SME Capital Gains Tax: Who actually gains?

The Thai capital gains tax debate is over a decade old. First, let’s set the stage:

Investopedia defines capital gains tax (CGT) as a tax “on the profit from an investment that is incurred when the investment is sold”. The seller pays CGT — never the buyer. If you don’t sell your shares, you don’t pay CGT (they stay as unrealized gains).

Overview of article contents

In Thailand, the capital gains of shares in all businesses, small and large, are treated as income. Whether you pay CGT depends on who you are (an individual vs. a legal entity), and where you’re selling (within vs. outside a stock market).

Owners (and therefore sellers) of startup and SME shares typically fall into one of two groups:

Startup Founders & Employees who hold company shares: one day, when they want to sell their shares, their options are:

• A secondary sale, where they sell part of their stock to a third party or back to the company to get some cash (the ability of companies to own their own shares is proposed under the new Thai regulation), or liquidity, prior to the startup’s exit. If the individual (seller) sells shares through this route, outside of the stock market, capital gains is subject to personal income tax.
• An exit, which is the owners’ strategic plan to sell the company. Common exit strategies include:
• An M&A or a Trade Sale, where the buyer is likely in the same industry and sees strategic benefits (e.g. synergy) of combining the startup with their existing business. Or, they may be an outsider to the industry, with deep pockets and a belief that the startup is undervalued. If the individual (seller) sells shares through this route, outside of the stock market, capital gains is subject to personal income tax. Although this route is more common when compared to IPOs, CGT discourages this (as well as the secondaries explained above).
• An IPO, where the seller can sell their shares in the stock market. Here, the individual, whether foreign or Thai, is exempt from CGT.

The issue is that not all companies want an IPO. The reasons are plenty — to keep their business plans private, save on registration costs and reporting burden, and focus on long-term growth; they may already have enough access to other sources of capital.

Thailand is not well-known for tech IPOs because of its many regulations, but in recent years, lots of companies that highlight the tech elements of their business (e.g. Humanica, TQM, Ngern Tid Lor) have been really outperforming the market4.

Investors are the second group of sellers, with 3 main players:

• Venture Capital Firms (including corporate VCs): as a legal entity, wherever they sell, within or outside of the Thai stock exchange, their capital gains are subject to a 20% corporate income tax if they’re Thai, or a 15% tax if they’re a foreign firm. Some countries offer tax benefits on capital gains, such as Singapore, Hong Kong, and Mauritius, under the Double Tax Convention.
• Angel investors: as individuals, whether they are exempt from CGT depends on where they’re selling (i.e. within or outside of the stock market), leading them to hold their breaths on an IPO exit.
• Special Purpose Vehicles (SPVs), or syndicates, are structures specifically created to pool together co-investors to back a startup, and are subject to a 20% corporate income tax. Led by a lead investor, participants include funds (e.g. smaller VCs) and/or individual investors in the startup ecosystem, such as angel investors. For example, Singapore-based 500 Durians formed an SPV to fundraise for its portfolio company.
• Others: PE trusts and VCs that registered with the SEC within 2018 got tax exemptions for capital gains and dividends for 10 years. Now expired, many VCs have been pushing for this regulation to be effective again.

In a DCT talk, Nichapat Ark, Director of Openspace Ventures (with HQ in Singapore), says that Openspace is one of the few VCs that don’t urge Thai startups to move their registration abroad:

Investors will go to where they are treated best, thanks to globalization. Singapore, Hong Kong and Malaysia all have 0% CGT.

According to Cento, in a pool of our six Southeast Asian neighbors, Thailand more or less received a 5% share of capital invested in technology in the region in the past five years.

While it is inaccurate to blame this low number on CGT, and countries with CGT can have highly competitive startups (e.g. Japan, Germany and India), tax is part of the story.

CGT increases investors’ cost of capital (unless you’re an individual selling shares in the stock market): assume that a foreign VC has a required return of 25%, in a 0% CGT environment like Singapore. If subject to a 15% CGT, the cost of capital will rise to 29.4%. That’s a 4.4% increase in required return.

This tax bias (both between seller identity and sale location) leads to system distortion.

The bigger cause of low VC investment in Thailand (focusing just on how enabling the operating environment is, not on the startups’ own success) may be rule of law: Singapore is an established financial hub, and investors may not understand Thai laws.

In his column on the CGT debate, Banyong Pongpanich says that if CGT is removed, it should be done across the board.

So what is the main rationale behind the CGT?

