United we start-up, divided we fail: the battle for CGT reform

25 Jul 2016

There is a window of just four or five months for the start-up community to get the capital gains tax reform it wants

The long-awaited changes to capital gains tax (CGT) are nearly within the Irish start-up community’s grasp. Now is the time to band together, writes John Kennedy

Last week, one of the most pivotal developments in the history of entrepreneurship in Ireland went almost unnoticed. The Department of Finance’s Tax Strategy Group produced a number of papers, including recommendations for the long called-for – and overdue – reform of the capital gains tax structure.

Hidden among several papers published on the website of the Department of Finance was a section on capital gains tax that recommended reducing capital gains tax to 10pc with a cap of €10m.

Future Human

A decision in last year’s Budget for 2016 to reduce capital gains tax from the existing 33pc to 20pc with a €1m limit on gains was labelled derisory by the start-up community and leading venture capitalists like Brian Caulfield.

‘Most FDI companies will not just recruit individuals, they will acqui-hire – that is, they will buy a company in its entirety solely to get their hands on talent and IP – which is precisely why a realistic CGT regime needs to exist’

The brew was all the more bitter because 2015 was a year of fierce activity among the various elements of the start-up and funding ecosystem, with groups lobbying hard for reform of CGT and over 400 start-up events taking place countrywide in the weeks preceding the Budget as part of the Startup Gathering.

The government has on numerous occasions pointed out that entrepreneurs are to be the life’s blood of the Irish economy, and that as many as 200,000 jobs could be generated by start-ups in the next 5-10 years.

But how can this be possible if such a punitive CGT regime exists? The outdated CGT was seen as an impediment to start-ups rewarding share options to employees, and diminished any gain entrepreneurs could enjoy from an exit such as a trade sale.

In fact, many Irish start-ups in the last year or two began locating north of the border or in Britain itself to avail of 10pc CGT rules in UK territory.

But now, Ireland is about to have a 10pc capital gains tax with a €10m cap. Surely everyone is happy, right? Wrong.

Entrepreneurs have been quick to point out that there is no cap on any gains in the UK system, for example.

Plus, the recommendations suggest benefit will not apply for the first five years, which means founders will not gain if they are bought quite early in their firms’ development, which is often the case.

After Brexit, the gloves will be off

It was suggested on a number of occasions last Friday that the reform of CGT was a reaction by the Irish State to Brexit – possibly a hustle designed to capitalise on attracting talent from a labour pool of 500m people, and to capitalise on the country’s position as a tech economy and the only English-speaking economy left in the EU (not forgetting Malta, of course).

Actually, the measure was proposed prior to Brexit, in the new Programme for Government in May.

The reform of CGT is long overdue, and it was questionable how long the establishment could allow construction to be the only sector of the economy to gain from low levels of CGT.

This, at a time when the digital economy is evidently the place to be. In fact, the digital economy is driving the construction industry in terms of new office builds, data centres, broadband rollout and more.

The reform of CGT could also be a magnet to encourage international entrepreneurs from Europe and elsewhere to consider starting up in Ireland – attracted by reduced bureaucracy and the ability to reward talented workers with generous share options.

This is fundamental.

Aside from the National Broadband Plan, SFI developing Ireland’s innovation infrastructure, and the great work of Enterprise Ireland and IDA Ireland, CGT could be the next concrete and tangible measure the Irish Government could take to really support the digital economy.

But it hasn’t happened yet. It is still only just a recommendation. It is four months to Budget 2017. Hopes could yet be dashed.

One island, one start-up community

Every time I talk to an entrepreneur, I learn something new. Truths are shared; sometimes even through frustration, valuable insight gleaned.

Last week, I interviewed David Coallier, founder of Barricade, a promising IT security start-up based in Cork. Coallier is young, but is nevertheless a seasoned and experienced entrepreneur who, along with Eamon Leonard, successfully sold Orchestra to Engine Yard in 2011.

The Orchestra acquisition, along with the Collison brothers’ (now of Stripe) sale of Auctomatic in 2008, when they were both just teenagers, and the acquisition of Sligo-based Polldaddy by WordPress creator Automattic the same year… in my mind these were the moments that got the people thinking once more that Ireland can field truly great global, digital companies.

It is 2016 and that start-up ecosystem is thriving – in spirit at least.

What will make the ecosystem thrive even further will be significant high-profile exits and acquisitions, the arrival of international start-up entrepreneurs to these shores and the reform of CGT. The reform of CGT will be the lynchpin.

But Coallier also lamented the fact that in Ireland we see the start-up communities separately – one in Dublin, one in Cork, one in Limerick, one in Galway, etc – when we should identify as one.

He pointed out, quite rightly, that Ireland’s start-up community collectively is smaller than those of London, Berlin or Paris, and that, instead of separate communities in Silicon Docks or Rebel Valley, we need to band together.

Coallier has a point. If you were to combine every university and college in Ireland, you may just about achieve the scale of a Stanford or a Harvard, for example. Scale is not on our side. We need to think outside the box.

Distinct communities in Dublin, Cork, Galway, Limerick, Belfast and the regions need to identify as one community with a powerful voice that is listened to when it matters.

Vital initiatives like the TechIreland.org database of start-ups, investors and other supports could play a key role in helping forge this identity and sense of self.

As the news emerged Friday that CGT reform was recommended by the Government’s financial boffins, discussion from various tweets saw initial euphoria descend into a sober, often caustic, assessment of the matter.

It was pointed out that the reforms will only apply to new start-ups formed after the commencement date in 2017. While there may be a chance this could be broadened to existing start-ups, it is only a chance, and no small comfort to founders and their staff who have fought the good fight up to now with no value in rewarding share options. How can start-ups in Dublin realistically compete for talent against Facebook or Google if all they can offer are meagre wages and no perks or incentives?

Also, what use is a cap on the first five years if that’s precisely when promising young companies are most likely to be acquired? It costs the State nothing, of course, but it will be the difference between entrepreneurs having the means to invest in other entrepreneurs and start even more successful businesses. Success breeds success.

The State must also be mindful that, without a start-up ecosystem, there will be no draw for foreign direct investment (FDI) companies in the future. FDI and start-ups will go hand in hand.

Most FDI companies will not just recruit individuals, they will acqui-hire – that is, they will buy a company in its entirety solely to get their hands on talent and IP – which is precisely why a realistic CGT regime needs to exist.

There is a small window of time for the start-up community to ensure it gets what it wants from CGT reform.

Bickering on Twitter won’t cut it. It never does. Never will.

As Coallier pointed out, the community needs to think of itself as a single community rather than separate city states with their own interests and grudges.

It needs to make some noise. It needs to lobby hard.

Because otherwise, there is a chance that, with limited CGT reform, we may only snatch defeat from the jaws of victory. At the very least, a diminished version of what the ecosystem really needs in order to thrive.

And that must not and cannot happen.

Start-up image via Shutterstock

John Kennedy is a journalist who served as editor of Silicon Republic for 17 years