ENTREPRENEURIAL EMPLOYEE STOCK OPTION SCHEME (Statement by the Minister for Finance)

Dr Richard Hu Tsu Tau: Mr Speaker, Sir, in my Budget Statement on 25th February this year, I said that a scheme to enhance the tax treatment of ESOP for high-tech start-ups would be announced by the end of May. Today, I am happy to announce the new "Entrepreneurial Employee Stock Option Scheme".

Employee stock options or ESOP play a key role in a vibrant entrepreneurial environment. Many fast-growing high-tech start-up companies attract talent, not through high salaries, but by offering stock options to employees. An attractive tax treatment of ESOP will therefore give a strong boost to entrepreneurship and risk-taking. Moreover, as talent is internationally mobile and is increasingly rewarded by means of stock options, especially in the high-tech start-ups, we must ensure that our tax treatment of ESOP is internationally attractive, to give us a competitive edge.

Entrepreneurial Employee Stock Option Scheme

This new scheme aims to foster an entrepreneurial spirit in the smaller high-risk companies and its employees, many of whom have to forgo more secure and higher paying jobs to start or join these start-up companies.

Under the Entrepreneurial Employee Stock Option Scheme, a 50% income tax exemption will be granted on gains arising from the exercising of ESOP. The 50% tax exemption would be granted to up to $10 million of gains, over a 10-year period. To illustrate, if an employee exercises his stock options and makes a gain of $1 million, 50% or $500,000 of the gains will be exempt from tax. Over the next 9 years, he can enjoy 50% tax exemption on a further $9 million gains from ESOP.

Companies with gross assets of up to $100 million at the time the ESOP are granted will be able to benefit from this scheme. Based on the existing top marginal personal income tax rate of 28%, an employee can enjoy tax savings on gains from ESOP of up to $1.4 million. Coupled with the absence of capital gains tax in our regime and our low personal tax rates, our tax treatment of stock options will be very attractive compared to most other countries.

The scheme has been structured with minimum restrictions, so as to give companies the maximum flexibility to implement their ESOP plans to suit their different business needs. I will now go through some of the details of the scheme.

Qualifying Companies

Instead of restricting the scheme to companies in specific high-tech sectors, which is difficult to define, I have decided that for a start, this scheme will be available to companies from all sectors. Companies, whether listed or unlisted, with gross assets of not more than $100 million, will be able to qualify for the scheme. In addition, these companies also have to be incorporated in Singapore and carry out business activities in Singapore.

Qualifying Employees

The scheme is targetted at those employees who devote a significant portion of their working time to the company. Therefore, to qualify, the employee must work at least 30 hours per week for the company. An employee who works less than 30 hours for a company can also qualify if he spends at least 75% of his total working time per week with that company. A non-executive director will not qualify. In addition, the employee should not control 25% or more of the voting rights of the company.

Effective Date and Timeframe for Review

The enhanced tax treatment will apply to ESOP issued on or after 1st June 2000. The scheme will operate for five years, after which the Government will review the scheme to evaluate whether the objectives of the scheme have been met. Mean- while, during these 5 years, we will continue to fine-tune the scheme as and when modifications are warranted.

Further Details

Details of the scheme, including vesting period requirements and treatment of discounted options, will be released by IRAS by 1st June 2000. They will be available on the IRAS website.

Conclusion

Through the Entrepreneurial Employee Stock Option scheme, Singapore is sending a clear signal of its support for enterprise and wealth creation, and strong encouragement to those entrepreneurs and employees who are willing to take risks. The use of ESOP is of course also relevant for the larger and more established companies and should be encouraged. But the degree of incentive will be less as established companies have less problems with attracting and retaining staff. My Ministry will be reviewing the tax treatment of ESOP for these larger companies. I will be announcing the scheme for the established companies in next year's Budget Statement.

Mr Leong Horn Kee: Mr Speaker, Sir, my GPC for Finance and Trade and Industry would definitely welcome this new Entrepreneurial ESOP scheme, because we think it is very generous and would be very effective in promoting the use of ESOP in companies in Singapore.

I would like to ask the Minister three questions. First, on the rule that qualifying companies must be, first of all, incorporated in Singapore. Should we not consider the case of other companies which are not incorporated in Singapore but have significant businesses in Singapore, and their employees therefore should be allowed to enjoy this benefit? My other members of GPC will probably elaborate on this point.

The second question is on qualifying employees: Why should there be a limiting percentage of 75% of the time spent in the company? There may well be individuals who do not spend their time in one company but in several other companies. Perhaps a lower qualifying percentage of 51% might be more reasonable for such cases.

The last point to ask the Minister is: Why is it not eligible for non-executive directors? These non-executive directors may also contribute to a company and therefore they should be able to enjoy this scheme.

