Employee share scheme tax systems set for an update

The federal government is set to consult with Australian industry over the tax treatment of employee share option schemes, which start-ups say needs to be overhauled to promote growth.

The government is aware the current tax situation around employee shares creates difficulties for some sectors of the economy, especially start-ups, and will consult with industry on the impact of tax and administration requirements for the schemes, StartupSmart has been told.

Revamping the tax treatment of employee share option programs is fundamental to growing the start-up sector in Australia, says Malcolm Thornton, investment director at venture capital fund Starfish Ventures.

“It’s a key currency that people employ to keep highly talented people on board while conserving cash,” says Thornton.

The start-up sector can expect consultations with the relevant federal government departments in the future, with sources telling StartupSmart the government is aware the current tax situation around employee shares creates difficulties for some sectors of the economy, especially start-ups.

Employee share option programs enable start-ups to attract and retain leading talent to their company by offering staff a proportion of the future company on top of the (often low) wages they are able to pay.

The complexity of the current system has held Australian start-ups back from embracing the system. A key drawback is that employees can become liable for significant amounts of tax based on the asset’s value, even if it’s not currently earning any capital.

Thornton says an update of taxation rules around the program is “imperative” for the start-up sector.

“It’s completely complicated and convoluted in Australia, compared to when our companies are US-based, and we can just take a program off the shelf and every lawyer in San Francisco knows how to manage the process.”

Thornton says the current system fails to grasp the variety of companies that would benefit from the implementation of such schemes.

“Start-ups and high growth companies have very different characteristics to large, mature multi-decade companies,” he says.

“One of the key elements to appreciate is that there is little to no value in the options until the company has grown and either lists or is acquired.”

Alan Downie, chief executive and co-founder of BugHerd, a visual bug tracker for web developers, has recently implemented an employee share scheme for one of his six staff and is working on setting the scheme up for another employee.

“It’s a critical issue for start-ups,” says Downie. “As a start-up you don’t have a lot of cash so it’s the way to keep talent. If you have to compete with guys like Telstra and Atlassian for developers, all you’ve really got is the growing company equity.”

Downie and his co-founder Matt Milosavljevic spent 12 months working out how to implement the scheme for their first hire, a developer.

“It was a very long and tedious and expensive process,” he says. “There is no standard way to do it and that’s the problem.”

“When our developer started with us, he was on a third of what he could make as a developer. But he was so engaged and he got we didn’t have the money, so it was really important to him to get a piece of the company.”

Downie says he spoke to four accountants, a few lawyers and several entrepreneurs about how to implement an employee share scheme, and they all had different answers.

“It’s still not ideal for the employee, as they still have a bit of uncertainty. From the employer’s point of view, you want to have solid understanding of what the government wants, rather than jumping through hurdles.”

He says the Australian Tax Office hasn’t spoken to any of the parties involved, so it’s still untested.

According to a report by the ABC, the employee share options scheme will be explored in the next update to the National Digital Economy Strategy.

This article first appeared on StartupSmart.