Tax incentives for early stage investors
On the back of the Turnbull Government’s push towards supporting an innovative Australian economy, a number of legislative measures were introduced in mid-2016 to support this broad agenda. The Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 was enacted with the two main aims being:
- To promote investment in Australian start-ups and early stage innovating companies
- To improve the attractiveness of venture capital regimes for investors
Therefore, from 1st July 2016, eligible investors who invest in a qualifying early stage innovation company (ESIC) may be able to access tax incentives as follows:
- A non-refundable carry forward tax offset equal to 20% of the amount paid for their qualifying investments. This is capped at a maximum tax offset amount of $200,000 for the investor and their affiliates combined in each income year
- Modified capital gains tax (CGT) treatment where capital gains made on shares that are continuously held for at least 12 months and less than 10 years may be disregarded. Capital losses on shares held less than 10 years would also be disregarded. If the shares are continuously held for 10 years or more then the first element of the cost base of the shares will be based on their market value at the 10th anniversary of the shares being issued to the investor.
Note the $200,000 maximum tax offset cap has no impact on the level of shares qualifying for the modified capital gains tax treatment.
Qualifying for the tax incentives
There are a number of conditions applicable in determining whether you may qualify for the tax incentives on offer:
- The company issues the investor with new shares that are equity interests (not debt interests) on or after 1 July 2016
- The company must meet the requirements of being an ESIC immediately after the shares are issued
- The investor and the company must not be affiliates of each other at the time the shares are issued
- Immediately after the shares are issued, the investor does not hold more than 30% of the equity interests in the company
- The company generally can’t be a widely held company (e.g. listed on a stock exchange or with more than 50 shareholders)
- The investor can’t acquire the shares under an employee share scheme
- The investor must meet the “sophisticated investor” test under the Corporations Act 2001 to be eligible for the tax incentives if their total investment in qualifying ESICs in an income year is more than $50,000
The early stage investor incentives are available to both Australian resident and non-resident investors. The tax offset can also apply when a trust or partnership invests in an ESIC. In this case the tax offset is provided to certain beneficiaries of the trust or partners of the partnership. The benefit of the tax offset can also pass from a trust to its beneficiaries regardless of whether the trust has a profit or loss for the year and, if the trust is a discretionary trust, it appears that the trustee can choose in a flexible manner how to allocate the tax offset.
Qualifying as an early stage innovation company
The obvious benefit of these tax incentives for investors in relation to innovative companies is the prospective ability for these companies to attract venture capital for funding. To do this though, the company must qualify as an ESIC. A company will qualify as an ESIC if it meets both:
- The early stage test; and
- Either the:
- 100-point innovation test; or
- Principles-based innovation test
The early stage test requirements are:
- The company must have been incorporated or registered in the Australian Business Register
- The company (and any wholly owned subsidiaries) must have total expenses of $1 million or less in the previous income year
- The company (and any wholly owned subsidiaries) must have assessable income of $200,000 or less in the previous income year
- The company’s equity interests are not listed for quotation in the official list of any stock exchange, either in Australia or a foreign country
The 100-point innovation test involves the company obtaining at least 100 points by meeting certain objective innovation criteria. The various criteria are set out in a table available from the Australian Taxation Office and each criterion is worth a certain number of points towards the accumulated total. This test is applied immediately after the shares are issued to the investor. Where a company undertakes activities that fit the criteria, it is likely to be the simplest way to determine eligibility as an ESIC.
The principles-based innovation test involves the company demonstrating how it meets each of five requirements. The company would need to show that it has taken (or will take) tangible steps towards these requirements via evidence such as business plans, commercialization strategies, competition analysis, etc. The five requirements are:
- The company must be genuinely focused on developing one or more new or significantly improved innovations for commercialisation
- The business relating to that innovation must have a high growth potential
- The company must demonstrate that it has the potential to be able to successfully scale up that business
- The company must demonstrate that it has the potential to be able to address a broader than local market, including global markets, through that business.
- The company must demonstrate that it has the potential to be able to have competitive advantages for that business
These measures are complicated and involved so should be carefully considered before actioning. If you are either an investor contemplating an investment in an ESIC or you have an innovative business idea that might be able to take advantage of these measures to attract venture capital, please contact us to discuss your options.
Jason Beare, Managing Partner
MBA Business Solutions
Image courtesy of freedigitalphotos.net