Employee Share Schemes and Start Up Companies

Transcription

1 Employee Share Schemes and Start Up Companies AIIA Response February Torrens St Braddon ACT 2612 Australia T E info@aiia.com.au W

2 Introduction The Australian Information Industry Association (AIIA) is the peak national body representing Australia s information technology and communications (ICT) industry. Since establishing almost 35 years ago, the AIIA has pursued activities aimed to stimulate and grow the ICT industry, to create a favourable business environment for our members and to contribute to the economic imperatives of our nation. Our goal is to create a world class information, communications and technology industry delivering productivity, innovation and leadership for Australia. We represent over 400 member organisations nationally including hardware, software, telecommunications, ICT service and professional services companies. Our membership includes global brands such as Apple, EMC, Google, HP, IBM, Intel, Microsoft, PWC, Deloitte, and Oracle; international companies including Telstra; national companies including Data#3, SMS Management and Technology, Technology One and Oakton Limited; and a large number of ICT SME s. AIIA is pleased to provide this response to the Government s current Employee Share Scheme (ESS) and Startups consultation process. We would also like to thank Treasury for the opportunity to participate in the face-to-face consultation in Sydney on 31 January. Page 2 of 7 7 February 2014

3 Overview AIIA has advocated strongly to amend current Employee Share Scheme (ESS) arrangements since their introduction under amendments made to the Income Tax Assessment Act in The position outlined in this paper is informed by direct member feedback in the period since and more recently by member participation in the Deloitte Barriers to Innovation survey conducted in September/October The survey included 130 companies, 55% of which were operating in technology, media and telecommunications sector. AIIA does not support current ESS arrangements. AIIA believes, as a matter of principle that the current policy is inequitable for all companies irrespective of size. AIIA believes that a policy that effectively taxes employees where no financial benefit is realised is flawed for businesses irrespective of size and age. AIIA s position is that employees should only be required to pay tax on shares or options when they are able to realise the benefit for cash (i.e. the shares become liquid). AIIA does not support a policy in which tax is paid on a theoretical issue price : firstly because the issue price is theoretical and secondly because employees may never receive a benefit or receive a benefit less than the value on which they have paid tax upfront. AIIA therefore advocates the following. That Government: acknowledge that current ESS arrangements are inequitable for businesses, irrespective of size; on the basis that it is inequitable and difficult to arbitrarily draw a line by exempting a defined class of businesses, commit to a staged reform process, repealing current legislation and reverting back to pre-2009 ESS arrangement; in recognition of the particularly adverse impact of current ESS arrangements on start-ups and SMEs, take immediate action to reform current ESS requirements for these companies (Stage 1) o for the purpose of simplicity, that this group is defined by the accepted definition of SME 1 ; o additionally, for the purposes of lower costs of operation for all parties that standardised documentation for ESS be accessible on the ATO s website in the context of the , repeal current arrangements for remaining businesses and as deemed necessary, impose more rigorous compliance arrangements to ensure policy objectives and intended outcomes are aligned; o AIIA understands that there are various mechanisms that could be applied such as withholdings and limits to deferrals for larger enterprises should the Government remain concerned about potential revenue impacts; commit in the future to evidence based policy reform, giving explicit consideration to the impacts and implications of proposed policy reform within the broader business and innovation eco-system. 1 As defined by the Australian Bureau of Statistics: organisations with less than 200 employees Page 3 of 7 7 February 2014

