the fair value of the award at vesting, meaning that the employer’s liability is
potentially unlimited.
Accordingly, employers liable to such taxes will sometimes make it a condition of
receiving a share-based award that the employee bear all or some of the employer’s cash
cost of any related employment taxes. This may be done in a number of ways, including:
• direct payment to the entity;
• authorising the entity to deduct the relevant amount from the employee’s salary; or
• surrendering as many shares to the entity as have a fair value equal to the tax liability.
The accounting treatment of arrangements where the recovery of the employer’s tax
cost from the employee is made through surrendering of a number of shares with an
equivalent value is similar to that discussed at 14.3 below for the recovery of the
employee’s taxes.
Where the scheme requires direct cash reimbursement by employees of the cost of the
employer’s taxes, different considerations apply, as illustrated by Example 30.57 below.
2732 Chapter 30
Example 30.57: Recovery of employment tax on share-based payment from
employee
At the beginning of year 1, an entity granted an executive an award of free shares with a fair value of €100,000
on condition that the executive remain in employment for three years. In the jurisdiction concerned, an
employment tax at the rate of 12% is payable by the employer when the shares vest, based on their fair value
at the date of vesting. As a condition of obtaining the shares on vesting, the executive is required to pay cash
equal to the tax liability to the employer.
When the shares vest at the end of year 3, their fair value is €300,000, on which employment taxes of €36,000
are due. The executive pays this amount to the entity.
In our view, this arrangement can be construed in one of two ways, with somewhat different accounting outcomes:
• View 1: The executive’s obligation to make whole the employer’s tax liability means that this is,
economically, not an award of free shares, but an option to acquire the shares for an exercise price equivalent
to 12% of their market value at the date of exercise. The employer’s tax liability is a separate transaction.
• View 2: The executive’s obligation to make whole the employer’s tax liability should be accounted for
as such, separately from the share-based payment transaction.
In our view, either approach may be adopted, so long as it is applied consistently as a matter of accounting
policy. The essential differences between View 1 and View 2, as illustrated below, are that:
• under View 1 the reimbursement received from the employee is credited to equity, whereas under
View 2 it is credited to profit or loss; and
• under View 1, the IFRS 2 charge is lower than under View 2 reflecting the fact that under View 1 the
award is construed as an option, not an award of free shares.
View 1 Reimbursement treated as exercise price
On this analysis, the award is construed as an option to acquire shares with an exercise price of 12% of the
fair value, at vesting, of the shares. The grant date fair value of the award construed as an option is €88,000.
The entity would process the following accounting entries (on a cumulative basis).
€000
€000
Employee
costs*
88
Equity
88
Employee
costs†
36
Cash
36
Cash§
36
Equity
36
*
IFRS 2 charge.
†
Employment taxes (12% of €300,000).
§
The receipt of cash from the employee to reimburse the tax is treated as the receipt of the exercise price
for an option and credited to equity.
View 2 Reimbursement treated separately from the IFRS 2 charge
On this analysis, the award is construed as an award of free shares, with a grant date fair value of €100,000.
The reimbursement is accounted for as such, giving rise to a credit to profit or loss. The entity would process
the following accounting entries (on a cumulative basis).
€000
€000
Employee
costs*
100
Equity
100
Employee
costs†
36
Cash
36
Cash§
36
Employee
costs
36
Share-based
payment
2733
*
IFRS 2 charge.
†
Employment taxes (12% of €300,000).
§
The receipt of cash from the employee to reimburse the tax is treated as a reduction in employee costs.
It will be seen that View 1 results in a total employee expense of €124,000, while View 2 results in a total
employee expense of €100,000.
14.2.3
Holding of own shares to ‘hedge’ employment tax liabilities
As noted at 14.2 above, an award of shares or options to an employee may also give rise
to an employment tax liability for the employer, often related to the fair value of the
award when it vests or, in the case of an option, is exercised. Employers may hold their
own shares in order to hedge this liability (in an economic sense, if not under the criteria
in IFRS 9 – see 2.2.4.H above), and later sell as many shares as are needed to raise
proceeds equal to the tax liability.
