Working Paper No. 1104

Stock Option Taxation and Venture Capital Activity: A Cross-Country Study

Published: January 11, 2016, revised August 2016, October 2017 and November 2017Pages: 30Keywords: Business taxation; Corporate governance; Entrepreneurship; Innovation; Institutions; Tax policy; Venture capitalJEL-codes: L26; H25; H3; K34

Stock Option Taxation and Venture Capital Activity: A Cross-Country Study Magnus Henrekson and Tino Sanandaji


The VC sector is interesting both in its own right and as a proxy for entrepreneurial finance in a broader sense. We highlight the tax treatment of stock options as an important factor for variations in the size of the VC sector. VC often relies on complex mechanisms and option-based contracts to mitigate incentive problems. Granting stock options to founders and key employees also allows credit-constrained start-ups to attract and retain top talent. This type of compensation cannot be unambiguously classified as either capital or labor income. Some tax systems treat stock options in VC-funded firms as employee compensation, which is subject to payroll taxes with high progressive rates, whereas others treat them as capital gains with low flat tax rates. The effective rate depends on tax practices and is not readily indicated by statutory taxes.

The tax consultancy firm PwC calculated the effective tax rate for a standardized entrepreneurial case in 22 countries, which is supplemented with our own calculations for 16 additional countries. In this sample of 38 countries, we find a negative cross-country relationship between the effective tax rate on employee stock options and the rate of VC activity. This negative effect is stronger for countries with high R&D investments and weaker in countries with low R&D spending.

 

Magnus Henrekson

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An Agenda for Europe

Institutional Reform for Innovation and Entrepreneurship

Omslag 2017 Institutional Reform for Innovation and Entrepreneurship.jpg

The authors of this book, Niklas Elert, Magnus Henrekson and Mikael Stenkula, advise the economies of the European Union to become more entrepreneurial in promoting innovation and economic growth. The authors propose a reform strategy with respect to several aspects to achieve this goal.

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