Employee share schemes review leaves experts sceptical about reform

While the start-up sector has welcomed the review of the employee share scheme options taxation regime, the discussion paper recently released by Treasury has some industry experts concerned for the review process.

Employee share schemes allow start-ups to attract and retain high-quality talent with lower wages in return for stock options. The government announced a review and industry consultation plans in June.

The review process is suspended as the federal government is in caretaker mode before the federal election.

Australian Information Industry Association (AIIA) president Suzanne Campbell told StartupSmart the start-up ecosystem needed to stay engaged in the process to ensure a workable new system was implemented.

She says the recently released discussion paper was cause for concern for the start-up industry, as it showed a fundamental misunderstanding of the situation.

“Start-up people need to engage in the process, when it resumes,” Campbell says. “It misunderstood the essential nature of start-ups, and tech start-ups especially. When they resume the process, we’re keen to ensure they do so with a clearer understanding of Australian tech start-ups and how successful and unsuccessful they can be.”

Campbell says the discussion paper didn’t take into account that start-ups are under-resourced, often struggle with cashflow and frequently fail. She says the current system requires small teams to undergo the same onerous processes to value their shares as listed companies.

“Essentially, 90% of Australian start-ups fail, so we need to do something about that but what we can do now is fix the taxation treatment. It’s unrealistic to imagine the world is other than what it is, and it’s really very risky for start-ups, and Australia’s tax system needs to recognise that,” Campbell says.

She says the paper assumes there is a market for these “highly uncertain options” and fails to demonstrate that an unsuccessful business may have no value. Both of these factors are key to why start-ups shouldn’t be taxed upon acquiring the shares, but as they become valuable.

“The paper doesn’t demonstrate anything other than lip service to the issue of options addressing the issue of chronic cashflow,” Campbell says. “It tries to limit the potential risk by applying a new and very narrow, I’d say mean-spirited, definition of ‘start-up’ for its own purpose. I guess we should be glad of a little bit of innovation from Treasury, but it’s not for a good outcome.”

Campbell adds the expectation that a more start-up friendly employee share scheme system would result in revenue loss was “old school thinking” that didn’t grasp the financial boon that an empowered start-up sector would be to the wider economy.

Despite issues with the paper, Campbell says she’s hopeful a more feasible tax regime will be created in the next few years.

“I’m optimistic because this is an issue that has to be resolved. We’re part of a global economy, and we’re competing for talent and revenue, so it’s ridiculous to assume we can keep being uncompetitive. We have no option but to fix this,” Campbell says.

Amanda Heyworth, company director and an investor with a long history in the start-up sector, agrees the paper has too limited a definition and fails to understand the reality tech start-ups live in.

Describing the discussion paper as “boring and arcane”, Heyworth says the government can do three things to create conversation and updated employee share scheme system.

“Tax should be payable when the option results in cash for the employee; valuation methods should be simple and realistic for start-ups and the reform needs to be more broadly targeted than the paper’s new definition of start-up,” Heyworth says, adding that the government already has an adequate working definition of start-up in its R&D tax break legislation.

Heyworth, who was a Federal Treasury economist early in her career, says she understands Treasury’s desire to protect revenue and ensure policies are tightly targeted, but it needs to do more to understand who the policy is designed for.

“With the typical tech start-up, every penny is going back into the business to build the future, and your focus is on capital growth rather than benefits or high wages. Employee share schemes are a really good way of getting everyone – founders, investors and incoming management – on the same page, and focused on what matters, which is capital growth,” Heyworth says.

Heyworth is also optimistic about the employee share schemes review, as both sides of government have agreed it needs to be reviewed.

“Our current system means we’re out of step with the rest of the world and the way it’s currently structured does impede our capacity to use options to recruit as well as we possibly can,” Heyworth says. “I can’t emphasise enough the importance of getting good people, as that’s what generates success, employment, wealth and productivity.”

A further discussion paper is due out in December.