"Definitely losing talent": Startup leaders fear tax settings pushing Aussie founders overseas

Australian startups with global ambitions may be incentivised to move overseas earlier than they otherwise would, startup sector leaders say, as growing valuations, increasingly complex ownership structures, and potential capital gains tax exposure make the shift harder the longer they wait.

It is a dynamic at odds with Australia’s push to encourage innovative businesses to build and grow at home.

For some startups seeking overseas investment to grow and expand, moving their corporate home can become necessary, yet increasingly complicated as the business grows.

Richard Pringle, principal lawyer at startup-focused Viridian Lawyers, said he sees several Australian startups re-domicile each year and founders can have an incentive to make the move early.

“The longer they stay, the more complicated the… flip-up is likely to be, and they are incentivised to go as early as possible,” Pringle told SmartCompany.

Once a startup is generating revenue, has raised capital and established a clearer valuation, Pringle said the process becomes much more complicated, particularly because of potential capital gains tax implications.

“It’s much easier just to avoid all of that, both from a cost and time perspective, and do it upfront nice and early if you can.”

One common route is a “Delaware flip”, where a new US parent company is inserted above an existing Australian company.

Pringle said around a quarter of his clients took funding from US investors, with some ultimately needing to re-domicile, most commonly to the state of Delaware.

AirTree Ventures also described Delaware flips as a “pretty common route” for Australian founders, particularly when they are looking to raise from US investors or expect a significant portion of their future growth or operations to be in the US.

The venture capital firm said moving early could avoid the tangle of investors, shareholders and competing rights that comes as a startup grows.

“The benefit of doing it early is that fewer stakeholders, shareholders and investors are involved, with less complicated shareholder rights and obligations,” an AirTree spokesperson said.

The tax bill before you’ve made an exit

Getting the tax treatment wrong can carry expensive consequences.

Moving a company’s corporate home overseas can expose founders and employees to so-called “phantom tax”, where a restructure triggers a capital gains tax liability even though they have not received cash or exited their investment.

Australian tax law provides scrip-for-scrip rollover relief that can defer a CGT liability, but Pringle said getting the restructure right was critical.

“You’ve got to get it exactly right, and if you don’t, and the details very much matter in this instance, if they’re not exactly right, that’s when you get your CGT event,” he said.

If rollover relief was unavailable, that liability could fall directly on shareholders.

“All of the startup employees and founders probably don’t have cash on hand to pay that tax,” Pringle said.

“It’s not the company’s money that’s the problem here… it’s actually the employees that are paying that tax out of their personal money.”

Jake Berger, partner at Pitcher Partners Sydney, said he was seeing an increasing number of startups establish overseas parent companies, with access to US venture capital a key driver.

Some US venture funds limit investment in foreign companies, Berger said, pushing Australian startups seeking their capital to establish a US parent.

But Australia’s tax settings can also influence where founders themselves choose to live.

“The changes to the tax system will likely create incentives for founders to personally break residency, as opposed to move the corporate structure offshore,” Berger said.

“I have seen this countless times and we are definitely losing talent due to our tax settings.”

Existing small-business CGT concessions can also become harder for startup founders to access as their companies grow and ownership changes.

The government has acknowledged concerns about the impact of its CGT reforms on startups, with Treasurer Jim Chalmers saying in May the sector was “a really important part of the economy”. “We will reflect and recognise that in our policy,” Chalmers said at the time.

The government has since proposed an Innovative Business CGT Concession (IBCC), which would preserve a 50% CGT discount for eligible founders, employees and early investors. Draft legislation released this month broadened the proposed concession.

Pringle said the concession could reduce the tax payable where it applied, but would not solve the “phantom tax” problem if a restructure triggered a CGT liability.

“It reduces your phantom tax if you actually get bitten by it, but it doesn’t get rid of it.”

Startups can seek certainty about their tax position from the Australian Taxation Office (ATO) through a private ruling before restructuring.

But Pringle said the process could be difficult to reconcile with the speed of venture capital deals.

“The ATO isn’t jumping at the bit to help you get your VC deal done, and time kills deals,” he said.

Pringle called for greater scope for startups to work with the regulator before completing a restructure and “a less adversarial ATO”.

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