What management must know about share-based payments to employees: Accounting & tax implications
Remuneration paid for the services rendered by employees is a major determinant of the dedication of such employee to the service of its employers. Recalling Abraham Maslow’s hierarchy of needs theory, which focused on the needs of employees in the workplace, it is important to state that the five needs highlighted by Maslow for an employee to reach full potential, are driven by his financial abilities as his needs move within the pyramid, and ultimately to self-actualisation at the top of the pyramid.
Employers have come to the consciousness that giving employees only monetary reward for their services may not be enough to win the loyalty of the employees. Rather, providing employees with opportunities to own a part of the businesses in which they work may increase the motivation of such employees, and in return give assurance of their dedication to the business of the employer, which ultimately guarantees the entity the required stability.
According to International Financial Reporting Standards (IFRS) 2, share-based payments apply when a company acquires or receives goods for equity-based payment. These goods can include inventories, property, plants and equipment, and other non-financial assets, while services may include services provided by independent professionals and the employees of the company.
A share-based payment can either be an equity-settled transaction or a cash-settled transaction. A share-based payment is said to be equity-settled where equity of the company will be issued to the seller or the provider of goods when it is due for settlement, while cash-settled share-based payment transactions occur where goods or services are paid for at an amount based on the price of the company’s equity.
The foregoing has clearly explained the general scope of share-based transactions.
However, the focus of this writing will be primarily on share-based payments to employees of a company, the accounting implications of such payments to employees, and the tax compliance obligations of the employer and employees with respect to such share-based payment arrangement.
Share-based payment to employees may take the form of (a) share options scheme; (b) phantom stock plan; (c) share appreciation rights, etc. This writing will focus mainly on the three listed forms of share-based payment to employees.
Share option scheme
Share option scheme is a form of share-based payment that gives an employee a right to purchase the shares of an entity for a price usually below the market value of the shares. The share option agreement will usually have vesting conditions which the employee must meet before the share option will vest.
There are, however, instances where the share option vests immediately (though uncommon). Where this is the case, it presumes that the option is issued in consideration of the past efforts of the employee to the organisation.
The accounting treatment of a share option scheme will depend on whether the share option vests immediately or vests over a period. Where the share option vests immediately, the value of the share option will be recognized as an expense in the profit or loss account of the entity, while equity is increased by the credit of the value of the share option.
However, where the share option vests over time, the entity is expected to estimate the numbers of share option that vests on an annual basis in line with the vesting conditions. The value of the share option multiplied by the numbers of vested share option on an annual basis shall be recognized as expense in the profit or loss account, with a corresponding entry being credited to equity.
The tax implication of share option is quite unique. Section 3 of the Personal Income Tax Act provides for the taxation of all benefits of employment, and share options are not exempted. In essence the benefits in a share option scheme to an employee is the difference between the market value of the shares and the exercise price.
Phantom stock plan
Just like the share option scheme, it contains vesting schedule that vests the right to this benefit based on certain criteria. This plan can be in the form of “appreciation only” whose only benefit to the employee is the increase in the company’s stock price or “full value plan.” This gives the employees the benefit of both the share and the appreciation value.
Accounting for phantom shares is a function of the criteria in the plan. Where the plan requires only cash to paid at the point of pay out, the entity shall debit the value of the payout as they vest on an annual basis. Where the payment is deferred to a future date, the value will be accrued as part of the payables of the entity for the relevant period.
Where the payment is made by the entity, the bank or cash ledger will be credited. In the event that actual shares are issued to the employee at the point of pay-out, the accrued expense or payable in respect of employee benefit will be debited while equity will be credited.
In relation to the employees’ taxes related to the phantom shares, the full value of the benefits received by the employee will be liable to PAYE tax at the point of payment.
Share appreciation right (SAR)
SAR are rights given to an employee to share a part of the value by which the shares to the employers has appreciated. This is usually a cash compensation, but the employer may decide to issue shares to the employee proportionate to the value of entitled cash compensation.
In relation to employee taxes, the full value of the benefits received by the employee from the SAR will be liable be PAYE taxes.
Generally, whenever an employee who has benefited from a grant of shares in a share compensation arrangement disposes of such shares, the gains of such disposal shall be liable to capital gains tax in line with section 32 of the Capital Gains Tax Act.
Share-based payments to employees generally may have deferred tax implications as they do not become tax deductible until such rights are exercised by the employees.
Every employer has a responsibility to account to the relevant tax authorities on all applicable taxes with respect to benefits enjoyed by its employees and including all share-based payments.
Obajimi, a senior associate in Olaniwun Ajayi LP, writes from Lagos