Employee share scheme changes only first step: Startups

The federal government's move to change to the employee share scheme (ESS) is just the first step of many on the path to correcting the "market failures" that have created barriers for Australian startups, according to industry group StartupAUS.

The Australian government released its Industry Innovation and Competitiveness Agenda (PDF) on October 14, which outlined a number of industrial changes aimed at "strengthening Australia's competitiveness", according to Prime Minister Tony Abbott.

The report comes nine months after the government launched its review into the ESS, which saw it commence consultation with industry and stakeholders from late January.

"Our competitors are cutting taxes, reducing compliance costs, building infrastructure, and reining in government expenditure," said Abbott, in his foreword of the agenda. "We need do likewise if we are to compete with them."

Of particular impact on Australia's startup sector is one of the the agenda's key initiatives, Proposal 15 — to improve taxation arrangements for employee share schemes, with the document highlighting the importance of startups for Australia's economy.

"Job creation and productivity growth don't just happen in a vacuum; they are supported by entrepreneurship and a flourishing startup community," the government said in the document. "The difficulties that startups face in administering ESS and problems around the taxation of options make it clear that the tax treatment of ESS needs to improve.

"Entrepreneurs and startups are important for testing new ideas, developing new products and implementing new business models, and international research suggests that companies in which employees have an ownership interest are more productive than those that do not."

Under the current general income tax law, if an employee is given shares or options through an ESS, any discount received by the employee through the acquisition of the shares or options — relative to the market — is considered a benefit relating to employment, and, as such, put in the same taxation bag as income.

In 2009, changes were made to the ESS arrangements, which saw ESS shares taxed upfront — effectively ending the provision of ESS options to employees. Before 2009, employees could choose to have qualifying ESS shares or options taxed upfront or at a deferred taxing point.

Now, the government has said that as a start, it will reverse the changes made in 2009 to the taxing point option, with change set to apply to all companies, meaning that discounted options will generally be taxed when they are converted to shares, rather than when the employees receive the options.

The government's move to roll back the 2009 changes is good news for startups and other early stage businesses, which often substitute higher salaries for their ground-floor employees with shares that would pay off if the company becomes successful.

Hamish Petrie, founder and managing director of Australian taxi app booking service startup Ingogo, said the move would remove a "huge headache" for local startups.

"Under the old structure, we've had to spend a ton of money on legal and accounting fees to put a legal scheme in place for our employees," he said in a statement. "And it's not just the money; it's the management time that was basically being wasted on red tape.

"Having logical regulations in place will mean that startups and early stage companies like Ingogo can use more time and resources to build new products and drive more growth. Our international competitors in other markets haven't had to grapple with this wasted time and energy. If Australia is serious about competing globally against other countries in this space, we need to get rid of these kinds of barriers," he said.

While StartupAUS and other industry players have generally supported the move, the organisation argues that there is still a long way to go in the government's support of Australia's technology entrepreneurs.

"Startup AUS ... hopes that it will be first step of many to correct the market failures that create unnecessary barriers to high-growth new ventures, and herald a sea change in how Australia supports its burgeoning startup ecosystem," the organisation said.

Meanwhile, chief executive of the Australian Computer Society, Alan Patterson, applauded the report, which also outlined initiatives to promote science, technology, and mathematics skills (STEM) in schools. However, he argued that it lacks focus on digital literacy for small and medium enterprises.

"We commend government for their focus on STEM in schools, but the ACS would like to see more focus on technology," he said in a statement. "Whilst mathematics is hugely important, particularly for coding, we also need to think about the here and now. We need more people to better understand technology and how to apply it in the short term.

"The AU$3.5 million funding initiative for coding is most welcome. It's a powerful step in the right direction, however much more needs to be done," he said. "We must recognise basic coding as a foundation skill and build it into the national curriculum. This needs to start at a young age, so that our students are better prepared and equipped to compete globally, as other countries such as the UK have these programs in place."

For Google Australia's director of engineering and StartupAUS board member Alan Noble, the move to grow the focus of STEM subjects in schools will allow Australia to better capitalise on the digital economy.

"It is encouraging to see the government recognise the importance of a tech-savvy and technically educated workforce as essential to Australia's future," he said. "Capitalising on the digital economy will only be possible if we have people with the ICT skills necessary to develop products that can compete globally."