The (not so) Hidden Impact of IFRS 2 – What is it doing to you now?

1. The (not so) Hidden Impact of IFRS 2 – What is it doing to you now? San Francisco Chapter Meeting National Association of Stock Plan Professionals January 11, 2012 Valerie Diamond – Partner, Baker & McKenzie LLP Barbara Klementz – Partner, Baker & McKenzie LLP

2. Agenda • IFRS 2 Primer • Impact on Tax Withholding Methods • Impact on Tax Withholding/Reporting Obligations • Impact on Corporate Recharge Arrangements

3. What Are IFRS & IFRS 2? • International Financial Reporting Standards (IFRS) are an alternative to local GAAP and intended to provide for consistent financial accounting across borders • International Financial Reporting Standard 2, Share-Based Payment (IFRS 2) deals specifically with financial reporting for share-based payments • IFRS 2 and Topic 718 generally similar -- like Topic 718, IFRS 2 requires entities to recognize an expense, measured at fair value, for share-based payments • However, certain differences between Topic 718 and IFRS 2 – convergence challenges

4. When Will IFRS 2 Apply? • Effective for annual periods beginning on or after 1/1/2005 (accounting impact for all unvested awards granted since 11/7/2002) • BUT IFRS must be adopted by a country to apply to that jurisdiction • Countries are adopting IFRS at different rates with different effective dates • EU adopted IFRS in 2005; since then, over 120 countries have moved to require or permit the use of IFRS • However, US has not adopted IFRS to date and may not

5. Adoption of IFRS 2 in the US? • Nov. 2008: SEC issues proposed roadmap for adoption of IFRS in the US by 2014 • Voluntary conversion starting with FY2009 for certain large companies • SEC to decide in 2011 when IFRS becomes mandatory • Feb. 2010: SEC issues statement in support of single set of global accounting standards and that IFRS best positioned to be global standard (with timeline to adopt between 2015 – 2018)

6. Adoption of IFRS 2 in the US? • April 2011: FASB and IASB announce delay for completion of convergence projects (likely into 2012) • May 2011: SEC introduces concept of “Condorsement” • U.S. GAAP would continue to exist • FASB and IASB would complete current convergence projects • FASB focus to converge U.S. GAAP to IFRS for projects not included above • FASB would have a process to adopt new IASB standards into U.S. GAAP with or without U.S. modification • No decision regarding adoption of IFRS to date

7. Current Relevance of IFRS 2 • Local subs in countries which have adopted IFRS have to expense equity awards locally in compliance with IFRS 2 (while parent still expensing under GAAP) • If IFRS adopted, will likely affect equity awards previously granted • Need to prepare statements for prior 3 years • Even if not adopted until 2016, could affect awards that vest in 2014 and beyond

8. Key Differences Between ASC 718 and IFRS 2 • Valuation on tranche-by-tranche (IFRS 2) versus straight-line approach (ASC 718) • Liability accounting for net share withholding (IFRS 2) versus net share withholding above minimum statutory rate (ASC 718) • Different treatment of payroll tax liability • No SAFE harbor treatment for 5% discount ESPP • Deferred tax accounting • Preference for lattice or binomial model under IFRS 2

9. Impact on Tax Withholding Methods • Key Withholding Methods Used for Equity Awards by Most US Companies • Cash Owed to Employee/Salary • Net Exercise/Net Settlement • Cashless Exercise/Sale of Shares to Cover Tax Liability • Stock Swap • Check or Wire from Employee

10. Impact on Tax Withholding Methods Net Exercise/Net Settlement • US GAAP (ASC 718-10) • Use of minimum statutory rate avoids liability accounting • Outside the US, no statutory rate, but generally the employee’s marginal rate acceptable (RSUs easy to plan for but options more challenging) • IFRS 2 • Net share issuance triggers liability accounting (at least for net settlement portion -- remainder of award treated as equity instrument/fixed accounting) • IFRS staff paper from November 2010 – acting as principal paying cash to tax authorities, not as agent in cashless exercise • In theory, local entity should be taking method of withholding into account but may not always be doing so

11. Impact on Tax Withholding Methods Net Exercise/Net Settlement • IFRS 2 – Alternatives to Manage Issues • Switch to forced sale of shares or withhold taxes from salary or cash payment to avoid liability accounting • Forced sale of shares may raise… • Employee consent/broker authorization issues • Blackout period/10b5-1 arrangements • Withholding at maximum vs. minimum rates • Share count/dilution concerns • Tip: Draft grant documents now to provide flexibility to take taxes through all possible methods of withholding

