Gov­ern­ment’s tax plan for em­ployee share op­tions is dead on ar­rival

Scheme com­bines fun­da­men­tal prob­lems with re­stric­tions of stag­ger­ing in­ep­ti­tude

The Irish Times - - Business News - Brian Caulfield

On bud­get day, the Gov­ern­ment an­nounced that it would re­form the tax­a­tion of share op­tions with a new scheme to be known as the key em­ployee en­gage­ment pro­gramme (Keep). De­tails were sketchy, but the news was greeted with cau­tious op­ti­mism by start-up founders, staff and in­vestors. There had been an ex­ten­sive con­sul­ta­tion process with in­put from many quar­ters, in­clud­ing tax ex­perts fa­mil­iar with the work­ings of the start-up ecosys­tem.

There had also been a great deal of frus­tra­tion that the can had been re­peat­edly kicked down the road but, fi­nally, we were get­ting ac­tion.

The op­ti­mism evap­o­rated quickly when peo­ple read the Fi­nance Bill and re­alised that, as one en­tre­pre­neur put it on Twit­ter, the Keep scheme was “dead on ar­rival”.

There are sev­eral fun­da­men­tal prob­lems with the scheme. To be­gin with, it ap­plies only to new grants of op­tions from Jan­uary 1st, 2018. If you al­ready have share op­tions in a start-up, then tough, you will still be sub­ject to a pe­nal rate of tax­a­tion on any gain and the ex­tremely un­fair sys­tem where you may be asked to pay tax in ad­vance on money that you have not re­ceived and, in­deed, might never re­ceive. No at­tempt what­so­ever has been made to ad­dress the in­equities of the cur­rent tax­a­tion of share op­tions.

Beyond that, the re­stric­tions in the Keep scheme make it use­less for all but a small num­ber of com­pa­nies. In­deed, the most am­bi­tious, high-growth com­pa­nies are ef­fec­tively com­pletely ex­cluded.

Stag­ger­ingly in­ept

Some of the re­stric­tions are stag­ger­ingly in­ept. For ex­am­ple, a com­pany must re­main small (as spec­i­fied by the Euro­pean Union’s def­i­ni­tion of a small or medium-sized en­ter­prise – an SME) through­out the pe­riod that an op­tion is held. God for­bid that a start-up might be so suc­cess­ful as to out­grow the SME def­i­ni­tion – its staff will lose the ben­e­fit of the Keep scheme.

Sim­i­larly, the to­tal value of all out­stand­ing op­tions granted un­der the scheme must, at all times, re­main be­low ¤3 mil­lion. Many start-ups, in or­der to en­cour­age em­ployee par­tic­i­pa­tion and to com­pen­sate for what are, in many cases, be­low-mar­ket salary and ben­e­fit pack­ages, grant op­tions at that early stage over any­thing from 10-20 per cent of the own­er­ship of the com­pany. Even at a rel­a­tively mod­est val­u­a­tion of, say, ¤25 mil­lion for the busi­ness, this ¤3 mil­lion limit could be ex­ceeded. This means that Keep treat­ment will not ap­ply to most op­tions granted in even a modestly suc­cess­ful com­pany.

Com­pa­nies will fre­quently be forced to main­tain two sep­a­rate op­tion schemes. It also cre­ates a per­verse in­cen­tive for com­pa­nies to sell early to pre­serve Keep tax treat­ment on op­tion grants. Pre­sum­ably not what was in­tended.

The Keep scheme also greatly re­stricts the type of com­pany that may qual­ify. Many fin­tech, pharma and ser­vices com­pa­nies will be in­el­i­gi­ble. Any com­pany that has, for ex­am­ple, in­cor­po­rated in the US to fa­cil­i­tate in­vest­ment will also be ex­cluded as com­pa­nies must be regis­tered in Ire­land to ben­e­fit. It will also only be pos­si­ble to grant Keep op­tions to full-time em­ploy­ees. Ad­vis­ers and non-ex­ec­u­tive di­rec­tors, who fre­quently play a key role in the de­vel­op­ment of early-stage com­pa­nies, are ex­cluded.

