When Paul Bassat, the high-profile co-founder of job ad website Seek, warned on LinkedIn that the Albanese government’s plan to abolish the 50 per cent discount on capital gains would be “disastrous” for entrepreneurs and “set back the startup ecosystem in Australia by a decade or more”, it caused a big stir in the startup and tax community.
Some entrepreneurs see the logic in the federal government’s plan to reduce the capital gains tax discount on property investments to address housing affordability, but they think the government should carve out the start-up sector.
While the CGT change has not been officially confirmed by the government, there is speculation that Treasurer Jim Chalmers will announce in Tuesday’s federal budget that Labor will return to the pre-1999 inflation indexation model for capital gains for all asset classes, including property and shares.
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Whether that change is “grandfathered” or “transitional”, as some reports suggest, also remains unclear.
But what is certain is that such a change would not just stop some property investors from getting a big tax break when they sell up. It would also increase the amount of tax some shareholders pay if they make a gain when selling shares.
Investors argue it would particularly hurt startups, which rely on employee share schemes to raise funds.
Paul Bassat says if there is tinkering with CGT discount for shares, “founders will leave Australia in big numbers”. (ABC News)
“Founders will leave Australia in big numbers,” Mr Bassat warned in a series of posts on his LinkedIn page.
“At a time when we are about to see a tsunami of job shedding by existing businesses, Australia’s best hope is a wave of startup innovation. A ~50% tax on gains by founders and team members will have disastrous consequences.
“This is not about a pampered sector wanting to be treated differently, but a decision about the sort of country and economy we want.”
This view was echoed by others in the tech sector who spoke to ABC News.
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Startups often struggle to attract talent and conserve cash. One way to do it is to promise big returns if the startup hits Silicon Valley giant status.
For most of the time the startup runs, the company makes a loss. But the promise of a big payday, if the company goes public or is acquired, is what enables many startups to attract talent when they are competing with listed companies that can, initially, often pay far higher salaries.
Should a startup hit the status of Canva or Atlassian, that is the point that the founders and employees could choose to sell their company shares and receive a 50 per cent discount on their marginal tax rate for the capital gains, or profit, they made on their stake.
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Doing so can be highly lucrative once companies hit multi-million-dollar valuations.
“Employee share ownership is actually a pretty powerful mechanism for retention and loyalty and hard work,” said Alan Jones, a prominent Australian venture capitalist and general partner of M8 Ventures.
He told ABC News that big cash-out events for startup founders and employees “don’t happen very often; they may happen once in 10 years in a startup”.
Alan Jones says employee share schemes drive loyalty and hard work. (Supplied)
But asked whether that can be very lucrative for those that do cash out at the right time, he said: “Yeah, it can be. There are a number of millionaires at Canva, right?”
“But we also have to remember that the failure rate in Australian tech startups, startups worldwide, is very high.”
Mr Jones said he thought changes to the CGT discount would make it harder for startups to attract talent and hurt the local ecosystem.
“Why would I choose to take $200,000 in employee share options in an Australian startup and get taxed at 50 per cent. I can get paid more, pay almost no tax on my share options, just for putting up with a different lifestyle in San Francisco and New York.
“Or when I can go and be a software engineer at CommBank and get very well paid, have lovely conditions … do I go and join this little five-person team that are trying to disrupt CommBank?
“Odds are most of the startups trying to disrupt CommBank will fail, but if one of them succeeds, the people who started that company have an opportunity to make good money from that. They’ve taken a huge risk.”
Negative gearing, CGT and trusts explained
The speculated return to indexation for Capital Gains Tax (CGT) would mean that, instead of a blanket 50 per cent discount for assets held longer than one year, the initial value of the investment would be indexed by the Consumer Price Index, meaning that tax would be owed when the asset is sold only on any profit above inflation over the period it had been held.
That so-called “real” profit would then be taxed at the investor’s marginal tax rate, which is currently a maximum of 45 per cent plus the 2 per cent Medicare Levy.
Depending on the inflation rate, the rate of asset price growth, and the length of time the asset is held before being sold, the indexation method can sometimes result in a lower CGT tax bill than the blanket 50 per cent discount.