To tax the rich. However, looking at a small sample of the largest Thai VCs and CVCs by portfolio size, their average return on equity (ROE) from 2018 to 2020 was hovering around -1% (*see methodology below). This is a very rough estimate: many of these portfolios may not have reached their maturity stage and have yet to harvest returns, holding unrealized gains for now. So, this average is not indicative of actual VC fund performance, but begs the question of how much CGT the government is actually collecting, when compared to VAT and income tax.

Let’s explore how the current CGT policy is hindering, and not supporting, Thai economic development:

1. Companies get incorporated offshore (eventually). As mentioned, investors go where they are treated best, and startups go where their investors go. The government has no way to prevent this, and it is happening with most of our homegrown startups.

Although CGT is not the only reason for investor flight, we can’t dismiss it as having just a negligible difference on startup growth. Even Thai VCs want their startups to incorporate abroad.

Khun Banyong believes that eliminating CGT across the board would promote VC investment and other important activities (e.g. M&As, restructuring). Moreover, Sarun Sutuntivorakoon, Partner at N-Vest, says that CGT exemption will help current players but won’t materially stimulate foreign VCs to set up new funds in Thailand3:

“It’s a good-to-have to match the rest of the world. At most, we catch up, but we’re still a follower — not a leader.” — Sarun Sutuntivorakoon

2. Wealth is accrued abroad. In Khun Banyong’s article, he notes that there are ways to lawfully avoid CGT (e.g. through trustees, holdings), causing capital flight, especially with increased globalization.

Foreign investors prefer countries that don’t collect CGT, while wealthy local investors look to invest abroad, such as in Singapore. While the wealthy have access to more investment options, this ultimately leaves the middle-income retail group subject to Thai CGT.

Doesn’t this call into question the foundation of CGT — to tax the rich and reduce our growing income inequality? Besides retail investors, startups are loss-making, not rich.

To further distort this system, BOI is tasked with enhancing our country’s competitiveness, implementing incentives without any change to fundamental tax policy:

Applying for BOI incentives has become much easier for IT startups. The new scheme has increased the digital business activities that are eligible, from 2 activities (i.e. embedded software; enterprise software and/or digital content) to 9 (new activities include cloud and digital services such as DigiTech and AgriTech).

Although this gives many more options to define a startup’s activities, it may lead to conflicted understanding among parties. Also, it is unclear whether some activities require ICT Board approval, which can take time, with lots of back and forth.

Let’s get our game on

Singapore has done a great job at attracting incredible founders who have built billion-dollar companies in the city-state. Going public in SG is easier, and they have 0% CGT in all cases, with no time limit.

In early December 2021, the Thai government green-lighted a decree for 0% CGT on investments in Thai startups. It is expected to be enacted into law in early 2022. How would implementing 0% CGT play out among the different players in Thailand?

1. VCs: Both foreign and Thai VCs should be eligible for a tax exemption. A maximum threshold based on the portfolio startups’ age may be set (e.g. VCs investing in startups that are less than 10 years old are CGT-exempt). This expectation is realistic: startups don’t produce much income in the early years.

VCs, as well as angel investors, should hold shares in the startup for a minimum period, before becoming eligible for a CGT exemption: under specific schemes in Australia, VCs and angel investors must hold shares for at least 12 months.

On the flipside, some could argue that VCs would be receiving a CGT exemption purely based on their business model, and that an exemption should only apply to startup founders and employees.

This argument may be countered by the economic value VCs create: Startup Genome says that an ecosystem that is 3x larger creates about 5x more economic value. If Thailand loses 40% of our startups, we’re risking over 50% of our ecosystem’s economic value.

2. Angel Investors support young startups through the risk-prone early stage and are therefore vital to the Thai startup ecosystem. Capital gains is only one of the few issues that this investor group faces. However, eliminating CGT, as well as giving tax breaks, may encourage them to be more active and deploy more cash:

• The UK gives angel investors tax reliefs through investment schemes that target both the startup seed and growth stages, if the investor holds the shares for at least 3 years. With income tax relief, investors receive a CGT exemption when selling their shares, as well as relief for capital losses against income.
• Australia gives angel investors a 20% non-refundable carry-forward tax offsets on the amount invested in eligible Early Stage Investment Companies (ESICs). The incentive is capped at 200,000 AUD per investor per year, and also gives a 10-year exemption on CGT for shares held for at least 12 months1.

Mark Gustowski, Managing Director at Innovation Architects, emphasized the need to incentivize more investors to invest in startups, where losses dominate wins.

He sees 0% CGT as a nice-to-have; however, with CGT occurring 5 to 7 years down the line, it may not be as appealing as providing incentives to invest today: this may take the form of government funding the establishment costs or management fees for angel groups1.

