The Government has introduced new tax incentives to boost investment in early stage innovation companies in Australia.
In particular, these tax incentives are designed to encourage new investment in small Australian innovation companies, often referred to as ‘startups’, with high-growth potential.
In our experience, the startup community are very interested in accessing the concession for their investors, however there have been difficulties with entities satisfying the relevant eligibility requirements.
To assist your understanding of the new tax incentive, we have summarised the key points below:
What are the tax incentives for investors?
- A 20% non-refundable carry-forward tax offset for qualifying investments in early-stage innovation companies (“ESICs”); and
- Modified capital gains tax (“CGT”) treatment:
- The investment in the entity is deemed to be held on capital account;
- A capital gain on sale of the investment is disregarded if the investment was held for at least one year but less than 10 years;
- Any capital loss on sale of the investment must be disregarded if the investment was held for less than 10 years;
- Investor gets a step-up in the cost base of the investment to market value at the end of the 10-year period (general CGT provisions apply from that point).
What is the maximum offset amount that can be claimed?
A tax offset directly reduces the amount of tax payable on the taxpayer’s taxable income. The maximum tax offset that can be claimed under the new provisions is dependent on the type of investor:
- Sophisticated investors are not restricted on the amount they may invest, however, the maximum tax offset that can be claimed is $200,000 (e.g. effective $1M investment). Note, a sophisticated investor is a type of investor who is deemed to have sufficient investing experience and knowledge to weigh the risks and merits of an investment opportunity; and
- Non-sophisticated investors are limited to a maximum investment amount of $50,000 in an income year (resulting in a maximum tax offset of $10,000). If the amount of investment exceeds $50,000 in an income year, there will be no entitlement to a tax offset and no modified CGT treatment.
When can an investor access the incentive?
The basic requirements for an investor to access the incentives can be summarised as follows:
- The investment is made in an eligible ESIC after 1 July 2016;
- The ESIC issues the investing entity with shares during the income year;
- The investing entity did not acquire the shares through an employee share scheme; and
- Immediately after the shares were issued, the investor does not hold more than a 30% investment in the ESIC.
The incentives are available to both Australian residents and non-residents.
Where investments are made indirectly (through a trust or partnership) the value of the tax incentives will flow through to the beneficiaries or partners.
What is an ESIC?
To qualify as an ESIC, a company must:
- Be at an early stage of its development (“The Early Stage Limb”) and either be:
- Developing new or significantly improved innovations with the purpose of commercialisation to generate an economic return (“The Innovation Limb”); or
- Satisfy a list of criteria (“100-point test”) at a particular time in an income year.
The Early Stage Limb
In order to satisfy the Early Stage Limb, the following must be satisfied by the ESIC (including any wholly owned subsidiaries):
It must have been either:
- Incorporated or registered with the Australian Business Register, within the last three income years (the latest being the current year);
- Incorporated within the last six income years (the latest being the current year), and across the last three income years, only incurred total expenses of $1M or less;
- Must have incurred total expenses of $1M or less in the previous income year;
- Must have derived assessable income of $200,000 or less in the previous income year; and
- Equity interests are not listed on an approved stock exchange either in Australia or a foreign country.
The Innovation Limb
To satisfy the Innovation Limb, the following must be satisfied:
- The entity must be genuinely focused on developing for the commercialisation of one or more new or significantly improved products, processes, services or marketing / organisational methods;
- The business relating to those products, processes, services or methods must have a high growth potential; and
- The entity must demonstrate that it has the potential to be able to address a broader than local market, including global markets, to have competitive advantages for that business and to successfully scale that business.
In our experience, to obtain certainty on whether the entity satisfies the Innovation Limb, a private ruling should be lodged with the ATO.
- (b) 100 Point Test
At a particular time in the income year, the entity must obtain at least 100 points from the following list of criteria:
- 75 points: At least 50% of the company’s total expenses for the previous year satisfy the conditions for the research & development (“R&D”) tax incentive;
- 75 points: The entity has received an Accelerating Commercialisation Grant;
- 50 points: At least 15% but less than 50% of the company’s total expenses for the previous year satisfy the conditions for the R&D tax incentive;
- 50 points: The entity has completed or is undertaking an accelerator program and has been operating that program or other accelerator programs for entrepreneurs for at least six months, and has provided a completed program of this kind to at least one cohort of entrepreneurs;
- 50 points: The entity has issued shares to an unrelated party, and the third party paid at least $50,000 for the shares and did not acquire the shares primarily to assist another entity to become entitled to the tax offset;
- 50 points: The entity holds patent rights or plant breeder’s right under a Commonwealth law granted within the last five years or equivalent rights under a foreign law;
- 25 points: The entity holds innovation patents or owner / licensee of a registered design under a Commonwealth law granted within the last five years or equivalent rights under a foreign law; and
- 25 points: The entity has a written agreement to co-develop and commercialise an innovation with certain prescribed entities.
Find out more
If you are interested in finding out if these tax incentives may apply to your circumstances, or if you have any questions, please contact me directly on 02 9619 1778 or Matthew.Saad@crowehorwath.com.au
Matthew Saad – Partner, Tax Advisory