4 Comments Building an innovation eco-system to drive business and economic growth As has been acknowledged by the current Government in their pre-election Digital Economy Strategy, innovation is central to making Australia more productive and more competitive. This is imperative for Australia participant in the global digital economy successfully. Achieving this, as acknowledged by successive governments, requires an effective enabling eco-system which provides the right incentives, support mechanisms and opportunities for individuals and businesses to innovate and grow. Enabling businesses to achieve their growth aspirations is good for business, the economy and society generally. The eco-system that stimulates innovation and growth is complex. It is multi-dimensional, requiring a balance of incentivising levers (e.g financial relief, compensation or reward), appropriate regulation, enabling policy and alleviation, if not removal, of potential obstacles to innovation. Employee Share Scheme arrangements are a part of this eco-system. They provide a mechanism to manage risk and drive innovation through the attraction and retention of appropriate talent, particularly for start-up companies with limited access to capital and cash flow. Similarly important are related innovation enabling policies such as R&D tax incentives, crowd sourcing and micro funding arrangements. To achieve the overarching objectives of innovation and ultimately growth and productivity benefits the ecosystem must be in balance. As AIIA has raised in other fora, we remain concerned that the complexity of this eco-system is under estimated and that the focus on point solutions or worse still, isolated policy decisions driven by short term revenue imperatives, is undermining the effectiveness of the system. It is our view therefore that a holistic approach to stimulating innovation and growth is required. As demonstrated by the 2009 changes to ESS arrangements, ad hoc perverse policy changes driven by motives inconsistent with innovation policy have an overall detrimental impact on the system. Role of Employee Share Option Schemes AIIA notes the explanation provided by Government at recent public consultations that the rationale for current ESS up front taxation arrangements is that the shares/options are considered to be in lieu of income and therefore deemed to be income at the time of employee receipt (irrespective of the fact they are not liquid). This implicitly and incorrectly assumes that a key motivation for the adoption of ESS by companies and employees is to reduce taxable income and hence tax liability. AIIA does not agree with this proposition. An effective ESS framework is an important mechanism to recruit, motivate and reward employees grow their company and in the case of start-up companies drive innovation. They are also an important mechanism to overcome the invariable cash flow constraints of start-ups. Page 4 of 7 7 February 2014

5 Across the ICT sector, the challenge for all companies, irrespective of size is the lack of suitable talent and difficulty in retaining talent. This is particularly true in our global economy where good people and good ideas are highly mobile. Failure to respond to this reality poses considerable risk to the Australian economy whereby uncompetitive tax arrangements risk us losing both (people and ideas) offshore. Concerns regarding current arrangements Based on recent analysis undertaken by Deloitte 2, current arrangements for ESS have resulted in a decline in the use of these arrangements by businesses, particularly innovative tech start-ups, looking for ways to attract and retain quality talent to drive business growth. While some 95% of the Deloitte survey respondents said they felt it is important to offer an ESOP to attract and retain talent in the medium to long term, less than 65% actually have them, sighting administrative complexity and current unfavourable tax treatment. Some 60% of companies participating in the Deloitte survey have discontinued ESS arrangements following the 2009 tax changes and have not replaced it. The fact that both larger companies (i.e. listed companies) and start-ups in other countries (e.g. the USA, UK, Israel and Singapore ) are able to offer greater cash and/or offer either ESOPs or tax-qualified ESOPs is regarded as a major impediment to attracting and/or retaining the talent required to drive business growth in Australia, and holding innovative businesses in Australia. A highly relevant report by Baker & McKenzie, provided to Treasury in , comparing Employee Share and Option Schemes from 41 leading industrial economies shows that both the USA and Israel allow the deferral of tax until employee options have been exercised and the resulting shares are sold for a net cash benefit to the recipient of the options. (In the case of the USA, some relatively simple conditions need to be fulfilled) AIIA is a strong advocate for start-up businesses and small and medium sized enterprises (SMEs). Indeed we would emphasise the very important contribution of early stage technology companies to a nation s innovative and entrepreneurial activity. The Australian tech start up sector has the potential to contribute $109 billion or 4% of GDP to the Australian economy and 540,000 jobs by 2033 with a concerted effort from entrepreneurs, educators, the government and corporate Australian. 4 These companies face particular challenges recruiting and retaining employees given the nature of the skills they require,, the fact that they are often under resourced and high risk with significant potential for failure,. One way to address these challenges is for early-stage technology companies to attract employees by packaging lower remuneration with shares or options. This enables early-stage technology companies to compete for staff against established companies offering more secure employment and allows scarce risk capital to be preserved. 2 Submission on Employee Share Schemes and Startup Companies: Administrative and Taxation Arrangements. Deloitte, February PwC Consulting, The startup economy. How to support tech starts and accelerate Australian innovation, April 2013, Page 5 of 7 7 February 2014