Dr Richard Hu Tsu Tau: Mr Speaker, Sir, on the first question, at present, the intention is to require companies to be registered in Singapore to qualify for the scheme, because the objective of the scheme is to encourage the setting up of such high-tech entrepreneurship companies in Singapore. Whilst I recognise that some companies may have their registration elsewhere and conduct part of their operations here, our preference is for them to be registered here. In any case, whether they are registered here or not, they have to conduct a significant proportion of their operations here. For the time being, we want to retain the requirement that they should be registered here in the first instance. If there are specific cases where a high-tech company can demonstrate that their presence here, although non-registered, can contribute significantly to value-added in Singapore, we may look at it on a case-by-case basis.

On the time spent criterion, this is intended to ensure that the employees spend a significant amount of their private time with the company. The whole purpose of the exercise is to allow the company to attract these people to help in the start-up process. If he dilutes his time among several companies, I do not think that will be very fair to the start-up company.

On the question of non-executive directors, the reason for excluding them is that being non-executive, they will clearly be unable to spend sufficient time to qualify under the time constraint. Therefore, they should be excluded.

Mr Chng Hee Kok (East Coast): Mr Speaker, Sir, two questions for the Minister. Will the scheme, as announced by the Minster, be applicable to existing ESOPs? If it is applicable, can a company then restructure their ESOPs to take advantage of the present scheme?

Second question is: How attractive this scheme will be is relative. It is relative to established markets, like the US, UK or Hong Kong. In other words, on this tax treatment, how do they compare to these established markets?

Dr Richard Hu Tsu Tau: On the first question of whether it is applicable to existing ESOPs, no, it does not. It applies to companies which issue employee stock options after 1st June. Those who have existing stock options will not qualify for this special incentive.

On the second question, I think our scheme is very attractive compared to practically all other incentive schemes, partly because our basic taxes are low already and we are giving a 50% reduction of that. As the top level of personal tax is 28%, qualifying stock option gains will be taxed at 14%, which is even lower than Hong Kong, and certainly a lot more attractive than the United States, for example, where the top level tax is approaching 40%; and similarly for most countries in Europe. So I think we are quite comfortable that the scheme itself will be very attractive.

Mr Inderjit Singh: Mr Speaker, Sir, first of all, I would like to thank the Minister for announcing the scheme, and I think that this will really encourage many entrepreneurs to have an alternative form of compensation, instead of a higher salary, maybe a lower salary and a higher incentive in stock option. This will help companies to at least improve their chances of success by lowering their cash flow. I have studied various stock option schemes and share ownership schemes in many countries and I think that the implementation of this scheme will probably be the best in the world. I have a few questions for the Minister.

First of all, will employee share ownership at inception of companies, that means these are not stock options, but equity in return for expertise that you bring to the table, be tax exempt in the first place?

Second question is: Will this scheme apply to companies that have already gone public but have yet less than $100 million worth of assets? On the point of Singapore incorporation, I support Mr Leong's point that more and more of our businesses are becoming very international, and while we may have the intention of wanting to operate out of Singapore, the real value sometimes will be generated in countries outside Singapore, for example, in the US and Europe. Therefore, I hope that the Minister can be flexible on this requirement of local incorporation.

The third question is the definition of "working hours". In the Internet economy, we talk about 24-by-7, which means that 24 hours in a day are considered working hours. So, is there a definition that the Minister will place on these working hours?

Finally, are there any restrictions as to what ownership the employee can have in a company, whether there are any conditions on employee ownership of companies, which means that an employee can own a substantial portion of the company in the beginning and yet enjoy 50% exemption in the new scheme?

Dr Richard Hu Tsu Tau: Non-registration in Singapore, as I have explained earlier, is a requirement to ensure that the benefits of this ESOP scheme will accrue to Singapore as a whole. Members have said that there are companies who want to be registered elsewhere but continue to operate in Singapore and I did mention that it will be considered on a case-by-case basis. If they can demonstrate that the bulk of their activities is in Singapore, even though they are not registered here, we might consider looking at it. But they have to be very sure that they are physically operating from here, there are people employed here, adding significant value before they qualify, otherwise the whole purpose of the exercise is defeated, if they register outside Singapore and they just come here to take advantage of the ESOP scheme.

On working hours, I know it is difficult to define, particularly on the Internet or the info-technology type of activity, but our guidelines are flexible to an extent. We will see how this present 30 hours plus 75% work in practice. If need be, if companies find that these are awkward or impractical, we are quite prepared, as I said earlier, to amend them as we go along during the five-year period of this exercise.