These are two separate transactions. The purchase and sale of own shares are treasury
share transactions accounted for in accordance with IAS 32 (see Chapter 43 at 9). The
accounting treatment of the employment tax liability is discussed at 14.2.1 above.
14.3 Sale or surrender of shares by employee to meet employee’s tax
liability (‘sell to cover’ and ‘net settlement’)
In some jurisdictions, an award of shares or options to an employee gives rise to a personal
tax liability for the employee, often related to the fair value of the award when it vests or,
in the case of an option, is exercised. In order to meet this tax liability, employees may
wish to sell or surrender as many shares as are needed to raise proceeds equal to the tax
liability (sometimes described respectively as ‘sell to cover’ or ‘net settlement’).
This in itself does not, in our view, require the scheme to be considered as cash-settled,
any more than if the employee wished to liquidate the shares in order to buy a car or
undertake home improvements. However, if the manner in which the cash is passed to,
or realised for, the employee gives rise to a legal or constructive obligation for the
employer, then the scheme might well be cash-settled (see 9.2.2 to 9.2.4 above), to the
extent of any such obligation.
In some jurisdictions where employees must pay income tax on share awards, the tax is
initially collected from (and is a legal liability of) the employer, but with eventual
recourse by the tax authorities to the employee for tax not collected from the employer.
Such tax collection arrangements mean that even an equity-settled award results in a
cash cost for the employer for the income tax.
In such a situation, the e
mployer may require the employee, as a condition of taking
delivery of any shares earned, to indemnify the entity against the tax liability, for
example by:
• direct payment to the entity;
• authorising the entity to deduct the relevant amount from the employee’s salary;
or
• surrendering as many shares to the entity as have a fair value equal to the tax liability.
If the entity requires the employee to surrender the relevant number of shares, in our
view it is appropriate to treat the scheme as cash-settled to the extent of the indemnified
2734 Chapter 30
amount, unless the criteria to account for the arrangement as equity-settled under the
limited exception in IFRS 2 are met (see further below). This view relating to the general
requirements of IFRS 2 was confirmed by the IASB in its discussions relating to the
introduction of the exception into the standard. [IFRS 2.BC255G].
IFRS 2 (as amended for accounting periods beginning on or after 1 January 2018)
contains a limited exception to the general requirement to consider whether a net-
settled arrangement needs to be split into equity-settled and cash-settled portions. An
entity is required to account for net-settled arrangements meeting certain specified
criteria as equity-settled in their entirety. However, the exception is narrow in scope
and the requirement to assess whether an arrangement has an equity-settled element
and a cash-settled element continues to be relevant in many cases. The exception is
discussed and illustrated further at 14.3.1 below.
The following example illustrates the application of IFRS 2 to an arrangement where
the exception does not apply and so the entity has to separate the transaction into
two elements.
Example 30.58: Surrendering of vested shares by employee to indemnify liability
of entity to pay employee’s tax liability (net settlement where
IFRS 2 exception does not apply)
An entity operates in a jurisdiction where the personal tax rate is 40%, and free shares are taxed at their fair
value on vesting. The entity grants an award of 100 free shares with a grant date fair value of £3 each. The
fair value at vesting date is £5, so that the employee’s tax liability (required to be discharged in the first
instance by the employer) is £200 (40% of £500). The award is to be satisfied using treasury shares with an
original cost of £2.50 per share. Tax law or regulation does not require the entity to withhold an amount for
the employee’s tax obligation (see Example 30.59 below for an illustration of that situation).
The terms of the agreement between the entity and the employee specify that the employee must surrender
the 40 shares needed to settle the tax liability. In our view the substance of the transaction is that, at grant
date, the entity is making an award of only 60 shares (with a grant date fair value of £3 each) and is bearing
the cost of the employment tax itself. On this analysis, the entity will have recorded the following entries by
the end of the vesting period:
£
£
Employee costs (based on 60 shares
180
at grant date fair value)
Equity
180
Employee costs (based on 40% of
200
vesting date value)
Employment tax liability
200
The award is then satisfied by delivery of 60 treasury shares (with a cost of £2.50 each) to the employee:
£
£
Equity
150
Treasury
shares
150
The entity might well then sell the 40 shares ‘surrendered’ by the employee in order to raise the cash to pay
the tax, but this would be accounted for as an increase in equity on the reissue of treasury shares, not as
income (see 14.2.3 above).
