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    Home > Frequently Asked Questions  > Share-based Payment Transactions

FAQ for Share-based Payment Transactions

 

Equity-settled Share-based Payment Transactions

1.

Q:

Where an entity fulfills its stock option or share award granted to its employees by issuing new shares, if it recognizes the fair value of the option or new shares so granted as an expense, is that expense allowable for tax deduction?

A:

Not deductible. Regardless of whether the equity instruments granted vest immediately or not, the "expense" recognized for accounting purposes in an equity-settled share-based payment transaction is not an outgoing or expense incurred for the purpose of section 16 of the Inland Revenue Ordinance ("IRO"). The Department follows the authority of Lowry v Consolidated African Selection Trust Ltd. [1940] 23 TC 259 and takes the stance that when an entity fulfills its obligations by issuing its own new shares, the share issue merely involves a movement in the entity's equity reserve account, and not an "outgoing" or "expense" for the purpose of section 16(1) of the IRO.

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2.

Q:

Is the IRD's tax treatment in A1 above consistent with the principle established in the case of CIR v Secan Ltd. & Ranon Ltd. 5 HKTC 266?

A:

Yes. The principle established in the Secan case requires that the assessable profits or losses of a taxpayer are to be ascertained in accordance with the prevailing generally accepted principles of commercial accounting, as modified to conform with the IRO. In an equity-settled share-based payment transaction, although the "expenses" arising are recognized in accordance with HKFRS2, the Department does not accept that any outgoings or expenses have been incurred for the purpose of section 16 of the IRO.

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3.

Q:

HKFRS2 requires an issuing entity to revise the estimate of number of equity instruments that eventually vest at each reporting date and to make any adjustments on a cumulative basis until the vesting conditions are satisfied. Are such adjustments deductible or taxable for tax purpose?

A:

As analyzed in A1 above, the entity has not incurred any outgoings or expenses under section 16 of the IRO in an equity-settled share-based payment transaction. Accordingly, the "expenses" so recognized are not deductible and the subsequent reversal arising from the same share-based payment transaction is not taxable.

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4.

Q:

An entity is not required under HKFRS2 to reverse the amount of expenses previously recognized for services received from employees if the vested equity instruments are later forfeited or, in case of share options, the options are not exercised. HKFRS2, however, allows a transfer within equity in amount equivalent to the fair value of forfeited or lapsed equity instruments. Is such a transfer within equity taxable for tax purpose?

A:

The transfer within equity made upon the forfeiture of equity instruments or the expiry of share options is not taxable because the "expenses" arising from the same share-based payment transaction have been disallowed in first place.

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5.

Q:

If the entity issuing the equity instruments cancels or settles a grant of equity instruments before the end of the vesting period, HKFRS2 requires the issuing entity to recognize immediately the amount that would otherwise have been recognized for services received over the remainder of the vesting period. Is that amount deductible for tax purpose?

A:

As analyzed in A1 above, the entity has not incurred any outgoings or expenses for the purpose of section 16 of the IRO. However, if the entity makes cash payments to employees upon cancellation or settlement, the cash payments are deductible if other normal rules in sections 16 and 17 of the IRO are satisfied. For example, if the cancellation or settlement is made to avoid a dilution of control or shareholders' interest, then the cash payment is not deductible under section 17(1)(b) of the IRO.

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6.

Q:

Are other expenses associated with the share option or share award granted to employees deductible for tax purpose?

A:

Other expenses associated with the grant or issue of equity instruments to employees should be deductible if the normal rules in sections 16 and 17 of the IRO are satisfied.

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Cash-settled Share-based Payment Transactions

7.

Q:

HKFRS2 requires an entity to recognize a liability under a cash-settled share-based payment transaction to pay the supplier of goods or services, although the supplier has not yet become unconditionally entitled to the payment. The entity is also required to re-measure that liability at each reporting date until that liability is settled by cash or debt instruments. Are the expenses thereby arising and the subsequent reversal respectively deductible and taxable for tax purpose?

A:

Any liability recognized under a cash-settled share-based payment transaction before the vesting conditions are satisfied is merely a contingent liability. Accordingly, it is not allowable for deduction. As a corollary, the "incurred" test under section 16 of the IRO is satisfied only when the supplier has become unconditionally entitled to the payment. The subsequent reversal of expenses previously recognized is taxable only to the extent of any amount already allowed for deduction.

