Professional content

Innovation and taxes

3.9.2013 Andri Gunnarsson og Páll Jóhannesson

The wheels of Icelandic innovation and entrepreneurial sector have started to roll and commercial banks have increasingly participated in that framework. The government could also do more to improve the overall regulatory framework to facilitate such activities, especially in the areas of tax and corporate law. Numerous examples show that the current regulatory framework reduces the scope and peoples possibility to initiate and fund own business, including rules on taxation of stock options.

Over the past few years, Icelandic innovation and entrepreneurship sector has been growing steadily. Commercial banks have increasingly participated on the market in relation to innovation by setting up centers for entrepreneurs with financial support etc. The logical next step would be that pension funds took part in financing innovation since such practice is well known abroad that large financial investors assign certain percentage of their assets into alternative investments (e. Alternative asset class), as capital risk constitutes innovation. At the same time it is expected that the government would improve the overall regulatory framework, particularly on tax and corporate law, to facilitate the functioning of such companies in Iceland. 

Furthermore, the government should look at how the neighboring countries, which are leading in innovation, have decided to conduct its regulatory framework. It is clear that in Iceland much could be improved. 

There are numerous examples where Icelandic legislation is outright hostile towards entrepreneurial companies. Rules on taxation of stock options are one and seem to have the goal to tax individuals before any monetary profit has been made. In stead the government should see stock options as one of the main currency that innovation in need of financial aid have in order to attract talented staff, as well as the goal should be to encourage as many as possible to make a difference as stock options obviously entail. Rules and case law on possession tax are much stricter than known in our neighbor countries and detracts people from both establishing business here and to participate as board members in new corporations. One of the most prominent examples is the transitional provision of the Income Tax Act, which was enacted shortly after the economic collapse in 2008þ the provision entails that the mutation of debt into equity can in certain circumstances be liable for income tax at the company. This change is absurd as one can see that the creditor could provide the company with new equity in order to pay its debt and thus not create any tax obligation. The provision is particularly inconvenient for start-ups where one convenient way to for investors and entrepreneurs to cover the gap between different pricing ideas is to use bonds that can be converted into shares at a later stage. 

The story of Peter Thiel (co-founder of PayPal) is relevant here, but he became one of the first investors in Facebook. Mark Zuckerberger and Peter had debated on what the valuation of the company would be but at that time Facebook had only several thousand users, no income and no idea of how they could create money out of the database of the users. The solution consisted of convertible bonds. Peter invested 500.000 USD in Facebook and the bond would be converted into shares few months later. Share price was associated with each number of users on Facebook at a specific time. As the number of users grew, Peter would acquire more shares in Facebook as its value rose with increase of users. 

The regulatory framework of the government is very important when it comes to making it possible for innovation companies to find solutions to fund their operations. It would be appropriate that the government reviewed the tax system with regard to their interests. Amendment of the tax system that increases revenues in the long-term and lets stop enacting and maintaining un-encouraging regulations, which do not deliver any revenues in the short or long term.