Various tax-reform measures for the startup community likely passed in 2016

Last Friday at the Federation of Icelandic Industry’s Technology Summit, Bjarni Benediktsson, Iceland’s Minister of Finance, spoke of changes to the tax system to help the startup community.

Bjarni announced plans to change the taxation of both stock-options and convertible bonds, making both a more viable instrument than they are now. He also discussed changed taxation on foreign specialist, and much anticipated plans for tax relief for individuals investing in startup companies.

When will this happen?

These changes will all be proposed to the parliament in 2016.

Teitur Björn Einarsson
Teitur Björn Einarsson

“We aim to propose the bill that would change the taxation timing of stock-options and convertible bonds, as well as the tax relief measures for individual investors, in 2016. We’re hoping they’ll be passed before the end of the year,” Teitur Björn says.

“However, because they are of relief to the taxpayer, they might be applied retroactively. That would mean gains and investments in 2016 would fall under these new rules.”

Teitur told Nordurskautid that they hadn’t experienced much political opposition to these measures, which is good news to the community.

Stock-options and convertible bonds

Under the current tax law, stock-options are taxed at the date of exercise. This means that if an employee of a startup exercises her options under other circumstances than a liquidity event (i.e. if she buys stocks, without selling them right away, like often happens in acquisitions for example), she must pay taxes on the unrealised gains on her shares.

These gains are based on the last valuation of the company – usually a private financing round.

Let’s say Sandra has 1000 vested stock-options in the startup she works at, Super-Startup, with the strike-price of $1. The last VC round valued the stock at $5 per share. She’s leaving the company to start her own, but wants to exercise her rights. She would have to pay $1,000 to the company to buy the shares (1,000 * $1 strike price), and an additional ~40% income tax on the $4 of unrealised gains (i.e. $1.6 per share), even though she doesn’t sell the shares.

A similar rule applies to convertible bonds.

Convertible bonds are financial instruments investors can use to lower their risk when investing in startup companies. Rather than buying shares outright, they purchase a corporate bond, with the option of converting the bond into shares.

For example, a $1,000 bond could have the option of being converted into $1,200 of equity. If and when an investor decides to exercise this right, she will be taxed for the gains, in this case, $200.

The problem here is, that individuals – often early employees or individual investors – are being taxed for unrealised gains. Financial gains that only exist on paper. There is still the real possibility of the company failing, and their shares losing all value. In those cases, people will have paid taxes on nothing.

Eggert Claessen. Picture:
Eggert Claessen. Picture:

“This would be great progress,” Eggert Claessen, Managing Director of venture fund Frumtak 2, told Nordurskautid. “It would make the involvement of smaller investors much easier and turn stock-options into a better tool for retaining employees.”

Tax relief for individuals investing in startups

Bjarni Benediktsson also mentioned making investments by individuals in innovative, growing companies deductible. He mentioned that he was putting emphasis on creating a bill on these matters. He didn’t mention which specific criteria the companies would need to fulfil to qualify, but there would be some.

“A bill focusing on tax relief for individuals investing in startup companies has been discussed for some time, but until now, delayed by technicalities,” Teitur Björn Einarsson, political adviser to the finance minister, told Nordurskautid.

Concrete details on these deductibles haven’t been announced, but the hope of the community is that they will help increase both the number of angel investors and available early-stage capital. Similar measures, focusing on tax-relief for individual investors, have been successful in other ecosystem, notably London.

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