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KEEP’s Fintech exclusion is madness – Start-ups and SMEs must be heard to ensure incentive scheme can be salvaged

By December 1, 2017No Comments
By Gill Brennan

In March 2015, the Irish Government launched IFS2020, a five-year strategy for the International Financial Services sector in Ireland. The Strategy, as part of the Government’s Action Plan for Jobs, aims to create 10,000 net new jobs in the sector by 2020. By the end of 2016, the numbers directly employed in this sector numbered around 40,000, and it appears the strategy is on track to meet one of its key stated targets.

Over the past 20 years, Ireland has become synonymous with a growing financial services sector and has garnered an equally strong reputation in establishing and scaling Irish technology companies focused on foreign markets and supporting financial services. FinTech is therefore at the core of the IFS2020 strategy for Government.

Fintech comprises every area of technology and innovation in the financial services arena, from payments, trading and FX, big data, risk, compliance and business intelligence to consumer-focused currency exchanges and peer-to-peer lenders. Fintech companies come in all shapes and sizes, ranging from payment companies facilitating transactions through technology, to technology companies selling cybersecurity products to banks, to payroll solutions providers, to fintech start-ups providing myriad services and the large banks who are investing in them.

This is where the problem begins for the new Key Employee Engagement Programme (KEEP) – announced by Finance Minister Paschal Donohue in October’s Budget.

In his maiden budget speech, Donohue stated: “Research has shown that Employee Financial Participation can be effective in increasing competitiveness and helping companies to attract and retain staff in a competitive labour market. Therefore, I am announcing a new Key Employee Engagement Programme, or KEEP for short, to support small and medium enterprises in their efforts to attract and retain key employees in a competitive International labour market, by providing for an advantageous tax treatment on share options. KEEP will allow small to medium enterprises to provide key employees with a financial incentive linked to the success of the company.”

KEEP is being introduced to help grow the indigenous start-up and SME sectors in Ireland but any hope for such companies utilising the new KEEP scheme or for employee share ownership improvements via this scheme was dashed within the opening lines of the new initiative.

The opening preamble for any new tax relief introduced through a Finance Bill usually lays out who or what can or cannot utilise the relief, and within the preamble for KEEP the first glaring hole in the foundation of the new relief came with the exclusion of companies involved in “financial activities”.

The definition of “financial activities” as per Section 488 of the Tax Consolidation Act 1997 reads:

financial activities means the supply of, and all things relating to the supply of, loans, mortgages, leasing, lease rental and hire-purchase, and all similar arrangements, equity or other investment, the factoring of debts and the discounting of bills, invoices and promissory notes, and all similar instruments, and the underwriting of debt instruments and all other kinds of financial securities, by any means which involves, or has an effect equivalent to, the extension of credit.

Why is this relevant? So far this year, 20,120 new company start-ups have been formed, 3,061 of which are FinTech companies. That’s more than 15% of the total but every single one of those start-ups are currently EXCLUDED from the KEEP scheme because of the above definition in the Finance Bill 2017. That’s only assuming those start-ups are pure FinTech, because if any Technology start-up provides anything relating to the above definition of financial activities – they too will be excluded! And going by the most recent Business Barometer from Vision-net.ie, that could be another 11% of new companies registered this year.

So with one fell swoop, KEEP writes out more than 25% of all new start-ups this year – but what about the start-ups from 2016, or 2015, or next year, or the year after? The field for the KEEP-Sweep Stakes hasn’t come out of the gate cleanly. The legislation has fallen at its first hurdle, and while it might manage to pick itself up and bring the remaining 75% of 2017’s start-ups with it, the next hurdle approaching is a real doozy: what happens if the start-up grows beyond its SME status – which is exactly what the Government and most businesses want, right?

This is a hurdle because of the relatively low financial limits of the scheme. A company may not have unexercised qualifying options with an aggregate market value in excess of €3 million, the total market value of all shares options granted to an individual may not exceed €100,000 in any tax year or €250,000 in three consecutive years, or 50% of the individual’s annual pay in the tax year in which is it granted.

According to Maura Roe, partner with William Fry: “A maximum limit of 50% of pay will make it impossible to grant options of any meaningful value to a skilled employee who joins a start-up and agrees to accept a below-market salary. These are the very employees that SMEs would like to benefit from favourable tax treatment.”

OK, so we are somewhere near the half way stage on our journey around the KEEP course. It’s looking very likely that most of the fallers in the KEEP-Sweep Stakes Hurdles are the young bucks, the young fillies and colts – the start-ups. Heading into the final furlongs, the SMEs are going ok on what is heavy ground. The next hurdle, however, is a rather difficult jump for the SME pack: determining the market value of the shares. As Roe rightly points out, many the conditions of KEEP pivot on the market value of the shares underlying the options. As of writing, there is no guidance on how an SME can determine the market value of its shares on a basis that Revenue will currently accept.

In its current format, KEEP fails the majority of SMEs regardless of what sector they operate in by virtue of the fact that SMEs need to incentive employees who join at any time and grant share options that employees can exercise whenever they choose. KEEP as currently proposed does not facilitate that essential flexibility and many SMEs we have spoken to since the announcement consider the KEEP scheme too complicated, restrictive and uncertain – some of the key issues it was meant to resolve.

The Irish ProShare Association (IPSA) has been at the forefront of lobbying for this change in the tax laws. We advocated vociferously that any change had to be meaningful, easy to implement, and crucially enhance productivity and growth for the start-ups and SMEs that are the backbone of the Irish economy.

Since Finance Bill 2017 was released, we have had on-going discussions with the Department of Finance in relation to KEEP, and it must be said that the officials we have been dealing with are very open to hearing real-world evidence to make the KEEP scheme better for those it was designed to support. These discussions are proving to be positive and moving in the right direction to create a robust and usable KEEP, but they are not moving fast enough. More input is needed from start-ups and SMEs on what changes are required to build a better KEEP scheme that is tailored to their needs.

We are moving into the final furlong of the KEEP-Sweep Stakes Hurdle, and IPSA is determined to help every start-up and SME faller pick themselves up, make sure that their voices are heard and get across the winning line.