If, instead of being required to surrender shares, the employee has a free choice as to how to indemnify the
employer, the employer will have recorded the following entries by the end of the vesting period:
Share-based
payment
2735
£
£
Employee costs (based on
300
100 shares at grant date fair value)
Equity
300
Receivable from employee (based
200
on 40% of vesting date value)
Employment tax liability
200
The award is then satisfied by delivery of shares to the employee, and the employee indicates that he wishes
to surrender 40 shares to discharge his obligation to the employer under the indemnity arrangement. The
entity then receives 40 shares from the employee in settlement of the £200 receivable from him.
In practice, this would almost certainly be effected as a net delivery of 60 shares, but in principle there are
two transactions, a release of 100 treasury shares, with a cost of £2.50 each, to the employee:
£
£
Equity
250
Treasury
shares
250
and the re-acquisition of 40 of those shares at £5 each from the employee:
£
£
Treasury
shares
200
Receivable from employee
200
The entity then settles the tax liability:
£
£
Employment tax liability
200
Cash
200
Even in this case, however, some might take the view that the substance of the arrangement is that the
employee has the right to put 40 shares to the employer, and accordingly 40% of the award should be
accounted for as cash-settled, resulting in essentially the same accounting as when the employee is required
to surrender 40 shares, as set out above. An entity should therefore make a careful assessment of the
appropriate accounting treatment based on the terms of a particular arrangement.
14.3.1
Share-based payments with a net settlement feature for withholding
tax obligations (net settlement where IFRS 2 exception applies)
IFRS 2 (as amended for accounting periods beginning on or after 1 January 2018)
contains an exception for specific types of share-based payment transaction with a net
settlement feature.
The exception was introduced as a result of discussions by the Interpretations
Committee about the classification of a share-based payment transaction in which an
entity withholds a specified portion of shares that would otherwise be issued to the
counterparty at the date of exercise or vesting. The shares are withheld in return for
the entity settling the counterparty’s tax liability relating to the share-based payment.
The question asked was whether the portion of the share-based payment that is
withheld should be classified as cash-settled or equity-settled in a situation where, in
the absence of the net settlement feature, the award would be treated in its entirety
as equity-settled?
2736 Chapter 30
The exception to the usual requirements of the standard (which are set out at 14.3
above) is narrow in scope and applies only in situations where there is a statutory
withholding obligation. The standard explains that ‘tax laws or regulat
ions may
oblige an entity to withhold an amount for an employee’s tax obligation associated
with a share-based payment and transfer that amount, normally in cash, to the tax
authority on the employee’s behalf. To fulfil this obligation, the terms of the share-
based payment arrangement may permit or require the entity to withhold the
number of equity instruments equal to the monetary value of the employee’s tax
obligation from the total number of equity instruments that otherwise would have
been issued to the employee upon exercise (or vesting) of the share-based payment
(i.e. the share-based payment arrangement has a “net settlement feature”)’.
[IFRS 2.33E].
If a transaction meeting the above criteria would have been classified entirely as equity-
settled were it not for this net settlement feature, then the exception in IFRS 2 applies
and the transaction is accounted for as equity-settled in its entirety (rather than being
divided into an equity-settled portion and a cash-settled portion as discussed at 14.3
above). [IFRS 2.33F, BC255G-I].
An entity applying the exception has to account for the withholding of shares to fund
the payment to the tax authority as a deduction from equity (in accordance with
paragraph 29 of IFRS 2). However, the deduction from equity may only be made up to
the fair value at the net settlement date of the shares required to be withheld. [IFRS 2.33G].
If the payment exceeds this fair value, the excess is expensed through profit or loss.
Where the entity withholds any equity instruments in excess of the employee’s tax
obligation associated with the share-based payment (i.e. the entity withholds an
amount of shares that exceeds the monetary value of the employee’s tax obligation),
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 545