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8.

Q:

If an entity recognizes a liability of HK$100 each in Year 1, Year 2 and Year 3 in relation to a cash-settled share-based payment transaction, and the liability becomes vested in Year 3. What are the tax treatments of that liability in each year of assessment?

A:

The liability of HK$100 each recognized for accounting purposes in Year 1 and Year 2 is not allowable for deduction because the counterparty has not yet become unconditionally entitled to the payment. In Year 3 when the liability becomes vested, a total amount of HK$300 would be deductible provided that other normal rules in sections 16 and 17 of the IRO are satisfied.

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Group Recharge Arrangement

9.

Q:

When a share-based compensation in form of stock option or share award is granted by a parent company, the entity concerned will debit the Profit and Loss Account and credit the "equity - reserve" account. Upon recharging, the entity will debit the "equity - reserve" account and credit the "payable to parent" account. Is the recharge deductible for tax purpose?

A:

A recharge is deductible as long as the conditions, including the "incurred" test, under sections 16 and 17 of the IRO are satisfied and the entity has become unconditionally liable to pay the recharge. Any provision for recharge claimed by the entity for deduction in the basis period in which the stock option / share award has not been exercised / vested should be disallowed.

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10.

Q:

Under a share-based compensation plan, the parent company acquired its own shares initially from the market and then recharged the subsidiary the fair value of the share awards at the end of each year during the vesting period. The actual costs incurred by the parent company for acquiring the shares, the recharge amount on the subsidiary and the market value of the shares upon vesting in the employees were different. What will be the deductible amount?

A:

The deductible amount would generally be the amount of recharge provided that it is not excessive in the circumstances. It is expected that adjustment of the recharge amount to account for the market circumstances should be provided under the terms of a commercial realistic recharge agreement.

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11.

Q:

The subsidiary in Q10 above settled the recharge to the parent company at the end of each year during the 3-year vesting period. Can it claim deduction of the recharge paid in each year of settlement?

A:

No. The subsidiary would be allowed deduction of the recharge only after the lapse of the vesting period. An employing entity is only liable  and has a definite liability for the expenses in connection with the provision of share benefits upon vesting of the shares in or exercise of the share options by the employees.

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12.

Q:

A parent company discharged the stock options obligations by either issuing new shares or acquiring the shares from the market. It then recharged the subsidiary. Assuming the parent company carries on a business in Hong Kong, will it be subject to tax for the recharge payment received?

A:

The recharge payment received by the parent company is a capital receipt and not taxable where it discharged the stock options obligations by issuing new shares. On the other hand, if the parent company discharged the obligations by acquiring the shares from the market, the taxability of the recharge payment would depend on whether the parent company was trading in the shares concerned. Where the parent company acquired the shares from the market solely for the purpose of discharging the obligations, the Department generally would not regard the recharge payment as a trading receipt.

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13.

Q:

If an employee was transferred from one subsidiary to another within the same group during the vesting period of the stock compensation plan, can both subsidiaries claim deduction for the respective amounts recharged by the parent company on them?

A:

Yes. Both subsidiaries can claim the respective deductions upon vesting in or exercise of the options by the employee provided that the recharge arrangement was properly documented and the terms were at arm’s length.

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Transitional Issues

14.

Q:

For those equity instruments to which HKFRS2 applies, HKFRS2 requires the entity to restate comparative information and adjust the opening balance of retained earnings for the earliest period presented. Are these prior period adjustments deductible for tax purpose?

A:

As analyzed in A1 above, the "expenses" recognized for accounting purposes under an equity-settled share-based payment transaction are not outgoings or expenses incurred for the purpose of section 16 of the IRO. Accordingly, the prior period adjustments are not allowable for deduction.

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15.

Q:

For liabilities arising from share-based payment transactions existing at its effective date, an entity may need to restate comparative information and adjust the opening balance of retained earnings for the earliest period presented. Are these prior period adjustments so arising deductible for tax purpose?

A:

Where the counterparty's rights have been vested before the first adoption of HKFRS2, the prior period adjustments are deductible in the year of first adoption (the decision in Pearce v Woodall-Duckham Ltd. [1978] 51 TC 271 followed). If the counterparty's rights have not yet been vested, the whole amount of prior period adjustments is not deductible as the adjustments relate only to contingent liabilities.

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