Co-authors: Matt Weerden & Nitya Varadavajan
Tax incentives
Designed to encourage new investment in Australian early stage innovative startups, the incentives are part of the Government’s larger vision to encourage innovation, risk-taking and an entrepreneurial culture in Australia.
Startups typically struggle to find access to funding to develop, commercialise their concept and fund their ongoing operations. These incentives are aimed at addressing this issue by bridging the gap between bootstrapping (investment through self-financing, family and friends) and securing investment through venture capital (generally aimed at companies in later stages of development).
The first element of the tax incentives is a non-refundable carry forward tax offset equal to 20% of the amount paid for shares in a qualifying ESIC (up to a maximum of $200,000 per year). The second element is a Capital Gains Tax (CGT) exemption for shares held for more than 12 months and less than ten years. For newly issued shares in an ESIC, the entire shareholding is deemed to be held on capital account rather than revenue account.
For sophisticated investors, there is no cap on the quantum of the investment which can be made, however the tax offset is capped at $200,000 per year. The same sophisticated investor test and definition applies as that under the Corporations Act and administered by ASIC.
For all other individuals, to access the incentives, the investment cannot exceed $50,000 in an income year otherwise neither the tax offset or modified CGT treatment will apply. The maximum tax offset for a non-sophisticated investor is capped at $10,000 per year.
Other investor eligibility requirements are that the investor cannot be a widely held entity, the ESIC and investor cannot be affiliates, the shares cannot be acquired under an employee share scheme and the investor cannot have a greater than 30% shareholding in the ESIC or its connected entities. The above eligibility requirements must be met immediately after issuing the shares to the investor.
An Australian-incorporated company will qualify as an ESIC where it can be shown that it is at an early stage of its development (the early stage limb) and it is developing new or significantly improved innovations with the purpose of commercialisation to generate an economic return (the innovation limb).
A company will satisfy the early stage limb where:
The innovation limb is satisfied where the company is able to demonstrate that it satisfies the “100 point innovation test” (an objective test broadly based on the R&D activities of the company) or the “principle based innovation test”. This is designed to take into account the company’s potential for growth and ability to scale its business beyond local markets. Where companies seek to rely on the principle based innovation test, they will likely have to apply for a ruling from the ATO to confirm whether they satisfy the innovation limb. In the interests of certainty for investors, it is recommended that companies seek to apply to the ATO for a ruling.
In order to access the tax offset and CGT exemption, the onus is on the investor to confirm that the startup qualifies as an ESIC at the time it makes investment. As such, the ESIC accreditation process detailed above is
important as investors will require confirmation that the company will be considered by the ATO to be an ESIC prior to investing.
The new rules, whilst offering major incentives to start-ups and investors alike are complex. Given this complexity and the ongoing compliance requirements, startups and investors should obtain legal and tax advice to ensure they are applying the rules correctly.
The views expressed in this article are the views of the author, not Ernst & Young. This article provides general information, does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Liability limited by a scheme approved under Professional Standards Legislation.
