One response to uncertainty and transactions costs in VC-finance is to compensate founders and other key personnel with stock options under complex contracts. Entrepreneurs are granted stock options contingent on firm performance, vesting and other criteria.
While most countries tax stock options as labour earnings, the US allows them to be taxed at a low capital gains tax rate. The interaction of favourable tax treatment and inherent advantages has led to near universal use of stock options in US venture capital deals, while this remains less common in Europe.
The effective tax treatment of stock options depends on tax practices and is not readily observed using statutory tax rates.
We asked the local offices of the tax consultancy firm PwC to calculate the effective tax rate for a standardised entrepreneurial case in 22 countries, finding that countries with favourable tax treatment have more VC activity.
One advantage of this tax policy is that it narrowly targets entrepreneurial startups without requiring broad tax cuts. u
Published on SSRN for full IFN Working Paper No. 1104. Available at http://ssrn.com/abstract=2713753
Effective tax rate on stock options in 22 countries, 2012
VC activity
Country Tax rate (%) as a percentage of GDP
Australia 24.8 0.026
Canada 31.9 0.040
China 45.0 0.052
Denmark 55.3 0.073
Finland 51.3 0.021
France 29.9 0.047
Germany 47.5 0.014
Hong Kong 15.0 0.227
Ireland 7.4 0.072
Israel 25.0 0.120
Italy 72.2 0.001
Japan 50.5 0.003
Netherlands 25.0 0.020
Norway 50.8 0.053
Portugal 56.5 0.009
Singapore 20.0 0.088
South Korea 61.5 0.038
Spain 52.0 0.012
Sweden 54.3 0.100
Switzerland 51.5 0.107
UK 28.0 0.075
US 15.0 0.199
Source: PricewaterhouseCoopers and Lerner and Tåg (2013)