Hong Kong Financial Reporting Standard 2 ("HKFRS 2") governs the accounting treatments for share-based payments ("SBP") and is effective for financial periods beginning on or after 1 January 2005. The introduction of HKFRS 2 has created controversial tax treatments on the deduction of SBP charged in the accounts.
It has been the Department's stance that SBP recognized in respect of stock option or share award obligations fulfilled by issuing new shares are not deductible [FAQ for Share-based Payment Transactions – Q1]. Where the obligations are met by acquiring shares from the market, the costs incurred in the acquisition are allowable deductions when the vesting conditions of the stock option or share award have been satisfied [FAQ for Share-based Payment Transactions – Q7 and Q8].
Stock option or share award obligations are sometimes discharged by recharge arrangements between group companies, i.e. an employing entity is recharged for shares issued or acquired by another group entity. The issues on recharge are most controversial that there are diverse views between the Department and tax practitioners. Having revisited the issues and with a view to resolving the prolonged tax disputes, the Department has decided to adopt the following positions for recharge arrangement with written recharge agreement:
Recharge in relation to both new issue of shares as well as acquisition of shares from the market by a group entity can be allowable.
The timing of deduction is the point of exercise of stock option or the point of vesting of share award.
The amount of deduction claimed must not be excessive [for example, it should not be more than the open market value of the shares acquired at the date when the stock option / share award is exercised / vested less the amount or value of consideration given by the grantee / awardee for the grant and / or exercise of the option / award, as the case may be].
Where any option shares / award shares are subsequently forfeited or cancelled, any deduction previously allowed should be written back as a trading receipt and offered for assessment.
Where it is suspected that any SBP transactions are entered into for tax avoidance purposes, the Department may inquire into the transactions in detail and may, where appropriate, invoke the anti-avoidance provisions to counteract the tax benefits obtained.