FAQ for Share-based Payment Transactions

Not deductible. Regardless of whether the equity instruments granted vest immediately or not, the "expense" recognized for accounting purposes in an equity-settled share-based payment transaction is not an outgoing or expense incurred for the purpose of section 16 of the Inland Revenue Ordinance ("IRO"). The Department follows the authority of Lowry v Consolidated African Selection Trust Ltd. [1940] 23 TC 259 and takes the stance that when an entity fulfills its obligations by issuing its own new shares, the share issue merely involves a movement in the entity's equity reserve account, and not an "outgoing" or "expense" for the purpose of section 16(1) of the IRO.

Yes. The principle established in the Secan case requires that the assessable profits or losses of a taxpayer are to be ascertained in accordance with the prevailing generally accepted principles of commercial accounting, as modified to conform with the IRO. In an equity-settled share-based payment transaction, although the "expenses" arising are recognized in accordance with HKFRS2, the Department does not accept that any outgoings or expenses have been incurred for the purpose of section 16 of the IRO.

As analyzed in A1 above, the entity has not incurred any outgoings or expenses under section 16 of the IRO in an equity-settled share-based payment transaction. Accordingly, the "expenses" so recognized are not deductible and the subsequent reversal arising from the same share-based payment transaction is not taxable.

The transfer within equity made upon the forfeiture of equity instruments or the expiry of share options is not taxable because the "expenses" arising from the same share-based payment transaction have been disallowed in first place.

As analyzed in A1 above, the entity has not incurred any outgoings or expenses for the purpose of section 16 of the IRO. However, if the entity makes cash payments to employees upon cancellation or settlement, the cash payments are deductible if other normal rules in sections 16 and 17 of the IRO are satisfied. For example, if the cancellation or settlement is made to avoid a dilution of control or shareholders' interest, then the cash payment is not deductible under section 17(1)(b) of the IRO.

Other expenses associated with the grant or issue of equity instruments to employees should be deductible if the normal rules in sections 16 and 17 of the IRO are satisfied.

Any liability recognized under a cash-settled share-based payment transaction before the vesting conditions are satisfied is merely a contingent liability. Accordingly, it is not allowable for deduction. As a corollary, the "incurred" test under section 16 of the IRO is satisfied only when the supplier has become unconditionally entitled to the payment. The subsequent reversal of expenses previously recognized is taxable only to the extent of any amount already allowed for deduction.

The liability of HK$100 each recognized for accounting purposes in Year 1 and Year 2 is not allowable for deduction because the counterparty has not yet become unconditionally entitled to the payment. In Year 3 when the liability becomes vested, a total amount of HK$300 would be deductible provided that other normal rules in sections 16 and 17 of the IRO are satisfied.

A recharge is deductible as long as the conditions, including the "incurred" test, under sections 16 and 17 of the IRO are satisfied and the entity has become unconditionally liable to pay the recharge. Any provision for recharge claimed by the entity for deduction in the basis period in which the stock option / share award has not been exercised / vested should be disallowed.

The deductible amount would generally be the amount of recharge provided that it is not excessive in the circumstances. It is expected that adjustment of the recharge amount to account for the market circumstances should be provided under the terms of a commercial realistic recharge agreement.

No. The subsidiary would be allowed deduction of the recharge only after the lapse of the vesting period. An employing entity is only liable  and has a definite liability for the expenses in connection with the provision of share benefits upon vesting of the shares in or exercise of the share options by the employees.

The recharge payment received by the parent company is a capital receipt and not taxable where it discharged the stock options obligations by issuing new shares. On the other hand, if the parent company discharged the obligations by acquiring the shares from the market, the taxability of the recharge payment would depend on whether the parent company was trading in the shares concerned. Where the parent company acquired the shares from the market solely for the purpose of discharging the obligations, the Department generally would not regard the recharge payment as a trading receipt.

Yes. Both subsidiaries can claim the respective deductions upon vesting in or exercise of the options by the employee provided that the recharge arrangement was properly documented and the terms were at arm’s length.

As analyzed in A1 above, the "expenses" recognized for accounting purposes under an equity-settled share-based payment transaction are not outgoings or expenses incurred for the purpose of section 16 of the IRO. Accordingly, the prior period adjustments are not allowable for deduction.

Where the counterparty's rights have been vested before the first adoption of HKFRS2, the prior period adjustments are deductible in the year of first adoption (the decision in Pearce v Woodall-Duckham Ltd. [1978] 51 TC 271 followed). If the counterparty's rights have not yet been vested, the whole amount of prior period adjustments is not deductible as the adjustments relate only to contingent liabilities.