• Malaysia gives angel investors an income tax exemption equivalent to the investment value if shares are held for at least 2 years.

3. Startup Founders may need to hold shares for a certain time period before they are eligible to sell without CGT, similar to requirements in the US (5 years, with limitations). Sarun says the benefits depend on flexibility: on one end, it’s a good-to-have if founders get 0% CGT by default. But, if they need to submit tons of paperwork to prove their identity, that cancels out the perks3.

Granted, CGT is not a founder’s typical blocker: more often than not, they aren’t able to find a buyer when they are looking to cash out a small amount for liquidity. Liquidity can be improved by having a secondary market for SMEs and startups (i.e. the SME Board).

We still have more laws to fix

(see Regulatory Guillotine)

A CGT exemption is not a silver bullet, but a gold starting point. Back in 2016 to 2018, the decrees , issued under the Revenue Code on Tax Exemption (№597) 2016 and (№636) 2017 (now expired), were in place to exempt CGT and corporate income tax for VCs.

During the DCT talk, Akkaraj Boonyasiri, Tax Economist at the RD, asked for input on the tax mechanisms that would meet the private sector’s needs, including how they would provide direct and indirect benefits (e.g. increase in the number of startups and investment). Due to the interconnectedness of tax and other factors, this is tough to silo and quantify.

The Option: Can we look at this situation as a financial option?

In our volatile world, Nassim Nicholas Taleb, author of “Antifragile”, argues that we do not need to understand what’s going on in a situation, if we can identify that it’s a case of limited loss and unlimited gains:

An asymmetry between the upside and downside from “Antifragile”

Applying this concept to CGT, the limited loss in the diagram represents the maximum amount of CGT being collected, which the government can quantify by looking into its past books. Then, the RD can decide whether losing that budget is tolerable.

Staying dynamic aligns with Khun Akkaraj’s view: the RD’s approach is to issue short-term measures, to monitor progress and improve upon or cancel less effective policies. This would minimize the magnitude of the loss.

The upside in the diagram, likely unquantifiable, is a boosted startup ecosystem, which happens to fall under one of the RD’s two main KPIs: to recommend tax policy to develop the economy and society.

Now that we’re exercising the option, will the conditions under our new 0% CGT policy enable us to book some (hopefully unlimited) gains? We’ll have to wait and see.

If you have new information regarding the contents of this article and would like to share, please email us at ama@aimventures.co — we’ll update the content.

*Methodology: Using SPHERE 8 Finder and filtering for VCs and Corporate VCs with Thai Portfolio Size 8–500, Status Active, Location Thailand, 5 Thai VCs were on the list. Their financial data was extracted from DBD DataWarehouse. Of the 5 Thai VCs, only 4 were included (True Incube, Beacon Venture Capital, AddVentures by SCG, and N-Vest Venture). The 5th VC (InVent by Intouch Holdings) was not found as a separate entity in DBD.

Thank you to my co-author Sheena Narula for making this article possible!

Contributors

1. Mark Gustowski is an experienced investment executive and has worked with innovative, fast-growth businesses and governments for over 20 years. A significant portion of that time focussed on equity investments for startups in the creative, food, agtech and FMCG sectors. Mark has been involved in a number of his own startups in the biotech, real-estate tech, edu-tech and FMCG spaces, as well as an angel investor, and has designed and delivered investment and accelerator programs across Australia, China, the US, UK and Thailand. Currently sitting on the boards of a number investee companies, Mark supports strategic direction, structuring, capital raising and market strategy. He has worked with Australian governments at all levels on program structure and delivery, policy implementation and investment, with key experience across Australia, SE Asia, the UK and the US. Following his BAppSci, he also completed the Venture Capital Executives Program at the HAAS Business School (UC Berkeley) on a Victorian Employer’s Chamber of Commerce and Industry (VECCI) scholarship, is a member of the Australian Institute of Company Directors (AICD), the Australian-ASEAN Business Council, and the Australia Thailand Business Council.
2. Maturos (May) Salayarg, Trade and Investment Manager — Tech and FDI Lead at the Department for International Trade, British Embassy
3. Sarun Sutuntivorakoon, Partner at N-Vest & President of TVCA
4. Kasama (Kate) Jatejarungwong, Founder and CEO of The Omelet

Other References:

1. Thai Tax Expert
2. Department for International Trade’s Tax in the UK
3. The Revenue Department’s Personal Income Tax
4. DCT, proposed by participants during event “DCT invites leading VC entrepreneurs & startups in Thailand to discuss proposals for CGT exemption”