Differences in the tax-benefit information that International Financial Reporting Standards require in the case of employee stock options could be challenging for companies, according to a new report from PricewaterhouseCoopers.
In a white paper authored by a U.S. PwC partner and a director in the Brussels office who is in the U.S. on assignment with PwC’s National Tax Accounting Services practice, the accountancy said that a switch from U.S. generally accepted accounting principles to international treatment of compensatory stock options “will impact a company’s reported earnings, effective tax rate, and cash flows when adopting IFRS.”
While the report noted that both GAAP and IFRS require companies to expense employee stock option awards based on the fair value of the option on the grant date, PwC noted that IFRS bases tax benefits on the estimated future tax deduction on the reporting date. In most cases, that means the deduction would be based on the “intrinsic value” of the stock option when it is exercised — or whatever stock value that exceeds the option exercise price.
“Consequently, for stock options granted with an exercise price that equals (or exceeds) the fair market value of the shares no deferred tax asset is recognized under IFRS at the time of the grant,” according to PwC [with PwC's emphasis], “because no inherent tax deduction is present in the award at that time.” Thus, tax benefits under IFRS are recorded only when the stock price rises. “Typically, this will trail, often by a considerable lenth of time, the recorded compensation expense,” the report said.
PwC’s report noted that because of that difference, companies will “often have greater reductions to after-tax earnings for stock option awards prior to the time the award settles than they would have under U.S. GAAP.” The report went on to say that “there will be volatility in the effective tax rate and deferred tax accounts over the life of the stock options due to the stock price movements in each reporting period.”
IFRS provides for such impact to be reported in the operating section of the company’s statement of reported cash flows, PwC said.
In the case of estimated or final tax deductions being smaller than the compensation expense recorded under IFRS, “the tax benefit shortfall is charged to equity only to the extent that a tax benefit for that individual stock option award has already been credited to equity,” PwC said. “IFRS does not apply the U.S. GAAP concept of an APIC ‘pool’ (also known as a ‘windfall pool’), which enables tax benefit shortfalls to be offset against aggregated prior windfalls.”
The PwC white paper said that, in general, under international standards “employee stock option plans and other share-based payment plans must also consider the differing tax systems worldwide and their impact on tax deductibility of stock options and other compensation-based rewards.” Under IFRS, “significantly more information will have to be tracked to recognize tax benefits appropriately.”
The Big Four accounting firms all have become more aggressive in the past year in producing reports about issues related to IFRS, and in planning educational programs for clients and others.