Tech start-ups may see change in the way the ATO sees their employee share plans after review.
After attending the government's first consultation meeting to discuss the problems with employee share plans in Australia, I see a glimmer of hope for the recently announced employee share plan review.
Around the table at the consultation meeting were many of the battlers I have lamented with over the years about how the Australian tax regime makes employee options for early stage companies a joke. Yet I think we all came out with a sense that the winds of change may be picking up.
Nick Abrahams, from Norton Rose. Photo: Supplied
Damien Tampling, technology leader for Deloitte, who has done a lot of work in the area, says "It is clear from the rhetoric around this review that the government recognises the importance of the issue".
No less than seven ministers in the Abbott government have gone on record as saying the issue needs to be resolved. This, combined with the government's distancing of itself from the Gillard government's previous somewhat unhelpful Discussion Paper on the issue (it has been removed from all government websites) leads me to think the message may have gotten through.
Government is rightly concerned with ensuring that any changes do not adversely affect tax revenue.
It seems unlikely that much revenue has been raised from early stage companies by the existing tax on options as most fast-growth companies either elect not to grant options or, if they do, use synthetic-option schemes such as that used by Bigcommerce.
Synthetic options arrangements mimic the financial impact of options to employees but do not result in a tax on the employee at the time of grant. The problem is that they are expensive to set up and administer, requiring the assistance of lawyers and accountants – soaking up money that the company could use on developing its business.
The government has asked industry to help it find a solution. At the risk of upsetting some people, here are some pragmatic thoughts:
1. Restrict the changes to start-ups
There are issues with the employee option regime which impact more than just early stage companies. We are far from world's best practice in the area. However, the reality is that the revenue impact of broader changes may make it unpalatable for Treasury. According to start-up guru, Phil Morle of Pollenizer, "start-ups are where the major pain is felt, so let's focus on resolving that issue".
2. How do we define start-ups:
I think we need a bright line so companies know clearly if they are in or out of the definition. Some key factors might be:
- annual revenue less than $15 million (we have precedent for this type of threshold in the privacy legislation which does not apply to companies with revenue less than $3 million).
- been going less than 10 years
- is not in an excluded category, for example not in real estate development.
3. Taxing point
Presently employees are taxed either at the time the options are given to them or on vesting, instead of on exercise of the options. This leads to the unusual situation where an employee in an early stage company is given options as an incentive but the options actually create an unfunded tax liability for them in the year of grant of the options or in the year the options vest. A bit like being taxed on the potential prize value of a lottery ticket before the lottery is even drawn.
The taxing point should be when the options are exercised and the employee is in a position to sell the options (or shares received on exercise of the options). That means they are taxed when (and if) they can realise money from the options.
Currently the options are required to be valued using a complex methodology. The valuation of the options should be simplified to be the greater of:
- net asset value calculated using Australian Accounting Standards; and
- the valuation given to the company in a recent third party investment.
Employee share schemes need to be simple to create and manage. In fact it would be preferable that there be standardised documents for such schemes. Tampling says "It is very helpful to look to the UK approach. Their taxation authority, the HMRC, actually has a standard set of share scheme documents available on their website."
This simplicity makes it very easy for companies to implement options plans. It is part of a drive by the UK government to attract innovative companies with tax and other incentives. A drive that clearly works as Atlassian has recently made the decision to re-domicile there.
It is clear that the government has heard the message and is interested in rectifying some of the major issues around the current employee share scheme regulation as it relates to early stage companies. We should aim to have a globally competitive structure that attracts and nurtures innovative companies.
How far reaching the changes are will depend on how much noise can be made now. So have your say but do it soon. Submissions can be made here until February 7.