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.
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.
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.
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