Providing services in return for equity / shares / options (sweat equity)

Hi there

If a startup company wanted an external service provider (ie not an employee) to provide professional services in return for equity (ie 'sweat equity'), what are the tax implications of this?

Eg 1: the service provider is entitled to 2 shares for every hour of services provided (ie 2 shares per hour of services provided). So, at the end of a calendar quarter, if the service provider has provided 50 hours' work, the service provider is entitled to 100 shares.

Eg 2: the service provider is entitled to 120 shares over a 12 month period (ie vesting at the rate of 10 per month) in return for a commitment to provide 10 hours of services per month for that 12 months.

Some specific questions;

1. What are the tax implications (including income tax and CGT) of these scenarios for the service provider and for the company itself?
2. Does it make a difference if the entitlement is to options instead of shares?
3. What is the significance of the fact that the startup has had no external investment to place a price/value on the shares issued?
4. What happens if the startup raises capital (say, valuing the company at $5m after the capital raising) just before shares are issued to the service provider in return for services provided?
5. Are there any ways for an external service provider (ie not an employee) to provide services in return for equity but where the tax liability is incurred at the time the shares are sold in an arm's length transaction?

Many thanks in advance

 

Hi

Quick follow-up about this post.

1. Does anyone know anything about this at all?

2. Or, does anyone know who would be a good expert to ask? It seems a little specialised for a run of the mill accountant perhaps, so any suggestions about useful experts would be appreciated.

Many thx

 

You need specialist advice. I have a client who did something similar, although they were an employee. They are up for some huge amounts of tax which could have been reduced if set up differently.