The re­stric­tions on in­di­vid­ual grants are also ex­tremely prob­lem­atic. It won’t, for ex­am­ple, be pos­si­ble to use Keep op­tions to at­tract that rock-star, US prod­uct man­ager you were hop­ing to tempt with a 1 per cent op­tion grant. Nor will you be able to use Keep op­tions to re­tain key staff on low salaries at the early stage. be­cause grants are re­stricted to less than 50 per cent of salary value.

Con­sul­ta­tion process

We have to ask our­selves how, af­ter many years of pa­tient lob­by­ing and an ex­ten­sive “con­sul­ta­tion process”, we have ended up with such a dis­ap­point­ing and, in­deed, mys­ti­fy­ing re­sult. Many, many sub­mis­sions have been made by in­di­vid­u­als, or­gan­i­sa­tions such as the Ir­ish Ven­ture Cap­i­tal As­so­ci­a­tion, Ir­ish Soft­ware As­so­ci­a­tion and oth­ers. Th­ese have set out clearly the prin­ci­ples that should gov­ern a re­formed sys­tem. Tax ex­perts fa­mil­iar with the op­er­a­tion of start-up busi­nesses have pre­pared draft leg­is­la­tion il­lus­trat­ing what’s re­quired. So how have we ended up with another, to all in­tents and pur­poses, use­less scheme?

It would be easy to con­clude (once again) that the Depart­ment of Fi­nance just doesn’t un­der­stand start-ups. But that’s too easy given the level of dis­cus­sion and con­sul­ta­tion that has taken place and the in­put that has been given to the depart­ment. Other lob­bies have achieved re­mark­able re­sults. The 9 per cent VAT rate for tourism has been re­tained in the face of rapidly es­ca­lat­ing ho­tel prices.

Prop­erty in­vestors who pur­chased prop­erty in re­cent years with 0 per cent cap­i­tal gains tax on gains have seen the time for which they must hold the prop­erty short­ened from seven years to four.

It is dif­fi­cult not to con­clude that start-ups, and the en­trepreneurial com­mu­nity gen­er­ally, are sim­ply not a pol­icy pri­or­ity for gov­ern­ment. And, yes, the depart­ment doesn’t un­der­stand start-ups and doesn’t seem to un­der­stand share op­tions ei­ther. That’s pretty dif­fi­cult to fathom in an en­vi­ron­ment where our of­fer­ing for for­eign di­rect in­vest­ment, which has been the bedrock of Ir­ish pros­per­ity for decades is be­ing as­sailed from all sides.

From the com­mon con­sol­i­dated cor­po­rate tax base to the pro­posed EU turnover tax for large dig­i­tal busi­nesses and the Trump gov­ern­ment’s cor­po­rate tax re­duc­tions and in­creas­ing pres­sure on large US cor­po­ra­tions to “bring jobs home”, threats are ev­ery­where. It has never been more im­por­tant to de­velop strong in­dige­nous com­pa­nies of global scale and am­bi­tion. But to do that we must cre­ate the right en­vi­ron­ment for young com­pa­nies to grow and thrive.

Per­cep­tive and rel­e­vant

The start-up com­mu­nity also has ques­tions to an­swer. I was once asked by Martin Fraser, sec­re­tary-gen­eral of the Depart­ment of the Taoiseach: “Who do I call if I want to talk to the start-up com­mu­nity?”

That’s a per­cep­tive and rel­e­vant ques­tion. It’s clear who he should call to talk to the farm­ing com­mu­nity, big busi­ness or the tourism sec­tor. The start-up com­mu­nity needs to get or­gan­ised.

Brian Caulfield is an en­tre­pre­neur, ven­ture cap­i­tal­ist, and gen­eral part­ner at Draper Es­prit. He cur­rently sits on a num­ber of boards in­clud­ing Datahug, Mo­vid­ius, MTT and The Ir­ish Times


It would be easy to con­clude that the Depart­ment of Fi­nance just doesn’t un­der­stand start-ups

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