The indexation system tends to favour longer-term asset owners, while the current discount system is generally more favourable for shorter-term investments.
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Sally-Ann Williams is the former CEO at tech incubator Cicada Innovations and has worked in the sector for decades. She also fears unintended consequences.
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“We risk repeating the disastrous 2009 Employee Share Option Plan (ESOP) ‘tax on innovation’, which required a six-year struggle to secure a rollback and cost Australia an entire generation of startups,” Ms Williams told ABC News.
The 2009 changes to the taxation of Employee Share Schemes in Australia, referred to by some as the “tax on innovation”, altered how employee shares and options were taxed, largely removing the ability to defer tax on these instruments, which severely impacted startup and growth-stage companies.
“This [possible] proposed CGT change once again penalises the very people building our future,” Ms Williams said.
“At best, it is a grave unintended consequence; at worst, it is a strategic misstep that threatens to dismantle an ecosystem it has taken us decades to build.
“It’s really hard to start a business and grow a business in Australia. And we don’t need any additional handbrakes around that,” she said.
Sally-Ann Williams says a change to the CGT discount would make it harder for startups to attract talent. (Supplied: Sally-Ann Williams)
Board director and venture capitalist investor Stephane Chatonsky also fears a change to the CGT discount could make it harder to attract talent.
“Often, people move from a high-paying job to get into startups. Charging that capital at a rate of 47 per cent [assuming the employee is paying the top marginal tax rate plus the Medicare levy once they sell their shares] is tremendously unattractive,” he said.
“And if the employees don’t find it attractive in Australia, they’ll go elsewhere.”
Carving out employee share schemes from possible CGT discount change could create ‘complexity’
Mr Chatonsky said while he was supportive of changing the discount for property investors to deal with intergenerational wealth inequity, employee share schemes should be carved out.
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“Not everybody, even in Canva’s situation, is going to make millions and millions of dollars. For a lot of those employees who have started discounting their salary and take risk, this is the best way and the only way to get money to pay for a deposit for a property. Not everybody is going to make tens of millions of dollars.”
Ms Williams said she also wanted the government to consider a carve out.
“There’s no quick and easy fix to housing affordability, but let’s make sure that the unintended consequences of trying to fix that then also [don’t] put the handbrakes on business growth,”
she said.
But The Tax Institute’s tax counsel John Storey said, while there were merits to look at changes to the CGT discount, simplicity had to be a factor and any changes should apply to all asset classes.
He said carving out startups using employee share schemes would be complicated because it would mean “different rules apply for different assets”.
“There shouldn’t be carve outs. It will make a complex tax system far more complex,”
Mr Storey said.
“Are we just talking small business? Do we use existing definitions of small business? It does create all sorts of complexities.”
Mr Storey said there were other concessions for small businesses that could help reduce the capital gains, but “it’s not the next inventor of Google who cashes out for a billion dollars”.
COVID-time loss carry-back scheme may be back on the table
To help maintain business investment, Tuesday’s budget could also include a loss carry-back scheme that allows incorporated businesses to “carry back” losses from the current financial year against previously taxed profits.
During the pandemic, businesses that had aggregated turnover of up to $5 billion were able to carry back losses for several years and get big refunds, and there are suggestions the government may be looking at it again.
Some entrepreneurs think the government should carve out the startup sector if the CGT discount changes. (Unsplash: Annie Spratt)
FinTech Australia CEO Rehan D’Almeida said she welcomed any moves to reinstate the loss carry-back scheme, modelled on the measure that ran during the pandemic.
“Carry-back is one of the most cash-flow effective levers available to early-stage and scaling fintechs, which routinely cycle between profit and loss years as they invest in growth, talent and product,”
he said.
But he also remained concerned about the proposed changes to the CGT discount for startups.
“Penalising this type of incentive will damage the technology sector,” he said.
“The fintech sector already supports over 50,000 jobs directly and 100,000 jobs indirectly, and these changes could pose a threat to these roles.”
Mr D’Almeida said the group was also opposed to a proposal to lift the minimum threshold for the Research and Development Tax Incentive claim.
“The current threshold is an important means of incentivising local R&D by startups and further risks driving them offshore,” he said.
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