes. The 'tax base' is often zero until the awards vest or are exercised, at which point a tax deduction becomes available, usually based on the intrinsic value of the shares or options at that time. This divergence creates the temporary difference that IAS 12 addresses.
Equity-Settled Share-Based Payments and Deferred Tax
For equity-settled share-based payments, such as employee share options, an accounting expense is recognized over the vesting period. A deferred tax asset is typically recognized in relation to this cumulative expense. IAS 12 permits the recognition of a deferred tax asset for the expected future tax deduction, even before the deduction is legally allowable. The crucial point here is that the tax deduction will likely be based on the fair value of the shares at the *exercise or vesting date*, which will almost certainly differ from the initial grant date fair value used for the IFRS 2 expense.
IAS 12 requires that this deferred tax asset be measured based on the 'best estimate of the probable tax deduction,' considering the *current share price* at each reporting date. If the estimated tax deduction (based on current share price) is *greater* than the cumulative accounting expense recognized in profit or loss, the deferred tax relating to this excess is recognized directly in equity, not profit or loss. This ensures that only deferred tax related to the expense recognized in profit or loss is reflected there, with the excess attributed to the equity nature of the instrument itself.
Cash-Settled Share-Based Payments and Deferred Tax
Cash-settled share-based payments, like share appreciation rights, are generally more straightforward regarding deferred tax. Here, a liability is recognized and remeasured at each reporting date based on the fair value of the awards. The tax deduction is typically based on the amount paid. Since the accounting liability and the eventual tax deduction usually track each other more closely (both tied to the intrinsic value at settlement), the deferred tax asset or liability arising from these arrangements is generally recognized directly in profit or loss, mirroring the recognition of the cash-settled share-based payment expense.
Conclusion
In summary, while IFRS 2 guides the initial accounting for share-based payments, IAS 12 dictates the intricate recognition of associated deferred tax implications. The key distinction lies in the treatment of equity-settled versus cash-settled schemes, particularly regarding the estimation of future tax deductions and the accounting for any 'excess' deferred tax through equity. Accurate application requires careful judgment and a deep understanding of how accounting profit and taxable profit diverge in these compensation structures.
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