Employees share based compensation (ESBC) has been described as one of the most novel innovations in the corporate business world and finance. First, because it creates a win-win situation between the employer and employees by aligning the interest of both parties towards increasing the net worth of the company. Secondly, it creates a cash free source of remuneration for employers. Thus, employers (especially start-ups and early growth companies) are able to channel scarce cash to other areas of business requiring urgent attention while still benefitting from the impact of a motivated work force.

ESBC is a form of employee remuneration that generally involves the grant of shares or stock options to the employees at a concessional price or a future cash payment based on the increase in the price of the shares from a specified level in return for their service as employees of the company. Such payments are known with a variety of names including employees stock option plans, stock acquisition plans among others.

Typically, ESBCs are granted to employees as part of their remuneration package, in addition to a cash salary and other employment benefits and it is usually conditional on the employee remaining in the employment of the company for a specified period of time. Additionally, there may be performance conditions that must be satisfied by the employee before being entitled to the shares. Such performance condition may include achieving a specified growth in profit or a specified increase in the share price of the enterprise. The date in which the ESBC is communicated to (and agreed by the employee) is the grant date while the waiting period for the fulfilment of the conditions attached to the scheme is known as the vesting period. When an employee becomes entitled to the shares, such shares are said to have vested.

While there are several issues to consider by a company planning the setup of an ESBC, two important areas of consideration are the assessment of the financial reporting requirements and tax implications of such option to the company. This article explores the financial reporting requirements for this type of compensation scheme as well as the tax issues surrounding its implementation.

Categories of ESBC

ESBCs are generally categorized into three, though there are several modifications of these three in practice. The three categories are Employees Stock Option Plans (ESOPs), Employees Stock Purchase Plan (ESPPs) and Stock Appreciation Rights (SARs). ESOPs are plans under which a Company grants options (a right to purchase) for a specified period to its employees to purchase its shares at a fixed or determinable price. The Option is granted to employees at the beginning of the scheme over a period of time after which they become entitled to exercise their right. ESPPs, on the other hand, are plans under which the enterprise grants rights to its employees to purchase its shares at a stated price at the time of public issue or otherwise. SARs are a form of employee share-based payments whereby the employees become entitled to a future cash payment or shares based on the increase in the price of the shares from a specified level over a specified period.

ESBC is currently a common feature in the compensation of senior level and long serving employees of companies in Nigeria especially in financial services, manufacturing and financial technology sectors. Some of these companies operate pure ESOPs while others have modified ESPP and SAR.

Financial Reporting Requirements

The provisions of International Financial Reporting Standard (IFRS) 2 guide how companies account for ESBCs in their books. The International Accounting Standards Board (IASB) issued IFRS 2 in 2004. Prior to the issue, ESBCs were not recognized in the books but only disclosed by way of notes in the financial statements. This led to high incidence of unknown/contingent liabilities.

For accounting purposes, IFRS 2 classifies ESBC into either equity-settled, cash-settled or share based payment with cash alternatives. In an equity-settled ESBC, employees are issued an equity instrument of the company in the form of either shares, share options or any other equity instrument. For cash-settled ESBC, employees receive cash based on the price of the company's shares. Under the share based payment with cash alternatives, either the employee or the employer has a choice of whether the company settles the payment in cash or by issue of shares.

In an equity-settled ESBC, companies are required to recognize an expense and a corresponding credit in equity (other equity component) over the period in which employees fulfill conditions attached to the compensation (the vesting period). The amount to be recognized is the fair value of the equity instrument issued to the employees. Where the equity issue is unconditional, employees become entitled to the shares immediately. Thus, companies are required to recognize an expense and a corresponding credit in equity to the full value of the shares issued.

In a cash-settled ESBC, companies recognize an expense (in a similar manner as equity-settled ESBC) and a corresponding liability by creating a provision thereof. The amount to recognize is the fair value of the liability. Until the liability is settled, the company is required to re-measure the fair value of the liability at each reporting date with changes in fair value recognized in the profit or loss account.

