In the start-up sector the topic „work for equity“ is currently of interest and quite common. This is the granting of shares in the company in exchange for work by shareholders. In this context tax consequences must be taken into account.

What is meant by “work for equity”?

In the context of founding companies and subsequent financing rounds, it often happens in the start-up sector that, in addition to the financial investors who have to pay the capital increase amount including the premium in cash, selected shareholders also raise the share capital in cash and additionally commit themselves to the provision of unpaid work performance (comparable to a premium payment). In this context the shares are granted immediately, while the service provision subsequently takes place over time. This is called „equity for work (or sweat money)”.

Often it is IT service providers (programmers), graphic designers, advertising companies, lawyers, tax consultants, other advisors for financing or contact brokering who provide their services free of charge as shareholders. The following analysis do not apply to salaried employees.

If a shareholder provides unpaid services instead of a premium in order to receive shares, the question arises how this non-cash benefit, i.e. the receipt of the shares in the startup, is to be treated for tax purposes at his level and at the level of the startup.

Tax aspects in connection with “work for equity”

Basically the remuneration for work performance is subject to taxation at the level of the service provider. In this context, both cash and non-cash benefits (e.g. in the form of shares granted) are taxable.

However with regards to “work for equity” it needs to be analysed whether it could be seen as a non-taxable usage contribution (“Nutzungseinlage”). Usage contribution means among other things the provision of services by a shareholder without a consideration or for an unreasonably low consideration.

In various cases, the Administrative Court has dealt with the tax assessment of management activities performed free of charge by a shareholder or with remuneration for the provision of capital or real estate by the shareholder to the corporation. In all cases an approach of fictitious remuneration has been excluded according to the fact that there was no arm’s length agreement and therefore no remuneration has to be assumed. The Austrian tax authorities follows that approach.

The cases decided so far by the Administrative Court have dealt with preferential services provided by shareholders, but without – and this is the difference – a connection to a directly linked granting of shares. However, we are of the opinion that there are good arguments that “work for equity” could be seen as tax neutral usage contribution. In our opinion, the fact that a shareholder relationship exists could be seen in favour of a classification as a usage contribution. Apart from that we assume that the statement on usage contributions of the Austrian tax authorities are to be interpreted to a very large extent and therefore – in the absence of other concrete statements to the contrary – also apply to “work for equity”.

Following this the startup does not have a contribution to be shown as an asset nor does it have a fictitious operating expense in the amount of the saved expenses. On the other side no fictitious income is to be recorded at the level of the founder and the acquisition costs of an already existing participation in the startup will not be increased.

Outlook

It would be desirable if the tax authorities assess and regulate key legal tax issues associated with the startup sector as simply and business-friendly as possible. This also includes „work for equity“. Its explicit inclusion in the regulatory scope of tax-free use contributions in the income tax and corporate tax guidelines would therefore be desirable for all users.

 

Authors:

Christoph Puchner, Managing Partner and Tax Advisor &
David Gloser, Managing Partner, Tax Advisor and Chartered Accountant from ECOVIS Austria, one of the leading tax consultants in Austria in the startup sector.