Working Paper Series
Stock Option Taxation and Venture Capital Activity: A Cross-Country Comparison
() and Tino Sanandaji
Abstract: 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.
Keywords: Business taxation; Corporate governance; Entrepreneurship; Innovation; Institutions; Tax policy; Venture capital; (follow links to similar papers)
JEL-Codes: H25; H30; K34; L26; (follow links to similar papers)
30 pages, January 11, 2016, Revised November 9, 2017
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- This paper is forthcoming as:
Henrekson, Magnus and Tino Sanandaji, 'Stock Option Taxation and Venture Capital Activity: A Cross-Country Comparison', Venture Capital.
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