6 Current arrangements are especially detrimental for innovative start-ups and SMEs with limited access to capital and cash-flow, competing for staff and significant completion for skills in a globally competitive market place. With these points in mind, AIIA s key concerns regarding current arrangements are outlined below. Australia s current tax regime in relation to the treatment ESS leads to perverse results for innovative ICT companies and employees: o it taxes employees at the point that a share and option grant is made, before any gain is realised and without taking into account that, in many cases, no financial benefit will be ever be realised; o it requires unlisted companies to undertake an excessively complex and costly process with an inherent negative impact on productivity, to value unlisted shares and options. In the case of private, unlisted companies, there are no buyers or market for early-stage company options shares cannot be traded. Irrespective of an estimated or perceived value, this value may never be realised. This is particularly the case for start-up companies 5. The requirement to pay tax upfront on an option can result in a scenario whereby an employee is taxed at a rate higher than the income or capital gain which may/may not be realised when the options are exercised or sold. This is exacerbated by the fact that any capital loss suffered by an employee cannot be offset against income earned. Current arrangements are complex and costly for companies to administer. o ESS arrangements are complex for companies to establish and administer and valuation requirements costly. o The consensus is that existing formulaic valuation methodologies are difficult to administer and inequitable. Current arrangements disincent businesses to innovate, operate and grow in Australia creating a real risk that smart, innovative, home-grown companies will move off-shore. 5 Silicon Beach. Building Momentum. A study of the Australian Startup Ecosystem Page 6 of 7 7 February 2014

7 AIIA position AIIA does not support current ESS arrangements. AIIA believes, as a matter of principle that the current policy is inequitable for all companies irrespective of size. Notwithstanding AIIA s strong support for start-up companies, a policy that effectively taxes employees where no financial benefit is realised is equally flawed for businesses irrespective of size and age. AIIA s position is that employees should only be required to pay tax on shares or option when they are able to realise the benefit for cash (i.e. the shares become liquid). AIIA does not support a policy in which tax is paid on a theoretical issue price : firstly because the issue price is theoretical and secondly because employees may never receive and benefit to the value on which they have paid tax upfront. While AIIA has not seen any evidence to suggest that reverting to pre-2009 ESS arrangements will have a detrimental impact on Australia s revenue, we concede that we are currently operating in a fiscally constrained environment and that this heightens perceptions of risk to revenue. AIIA therefore advocates the following. That Government: acknowledge that current ESS arrangements are inequitable for businesses, irrespective of size; on the basis that it is inequitable and difficult to arbitrarily draw a line by exempting a defined class of businesses, commit to a staged reform process, repealing current legislation and reverting back to pre-2009 ESS arrangement; in recognition of the particularly adverse impact of current ESS arrangements on start-ups and SMEs, take immediate action to reform current ESS requirements for these companies (Stage 1) o for the purpose of simplicity, that this group is defined by the accepted definition of SME 6 ; o additionally, for the purposes of lower costs of operation for all parties that standardised documentation for ESS be accessible on the ATO s website in the context of the , repeal current arrangements for remaining businesses and as deemed necessary, impose more rigorous compliance arrangements to ensure policy objectives and intended outcomes are aligned (Stage 2); o AIIA understands that there are various mechanisms that could be applied such as withholdings and limits to deferrals for larger enterprises should the Government with to control potential revenue impacts; commit in the future to evidence based policy reform, giving explicit consideration to the impacts and implications of proposed policy reform within the broader business and innovation eco-system. 6 As defined by the Australian Bureau of Statistics: organisations with less than 200 employees Page 7 of 7 7 February 2014