With stock options being taxed immediately, start-ups are being held back.
Start-up companies across the country are hoping Joe Hockey and the federal government follow through with a pre-election promise to fix the employee share option tax rules.
Start-up companies typically have little cash to splash around, so having methods at their disposal to attract and retain the best people is critical. One way has been to grant shares or stock options to key personnel, with the aim of getting them to buy into the vision, and giving them a promise of some ‘blue sky’ on the upside if everything works out well.
The trouble with this latter ploy has been that, since 2009, all such employee share schemes have been subject to an immediate tax liability for the staff members concerned.
This is not such an issue for public-listed companies where the shares might be tradeable. Founders of fledgling start-up companies, however, are hardly going to be dishing out options if they are merely handing their staff more tax to pay in their current financial year.
Given that these shares and options are usually illiquid, and (in many cases) not going to amount to any pay off at all, it would take a brave employee to leap at the chance to be granted such a ‘benefit’.
It actually becomes a disincentive to work in a start-up at all.
“Employee stock options are critical for attracting and retaining top talent to a start-up. But they’re more than that; I think they're the right way to treat people,” Perth-based mining mobile software company Synaptor’s managing director, Justin Strharsky, told Business News.
“I want to build a company in which everyone is motivated by a sense of shared ownership and direction. I certainly don’t want to slap a new hire with a tax liability, so I’d love for the regulations to change.”
WA Angel Investors president Greg Riebe believes changes to the tax regulations would be a benefit for small businesses struggling to secure a foothold in the market.
“We need a much better tax regime for start-ups,” Mr Riebe told Business News.
“It’s all about aligning incentive with reward.”
StartUp Weekend organiser Sam Birmingham said the current employee share option tax rules were a disincentive to business.
“If Australia’s economy is to evolve and thrive, surely we should be making it easier for founders, not harder,” he said.
Last year in opposition, Mr Hockey described the tax rule as a “massive handbrake” on start-ups and promised to fix the employee share option tax rules if a coalition government were elected.
In his current role as communications minister, Malcolm Turnbull said he had met Australian start-ups that had moved to the US in order to get around this issue. In the US, employees are only taxed when they yield a gain from their options or shares, not immediately as in Australia.
Last month, the government held a two-week consultation on this issue, with interested parties invited to make written submissions.
Business News has seen one such submission from legal firm Squire Sanders.
One of the authors of the submission, Louise Boyce, was in Perth last week.
“Before 2009, companies had the choice to defer the tax liability or pay upfront. Since 2009, employees are taxed upfront on market value and at the top marginal tax rate”, Ms Boyce told Business News.
“In some companies the shares can be traded so that is fine, but for start-ups this is not often possible. We need these companies to stay in Australia, and not be restricted by doing so.”
Investment director of Perth-based venture capital fund Yuuwa Capital, Matt Mcfarlane, has years of experience in investing in Perth’s start-up sector. He said having an option tax exemption for growth companies would be a great improvement for tech oriented start-ups.
One issue here is how to define a start-up company – is it determined by the number of staff, turnover or growth of the business?
“The government could set a limit in terms of number of employees of the company, scale of revenues, profitability or even age of business as limits and I would applaud any movement,” Mr Mcfarlane said.
Although the submission process was swift, there is a feeling among the start-up community that the government might do something about this issue in the upcoming federal budget in May. Certainly many people involved in Western Australia’s burgeoning start-up sector in are hopeful this will be the case.
Charlie Gunningham is an internet entrepreneur and GM of Digital at Business News