Changes to the accounting treatment for share-based payments
The International Accounting Standards Board (IASB) is considering changes to the accounting treatment for share-based payments under IFRS2. The changes would allow an award that is settled net of withholding taxes to be treated as entirely equity settled for accounting purposes.
In many countries where companies operate equity incentive arrangements for employees (including the UK and United States), an employee may incur a liability to income tax on the acquisition of shares of which the income tax liability may need to be withheld by the employer and accounted for to the tax authorities. Usually the tax liability will be too great to withhold from an employee’s regular monthly salary, and therefore needs to be funded in some other way. Traditionally, UK companies whose shares are listed on a stock market have given their employees the choice to sell sufficient shares to fund the tax liability (also known as a ‘sell-to-cover’ election). However, an increasing number of UK companies operate a ‘net settlement’ mechanism as a way of funding the tax. In essence, a net settlement involves the employee receiving a reduced number of shares (broadly the number they would have received under a sell-to-cover), and the tax liability then being funded by the company.
There are some significant benefits to net settlement mechanisms; the company does not need to use as many shares, which can help with managing dilution limits, and there is also a saving in terms of dealing costs. In addition, for companies with shares that are relatively thinly traded, or those with a large number of employees with awards vesting on the same day, trying to sell sufficient shares in the market to fund the tax liabilities can be very challenging. A net settlement can also have negative accounting consequences as it results in an award being partially equity-settled and partially cash-settled. It is due to this that the proposed change to IFRS2, whereby an award which is net-settled is treated as wholly equity-settled for accounting purposes, is likely to be welcomed by companies.
What does this mean for my company?
There is currently no guidance as to when the changes to IFRS2 would come into effect although it is proposed that the changes would apply to both existing awards that vest after the changes come into effect as well as new awards. There are also proposals to clarify the accounting treatment of cash-settled share-based payments.
Companies should ensure that their current award documentation is flexible enough to permit net settlement if they may want to use that mechanism at some point in the future.
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