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Glimmer of hope for start-up employee share plans

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Nick Abrahams

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Opinion

Tech start-ups may see change in the way the ATO sees their employee share plans after review.

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.

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.

4. Valuation

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.

5. Simplicity

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.

Nick Abrahams is a technology partner with global law firm Norton Rose Fulbright and a technology investor. Follow Nick on Twitter: @NickAbrahams

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3 comments

  • I think your point 3 is not right, in that what you desire is already in place. You are not taxed unless the option or share grant is actually exercisable. In other words, you can sell them to fund your tax liability. If the option or share grant CANNOT be exercised or sold (i.e. it is in a holding lock, or subject to certain individual or company performance hurdles being met) then they are NOT a realisable asset but a theoretical one (you might not ever get them) and hence you are NOT taxed.

    You might be thinking back to what was originally proposed by the previous government, which would have had the effect you say. But they were convinced to change the legislation before it became law.

    Re point 2 - 10 years is way to long to be called a "start up". 3-5 years max.

    Commenter
    Employee
    Location
    Sydney
    Date and time
    February 07, 2014, 1:36PM
    • The Labor government(s) screwed up the rules on employee share schemes, partly due to their usual spite-and-envy attitude, and partly because they didn't know what they were doing.

      Hopefully Nick Abrahams is right when he says that the current govt is aware of the problems and wants to fix them.

      Commenter
      Vivian
      Date and time
      February 07, 2014, 6:39PM
      • I understand the desire to limit this to start up organisations. But as you acknowledge there are significant problems for larger organisations too. Employee share options are a useful tool to align employees with owners. However the current taxation regime encourages a short term approach as employees quickly exercise options and sell the shares in order to fund the tax liability. Employees who don't exercise run the risk of paying tax on options that may later reduce in value, with no possibility of a refund from the tax office. In no way can this be considered fair.
        It would be far preferable to defer taxation for everyone until the option is actually exercised, or even better, when the share is actually sold and converted to cash.

        Commenter
        Innovator
        Location
        Exporting worldwide
        Date and time
        February 13, 2014, 5:30PM
        Comments are now closed