Share-based payment simplification will mean more income tax volatility

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In brief , PwC US Mar 31, 2016

The FASB released the final share-based payment simplification guidance, which will significantly impact net income.

Authored by

Jay Seliber

Partner, National Professional Services Group, PwC US

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Lindsey Morris

Senior Manager, National Professional Services Group, PwC US

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What happened?

On March 30, 2016, the FASB issued Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation – Stock Compensation.

Key Provisions

The ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements.

Income tax effects of share-based payments

A new requirement to record all of the tax effects related to share-based payments at settlement (or expiration) through the income statement was the topic that attracted the most attention during the comment letter process, and could have the most significant impact. Currently, tax benefits in excess of compensation cost (“windfalls”) are recorded in equity, and tax deficiencies (“shortfalls”) are recorded in equity to the extent of previous windfalls, and then to the income statement. While the simplification will reduce some of the administrative complexities by eliminating the need to track a “windfall pool,” it will increase the volatility of income tax expense. This change is required to be applied prospectively to all excess tax benefits and tax deficiencies resulting from settlements after the date of adoption of the ASU.

The ASU also removes the requirement to delay recognition of a windfall tax benefit until it reduces current taxes payable. Under the new guidance, the benefit will be recorded when it arises, subject to normal valuation allowance considerations. This change is required to be applied on a modified retrospective basis, with a cumulative-effect adjustment to opening retained earnings.

All tax-related cash flows resulting from share-based payments are to be reported as operating activities on the statement of cash flows, a change from the current requirement to present windfall tax benefits as an inflow from financing activities and an outflow from operating activities. Either prospective or retrospective transition of this provision is permitted.

Minimum statutory tax withholding requirements

Currently, employers are permitted to withhold shares upon settlement of an award to satisfy the employer’s tax withholding requirement without causing the award to be liability classified. However, the amount is strictly limited to the employer’s minimum statutory tax withholding requirement. The simplification allows entities to withhold an amount up to the employees’ maximum individual tax rate in the relevant jurisdiction without resulting in liability classification of the award. This provision is required to be adopted using a modified retrospective approach, with a cumulative-effect adjustment to opening retained earnings for any outstanding liability awards that qualify for equity classification under the ASU. Additionally, the ASU clarifies that all cash payments made to taxing authorities on the employees’ behalf for withheld shares should be presented as financing activities on the statement of cash flows. This change should be applied retrospectively.

Forfeitures

Under the new guidance, entities are permitted to make an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards. Forfeitures can be estimated, as required today, or recognized when they occur. Estimates of forfeitures will still be required in certain circumstances, such as at the time of modification of an award or issuance of a replacement award in a business combination. If elected, the change to recognize forfeitures when they occur needs to be adopted using a modified retrospective approach, with a cumulative effect adjustment recorded to opening retained earnings.

Nonpublic entity-only simplifications

Lastly, there are two provisions that are only available to companies that are not public business entities, as defined in ASC 718: (1) a practical expedient for determining the expected term of certain share-based awards, which would be adopted prospectively, and (2) a one-time opportunity to change its measurement basis for all liability-classified awards to intrinsic value upon adoption of the ASU.

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Why is this important?

While the amendments are aimed at reducing the cost and complexity of accounting for share-based payments, they will likely result in significant changes to net income and earnings per share, including the effect of the exclusion of windfall tax benefits from the hypothetical proceeds used to calculate the repurchase of shares under the treasury stock method. Additionally, there are expected to be administrative and other challenges (such as possible changes to systems, processes, and controls) to implement the guidance for companies with significant share-based payment activities.

What's next?

ASU 2016-09 is effective for public business entities for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. For all other entities, it is effective for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. Early adoption will be permitted in any interim or annual period, with any adjustments reflected as of the beginning of the fiscal year of adoption.

Questions?

PwC clients who have questions about this In brief should contact their engagement partner. Engagement teams who have questions should contact the Compensation team in the National Professional Services Group (1-973-236-7802).

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David Schmid

IFRS & US Standard Setting Leader, National Professional Services Group, PwC US

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