Are tax reforms for US startups a boon for Canadian tech?

The startup tech community in the United States is currently in a panic over proposed legislative changes to the taxing of share options, a move which would put a damper on tech entrepreneurism across the country and could be a boon to Canada’s startup culture if the reforms proceed.

The provision in the US Senate’s new tax reform plan calls for an earlier taxation of stock options, a move which supporters say could bring in $13.4 billion (USD) in tax revenue over the next ten years from the American startup sector.

Typically, cash-poor new companies turn to stock options as a way to compensate employees, by giving them the right to purchase shares in the company at a time in the future for a set price, the incentive being that if and when the business takes off and share prices grow, the employee will get his or her reward for years of service.

The proposed changes would see options taxed not just when exercised but over the vesting years, as well, often a four-year period. That would mean employees would be paying regular income tax on assets that they don’t yet truly have, say the provision’s critics, who say that the changes would crush the startup culture across the country and take away the incentive for entrepreneurs to make bold and big plans based on the promise of future riches.

“It would mean that I would have to sell the company,” said Shoaib Makani, founder and chief executive of long-haul trucking startup KeepTruckin, to Reuters. “I have zero net worth aside from the common stock I hold in the company. It would be impossible. I would be in default.”

Reportedly, the changes have been introduced as part of a cost-saving measure to offset tax breaks contained in the new plan.

“If there were a single piece of legislation to adversely affect startups, it would be this,” said Venky Ganesan, managing director at venture capital firm Menlo Ventures. “Everyone is freaked out.”

But others say that while potentially hurting some new businesses, the revisions may force startup culture to change its compensation practices, which have been criticized for being exploitative of tech labour. Many companies currently place restrictions on when employees are allowed to sell shares, effectively acting as “golden handcuffs” by preventing employees from quitting the company and selling their shares. As well, the changes would likely force startups to look to different measures to keep employees on board such as profit sharing.

Such reforms might also be seen not only as a gift to larger US tech companies such Google and Amazon who don’t have the liquidity problems of a startup but, potentially, to the Canadian tech scene, as well.

Under Canadian tax rules, startups usually qualify for the Canadian Controlled Private Corporation exemptions which include the provision that stock options are only taxed after employees exercise their right to purchase.

But Canada has also had considerations about changing the rules around stock options. Last year, Canada’s tech community spoke out against reforms promised in the federal Liberal party’s election campaign, ones which would restrict the amount of stock option gains that could be taxed at a lower rate. That initiative has yet to be brought forward, although it has its supporters, as well, who say that in practice, stock-based compensation often results in big bonuses for company executives.