Share-based payments

The Inland Revenue Department (IRD) announced its new stance on allowing tax deductions for group-recharge situations on 6 March.

In a group context, it is common for a holding company to grant its own stock options or share awards to employees of its subsidiaries under a group employee share-based incentive scheme. In return for their employees being covered by the group scheme, the subsidiaries often agree to pay the holding company a certain amount under a recharge agreement.

Under the new stance, a company would be allowed a tax deduction if it is recharged by another group company for the latter using its own shares to discharge the obligations of the former under a group scheme covering the employees of the former. This is the case regardless of whether the shares involved are a new issue of shares or are shares acquired from the market by the latter group company.

Previously, a tax deduction for the recharge would only be allowed when the shares involved were acquired from the market by the latter group company.

It has been the IRD's stance that the expense recognized in the income statement under HKFRS 2 in respect of an employer issuing its own stock options or new shares to discharge its obligations under an employee share-based incentive scheme is not tax deductible.

The IRD takes the view that when an entity fulfills its obligations under an employee share-based incentive scheme by issuing its own stock options or shares, the option or share issue merely involves a movement in the entity's equity reserve account. Therefore, the IRD's position is that the expense recognized under HKFRS does not represent a legal or contractual liability to pay the relevant amount as required by section 16(1) of the Inland Revenue Ordinance (IRO), but is in a sense only an economic opportunity or notional cost suffered by the entity. As such, the amount is not tax deductible under section 16(1) of the IRO.

While the IRD's disallowance of the tax deduction for the expense recognized under HKFRS 2 in a single company situation has generally been accepted by taxpayers, many taxpayers have challenged the IRD on its extension of the disallowance to group-recharge situations.

The IRD's announcement made on its website is quoted below:

Stock option or share award obligations are sometimes discharged by recharge arrangements between group companies, i.e., an employing entity is recharged for shares issued or acquired by another group entity. The issues on recharge are most controversial that there are diverse views between the Department and tax practitioners. Having revisited the issues and with a view to resolving the prolonged tax disputes, the Department has decided to adopt the following positions for recharge arrangement with written recharge agreement:

  • Recharge in relation to both new issue of shares as well as acquisition of shares from the market by a group entity can be allowable.
  • The timing of deduction is the point of exercise of stock option or the point of vesting of share award.
  • The amount of deduction claimed must not be excessive
    [for example, it should not be more than the open market value of the shares acquired at the date when the stock option/share award is exercised/vested less the amount or value of consideration given by the grantee/awardee for the grant and/or exercise of the option/award, as the case may be].
  • Where any option shares/award shares are subsequently forfeited or cancelled, any deduction previously allowed should be written back as a trading receipt and offered for assessment.

Should you have any enquires on above tax deductible, you may consult your tax representative for overall view.

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