12. Impact on Tax Withholding/Reporting Obligations • Payroll Taxes • US GAAP • Companies record payroll tax expense when liability accrues (e.g., exercise of options, vesting of RSU shares) based on intrinsic value • IFRS 2 – Accrued over service period • Estimate payroll tax liability and record expenses in advance • Accrued mark-to-market each quarter until liability determined • Not clear if local entity currently properly accounting for these expenses. How do you deal with caps/thresholds? • May make tax qualified plans more appealing (e.g., France, UK) and UK NICs joint election form (vs. promise) to shift liability at grant

13. Impact on Tax Withholding/Reporting Obligations • Local Entity Accounting Treatment May Alter Employer’s Withholding/Reporting Obligations • Brazil – new requirement to expense using IFRS 2 in statutory books of local entity makes it more likely withholding/social taxes due on award • Countries where no withholding/social taxes absent recharge of costs/local corporate deduction sought include: Belgium, Brazil, Chile, Colombia, Czech Republic, Indonesia, Korea, Mexico, Philippines, Taiwan and Thailand

14. Impact on Corporate Recharge Arrangements • Companies implement recharge arrangements for variety of reasons: • To obtain local tax deduction • Cash savings at local sub level • Decreased effective tax rate • Under Topic 718, availability of local tax deduction reduces book expense • Tax-free repatriation of cash under Section 1032

15. Impact on Corporate Recharge Arrangements • Availability of local tax deductions: • In a few countries (e.g., UK), statutory deduction is automatically available to the subsidiary in amount of taxable income to the employee (e.g., spread at exercise, FMV of RSU shares at vesting) • In a few other countries – NO tax deductions available (e.g., Canada, Netherlands) • Majority of countries tax deduction available only if … • Subsidiary bears the cost of the equity award • Cost charged by the issuer to the subsidiary is documented by a recharge agreement • Generally recharge agreement must be in place from grant • But, in some countries, exchange control approvals or other legal requirements limit availability of deduction

16. Impact on Corporate Recharge Arrangements • Section 1032 Considerations: • When US issuer recharges equity cost to non-US sub, it typically will limit amount and timing of payment to Code Section 1032 amount/timing. Why? • To avoid recognizing taxable dividend income in the US  amounts received by issuer for its own stock under Section 1032 are not treated as a dividend payment by the subsidiary • Amount and Timing under Section 1032 • Amount under 1032 is limited to spread at exercise (1.1032-3(b)) • Timing of payment must correspond to the issuance of the shares • Under Section 1032, tax-free repatriation of cash is possible even where no local tax deduction is available • But need to confirm no local tax or accounting charge

17. Impact on Corporate Recharge Arrangements Adoption of IFRS 2: • For countries where statutory deduction is available to sub, no changes • May increase number of countries in which local tax deductions available (even in the absence of reimbursement agreement) – Why? • Now that local entity has to expense equity cost, more likely to be considered true expense to local sub and, hence, deductible • May impact amount and timing of tax deduction • Possible that amount of local tax deduction will be limited to book expense under IFRS 2 (Japan?) • Uncertain whether the timing of this deduction would be as expense is booked or when exercise occurs

18. Impact on Corporate Recharge Arrangements Adoption of IFRS 2 (cont’d): • Code Section 1032 considerations: • If deductible amount greater than spread, reimbursement needs to be limited to spread to avoid 1032 issues • If deductible amount smaller than spread, may reimburse spread, unless triggers local tax or accounting charge • Consider delaying the timing for recharge of costs until settlement to avoid 1032 issues • Make sure recharge agreements are drafted appropriately!

19. Impact on Corporate Recharge Arrangements • Bonus Issue: Impact on Cost-Plus Entities • Local sub charges parent for its costs plus mark-up (e.g., 5%) • If in IFRS 2 country, increased cost due to expensing of equity cost • Results in additional taxable income to local sub (in the form of reimbursement from parent to sub of cost plus mark-up) • Important to offset additional tax through tax deduction for equity awards (but problem in countries where tax deduction not available)

20. Questions?????? Please contact Valerie Diamond or Barbara Klementz at Valerie.Diamond@bakermckenzie.com or Barbara.Klementz@bakermckenzie.com.