Labor on startup capital gains issues
Capital gains: Alex McCauley and Ed Husic at the StartupAUS - InnovationAus.com briefing
Labor has been urged to consider the impact of its planned changes to the capital gains tax on the Australian tech sector and whether a startup exemption is needed if it wins Saturday’s federal election.
The Opposition announced its plan in 2016 to halve the capital gains tax (CGT) concession from 50 per cent to 25 per cent. The capital gains tax applies to the appreciation of assets held for more than 12 months.
While Labor’s policy is largely targeted at property investors, there are concerns among startups that it could have an unintended impact on the industry, both on founders and investors, StartupAUS CEO Alex McCauley said.
“Some founders are very concerned about the potential impact of these changes, and I’ve had quite a few queries about it,” Mr McCauley told InnovationAus.com.
“Others are less worried because it won’t impact them directly since the changes will only take effect from 1 January 2020 and will be grandfathered to protect assets purchased before that date,” he said.
“There’s also a third category who see these changes as harmful for a limited number of successful entrepreneurs, but overall good for the country.”
The CGT is especially relevant for startups as capital gains is the main source of return on investment for founders, as opposed to salaries. Founders often receive shares in their own company when they are worth virtually nothing, and if successful, receive significant capital gains from these shares.
Under Labor’s proposed changes, these founders, and some investors, would pay more capital gains tax if they achieve a successful exit.
Labor’s policy would not come into effect until 1 January 2020, and is grandfathered, so would only apply to new startups and investment funds founded after that date.
Founders who start a company after the start of 2020 and later achieve an exit would pay roughly half again on capital gains tax if the Labor changes come into effect, Mr McCauley said.
“That would be a big deal for startup founders, who tend to structure their finances in a way that prioritises capital gains – increasing the value of the businesses – over salary,” he said.
“Because it’s about capital gains rather than salary, it will only kick in if a founder has a successful exit.”
“And it’s worth remembering that even under the new regime proposed by Labor, founders will pay less tax on capital gains than they would on income.”
The issue has been raised by shadow digital economy minister Ed Husic, who has discussed it with shadow treasurer Chris Bowen, InnovationAus.com understands.
“We’ve raised these issues with Labor and they’ve been open to talking. Obviously this is a huge policy with broad-reaching effects, and this is just one part of that. And they’ve got quite a few things on their mind at the moment of course,” Mr McCauley said.
“If we see a Labor win on Saturday I expect we’ll want to have some more focused conversations about whether tweaks to CGT to support entrepreneurs would make sense.
“We’d also need to sit down as a community and think about whether CGT exemptions are the most effective levers we can pull to boost Australia’s ecosystem – I’m not sure what the answer there is yet.”
As part of the National Innovation and Science Agenda, investors in early-stage innovation companies (ESICs) were handed a 10-year exemption on capital gains tax for investments held in shares for between 12 months and 10 years.
But this tax break did not extend to startup founders, whose primary source of return on investment is typically the capital gains from shares owned in the business.
It also does not apply to investors not working through a vehicle with capital gains tax exemptions, such as an early-stage venture capital limited partnership (ESVCLP) or through the ESIC scheme.
Prominent Australian entrepreneur and tech investor Steve Baxter, who has been arguing against the changes, said the impact of the CGT policy could be “huge” and might disincentive investment in the sector in the long-term.
“It’s not good. If you’re out to encourage people to invest in businesses, this is going to hit them more. In the long-term, it’s not encouraging people to invest in these businesses, they’re going to stick to traditional businesses. It’s an investment disincentive,” Mr Baxter told InnovationAus.com.
“It makes Australian companies less desirable to invest in. They’ll charge us more for the wins. This 100 per cent solely hits founders, it’s a founder tax.”
Other jurisdictions have made carve outs in capital gains tax scheme for startups.
“Elsewhere, the argument has been successfully made that value created by entrepreneurs deserves to be treated differently to normal asset appreciation,” Mr McCauley said.
“The argument goes that selling a parcel of shares or an investment property for a profit isn’t as beneficial for the economy as creating a new business that you sell for a profit.”
He said a carve out in the scheme similar to what currently exists in the UK could be a potential policy option. The UK entrepreneurs’ relief from capital gains tax allows those selling all or part of a business to only pay 10 per cent on all gains, significantly lower than the normal rate.
“We could look at something like that. Another option is to think about how the additional CGT paid by entrepreneurs specifically would be reinvested into early-stage companies, paving the way for more successful entrepreneurs to come through the system,” Mr McCauley said.
“In the most successful ecosystems around the world, the profits entrepreneurs make from selling businesses are often heavily re-invested in new enterprises. I would think we’d want to encourage that here too.”