10.5 Cost-Sharing Arrangements

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10.5 Cost-Sharing Arrangements

Related entities in different tax jurisdictions may enter into cost-sharing agreements under which one party is reimbursed for a portion of certain costs it incurred in undertaking shared development activities associated with intangible property. A jurisdiction may permit or require the resident entity to include stock-based compensation cost in the joint cost pool that is reimbursed (commonly referred to as the all costs rule).

The guidance in this section is applicable for entities that are allocating stock-based compensation to related parties under a qualified cost-sharing arrangement. See Section 4.6.3 for a discussion of uncertain tax positions associated with transfer pricing.

The issue of accounting for income taxes related to cost-sharing arrangements in the U.S. federal tax jurisdiction was discussed at the FASB Statement 123(R) Resource Group’s July 21, 2005, meeting. The discussion document for the meeting states, in part:

Related companies that plan to share the cost of developing intangible property may choose to enter into what is called a cost-sharing agreement whereby one company bears certain expenses on behalf of another company and is reimbursed for those expenses. U.S. tax regulations specify the expenses that must be included in a pool of shared costs; such expenses include costs related to stock-based compensation awards granted in tax years beginning after August 26, 2003.

The tax regulations provide two methods for determining the amount and timing of share-based compensation that is to be included in the pool of shared costs: the “exercise method” and the “grant method.” Under the exercise method, the timing and amount of the allocated expense is based on the intrinsic value that the award has on the exercise date. Companies that elect to follow the grant method use grant-date fair values that are determined based on the amount of U.S. GAAP compensation costs that are to be included in a pool of shared costs. Companies must include such costs in U.S. taxable income regardless of whether the options are ultimately exercised by the holder and result in an actual U.S. tax deduction.

The example below, adapted5 from the discussion document, illustrates the accounting for income taxes associated with the allocation of share-based payment awards under a cost-sharing arrangement in the U.S. federal tax jurisdiction.

Example 10-8

Company A, which is located in the United States, enters into a cost-sharing arrangement with its subsidiary, Company B, which is located in Switzerland. Under the arrangement, the two companies share costs associated with the R&D of certain technology. Company B reimburses Company A for 30 percent of the R&D costs incurred by Company A. The U.S. tax rate is 25 percent. Cumulative book compensation for a fully vested option issued to a U.S. employee is $100 for the year ending on December 31, 20X6. The award is exercised during 20X7, when the intrinsic value of the option is $150.

The tax accounting impact is as follows:

Exercise Method

On December 31, 20X6, Company A records $18 as the DTA related to the option (rounded for $100 book compensation expense × 70% not subject to reimbursement × 25% tax rate). When, in 20X7, the option is exercised, any net tax benefit that exceeds the DTA is an excess tax benefit and is recorded in the income statement. The company is entitled to a U.S. tax deduction resulting in a benefit (net of the inclusion) of $26 (rounded for $150 intrinsic value when the option is exercised × 70% not reimbursed × 25%). Accordingly, $8 ($26 – $18) would be recorded in the income statement as an excess tax benefit.

Grant Method

The cost-sharing impact is an increase of currently payable U.S. taxes each period; however, in contrast to the exercise method, the cost-sharing method should have no direct impact on the carrying amount of the U.S. DTA related to share-based compensation. If there was $100 of stock-based compensation during 20X6, the impact on the December 31, 20X6, current tax provision would be $8 (rounded for $100 book compensation expense × 30% reimbursed × 25%). If the stock-based charge under ASC 718 is considered a deductible temporary difference, a DTA also should be recorded in 20X6 for the financial statement expense, in the amount of $25 ($100 book compensation expense × 25%). The net impact on the 20X6 income statement is a tax benefit of $17 ($25 – $8). At settlement, the excess tax deduction of $13 would be recorded in the income statement.

An entity should consider the impact of cost-sharing arrangements when measuring, on the basis of the tax election it has made or plans to make, the initial and subsequent deferred tax effects associated with its stock compensation costs. If regulations in a particular jurisdiction vary significantly from those in the U.S. federal tax jurisdiction described above, the entity should consult with its accounting advisers regarding the appropriate accounting treatment.

Footnotes

The original example included in the discussion document for the FASB Statement 123(R) Resource Group’s July 21, 2005, meeting was developed before the issuance of ASU 2016-09. The example has been modified herein to reflect the guidance in ASC 718-740-35-2, as amended by ASU 2016-09, which indicates that all excess tax benefits and tax deficiencies should be recorded in the income statement.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.