For ESBCs with cash alternatives, the accounting depends on the party exercising the option. Where the company has the choice of determining how the payment will be settled, the company is required to evaluate if it has a present obligation to settle in cash. If such obligation exist, the ESBC is treated as a cash-settled one. Where such obligation does not exist, the ESBC will be treated as equity-settled. However, if a company has granted the employees the right to choose whether the ESBC is to be settled in cash or by issuing shares, then the plan is deemed to have two components.

First is the liability component, which is the employees' right to demand settlement in cash, and secondly, the equity component, that is, the employees' right to demand settlement in shares rather than in cash. The enterprise should first measure, on the grant date, fair value of the ESBC presuming that all employees will exercise their option in favour of cash settlement. The fair value so arrived at should be considered as the fair value of the liability component. The enterprise should also measure the fair value of the employee ESBC presuming that all employees will exercise their option in favour of equity settlement. The excess, if any, of the fair value of equity- settlement over fair value of cash- settlement is the fair value of the equity component. The fair value of the equity and liability components are to be accounted for in line with equity-settled and cash-settled ESBCs respectively.

Tax Peculiarities

There are no specific provisions for the taxation of employees share based compensation under the Personal Income Tax Act (PITA). Hence, reference is usually made to the provision in section 3(b) of PITA(as amended) which provides that all forms of compensations, benefits and perquisites accruing to an employee in relation to employment is taxable in the hand of the employee. Where the ESBC is cash-settled, employers are obligated to deduct and remit PAYE on the amount being paid. The controversial aspect relates to equity-settled ESBCs. This is because taxation of share stocks, options and related instruments had always been dealt with under the Capital Gains Tax Act (CGTA). Prior to 1998, stocks and shares of every description constituted chargeable assets under section 3a of the CGTA on which Capital Gains Tax was payable. Up until date, options are still listed as chargeable assets on which capital gains tax is payable. Section 31 of the CGTA further exempts gains accruing from disposal of Nigerian government securities, stocks and shares from Capital Gains tax.

Practices in other jurisdictions like the United States of America (USA), United Kingdom (UK) and South Africa are however different from Nigeria as there are specific provisions in the respective tax laws providing for how ESBCs should be assessed to tax. In the US for example, taxability depends on whether the option exercised are qualifying or non-qualifying options. Exercising non-qualifying stock options exposes the employee to income tax on the difference between the market value and the exercise price on the vesting date. However, if the ESBC is a qualifying one, the employee is exempted from income tax when the option is exercised but would be taxed at the long-term capital gain tax rate provided that the holding period requirement of two years is met. Similar provision exist for South Africa. In the UK, further exemption (e.g. under the Shares Incentive Plans) from capital gains tax exist if certain conditions are met by the employees.

It is without a doubt that benefits accrue to employees under an ESBC scheme. The question to clarify is whether such benefit falls under the provisions of PITA or CGTA? If the benefits are within the provisions of the former, PAYE tax becomes due upon exercise of option by employee. If however, the benefits are capital gains related, no tax is due upon exercise and eventual disposal as gains on disposal of stocks and shares are exempted from CGT.

The Lagos Internal Revenue Service (LIRS) made known its position in a recent public notice where it stated that the benefit accruing to employees at the point of exercising the right (which is the difference between the Market Value on that date and the exercise price) constitutes a taxable benefit under PITA. The LIRS further instructed employers to deduct PAYE from employees' remuneration once the right has been exercised.

The LIRS' position however, seem to contradict the legislative intent on amendments relating to exemption of gains from disposal of shares and stocks from capital gains tax as it subjects the exempt gains to Personal Income Tax (through PAYE).


It has been established that there is an urgent need for an amendment to PITA to include provisions relating to ESBCs. In carrying out the amendments, the legislature should ensure that it is consistent with the existing fiscal arrangements for shares and stocks under the CGTA. While we await legislative amendments, it is our view that ESBCs should not be liable to any income tax as gains arising from the disposal of shares are clearly exempt from tax, irrespective of whether the shares were acquired under ESBC scheme or purchased directly from the capital market. This preserves the benefits to taxpayers as intended by the current legislature.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.