On the issue of whether someone who owns shares originally in the company would qualify under this scheme, the Member is probably referring to founder shares, ie, a group of people get together to start up a new company, and these people then hold shares in the company in various ways. Their contributions could be through money or ideas, and so forth. But these are founder shares. If at a subsequent date they resell the founder shares at whatever value, the gains would be capital gains and therefore not subject to tax. So gains from sale of founder shares are not taxed. But they do not fall under the ESOP scheme.

Finally, the issue of ownership of company. We did say that they should not own more than 25%. Effectively, 25% means effective control of the company and we do not wish somebody who controls the company to be offering himself preferentially large amounts of share options. So the requirement is that he should not control more than 25% of the shares of the company.

Mr Inderjit Singh: My next question was: does this apply to a company that has already gone public? Will the stock option then also be tax exempt?

Dr Richard Hu Tsu Tau: I did say that for those who have stock options which have already been issued, they will not qualify. It has got to be new shares.

Mr Inderjit Singh: I was referring to companies with less than $100 million worth of assets that have gone public and they still issue a stock option after they have gone public. Will those qualify for tax exempt?

Dr Richard Hu Tsu Tau: Those would qualify.

Mr S. Iswaran (West Coast): Sir, I welcome the Minister's announcement that the scheme will be applied to all sectors without constraints. But I would like to explore further with the Minister why the limit to companies if its assets are less than $100 million. In the market, there is already a migration of talent from the old economy as it were to the new economy and typically, new economy companies tend to fit this less than $100 million gross asset test and the old economy may be less so. I am not just talking about the large companies, but even some of the medium size companies.

Sir, it would appear that any differential tax treatment for ESOP of these two categories will exacerbate the migration and make it even harder for the old economy companies to retain talent. So the question I really have for the Minister is: why can the scheme not be open to all companies in the first instance or, if not, at least if he could share with us why or how this $100 million figure was arrived at? What is the thinking behind it and how soon can that be reviewed? Does it have to wait for the full five years?

Dr Richard Hu Tsu Tau: There is no magic formula to the $100 million figure. No one really knows the borderline accurately as to which company should qualify. It is a figure we think is sufficiently large to include a lot of the new technology companies which we are trying to incentivise. We could bring the capital amount down so that some of the start-ups which require less capital would be captured. But we have to draw the line somewhere and $100 million is based on our discussions with MTI who have a feel of the type of companies they want to incentivise. So it is an experimental level which we will be prepared to reconsider from working experience over the next five years.

The other question is whether the scheme should not be extended to the established companies. I did mention earlier that we are looking at whether we should have some form of ESOP scheme for these companies too, but not quite so attractive as the 50% tax rebate. Established companies need quite a lot of talent, but because they are established, they are better able to attract qualified staff because they can afford to do so. It is the new companies which are starting up and without a track record who will have difficulty in getting high quality staff to join them, and usually, they can only attract them to do so by offering share options.

Mr Kenneth Chen Koon Lap (Hong Kah): Can the Minister explain the rationale of imposing this time restriction on someone who qualifies for the stock option? The time and contribution are two different things. A person may work 50 hours a week but his contribution is not as much as one who spends 10 hours. For the same reason, why is it not extended to non-executive directors because their contribution may sometimes be more critical than an employee who spends full time in the company?

Dr Richard Hu Tsu Tau: Time qualification is necessary in order to ensure that the employee who is incentivised to join spends a significant part of his working life with the company. Whether the figure we have used is the proper criterion, I am not going to argue, because it is, to some extent, arbitrary. But I cannot measure whether a person who is spending one hour contributes more than somebody who is spending two hours. This is again a very subjective matter. But we have to establish some criteria, in terms of time, in order to ensure that a person, who joins a company to enjoy this incentive, devotes a significant amount of his working time to the company. If you get a person who may be utterly brilliant and spends one hour, but joins 10 or 20 companies, I am not sure that this is the group of people we want to incentivise. It would be very difficult to quantify anyway.

On non-executive directors, I have explained earlier that a non-executive director is one who from time to time contributes but not on a full-time basis, and therefore would not qualify under the time constraints we have imposed.

Mr Kenneth Chen Koon Lap: Should the decision then not be left to the company to decide whether that person should be entitled to have this share option in that case?

Dr Richard Hu Tsu Tau: We cannot allow that, because it is the Government who is giving the tax incentive, not the company.

Mr Lew Syn Pau (Kreta Ayer-Tanglin): I would like to ask how do you treat somebody who is an executive initially at the time the scheme is introduced, but subsequently becomes non-executive. Does he still qualify after he becomes non-executive?

Dr Richard Hu Tsu Tau: The title of "non-executive director", I am not sure really means very much. Really, the criteria should be: what are you doing in the company, are you one of the pioneers who are the founder shareholders and therefore enjoy certain privileges or are you the people recruited at the early stages and gain stock options in lieu of salary to start up the company? A non-executive director simply does not fit into this mould.