12 Sep Early-Stage Tax Incentives

Posted at 01:28h in Uncategorized by

By Genevieve Rajakulendran

Early-stage innovation companies (ESIC) have often struggled with trying to attract seed and pre-commercialisation funding during the earlier stages of their development. However, it is often through the high- risk period from initial funding to when a company starts generating revenue, that they need to attract investors to help them get off the ground and survive.

In 2016, to increase new investment in Australian ESICs with high growth potential, the Government provided tax incentives to investors in these companies.  The tax incentives were in the form of a tax offset and a capital gains tax (CGT) exemption for their investment.  These tax incentives are called the early-stage tax incentives- available to Australian residents and non-residents.

It is important for investors to understand the intricacies of the requirements of these tax incentives to be eligible for them.

The tax incentives provide:

  • 20% of the amount paid for the eligible investment. This is capped at a maximum tax offset of $200,000 for the investor and affiliates combined in each income year.
  • Modified capital gains tax treatment- capital gains where the shares are continuously held for at least 12 months and less than 10 years may be disregarded. Capital losses held less than 10 years are also disregarded.

Broadly, the tax incentives are available if you

  1. Are a sophisticated investor** or your total investment in one or more ESICs in an income year, is not more than $50,000 investment.
  2. Invested in the ESIC and it is a qualifying ESIC and satisfies the “early stage” test and either the 100-point innovation test or principles-based test.
  3. Are an investor that is an individual, trust, corporation, partnership, or self- managed superannuation fund (but not a widely held company or a subsidiary of a widely held company.)
  4. Do not hold more than 30% of the equity interests in the ESIC (including any entities connected with the ESIC) immediately after the investor is issued with the new shares.

Some qualifying requirements

To qualify for the tax incentives the following conditions must be satisfied:

  • Investors must have purchased new shares in the company, meeting the requirements of an ESIC immediately after the shares are issued.
  • The shares must be issued on or after 1 July 2016. If issued because of converting the convertible notes, it is the date of conversion that is relevant.

a. The early-stage tax incentives are not available to you if:

i. you did not purchase the shares in the ESIC directly from the company as newly issued shares

ii. if you are early-stage venture capital limited partnership (ESVLCP)

iii. you are a widely held company* or a 100% subsidiary of a widely held company

iv. your total investment in one or more of the ESICs for the income year is more than $50,000 and you did not meet the sophisticated investor test in

relation to at least one of those share offerings.

Note- if you meet the sophisticated investor test you are eligible for the early-stage investor tax incentives and are not restricted to the amount you invest in an income year.

v. You or the ESIC?? are affiliates of each other at the time the shares are issued

vi. You hold equity interests in the ESIC (including any entities connected with the ESIC) immediately after you are issued with the new shares that carry

the right to:

1. Receive more than 30% of any distribution of income or capital by the company or the entities or

2. Exercise or control the exercise of more than 30% of the total voting power in the company or the entities.

vii. You acquired the shares under an employee share scheme or by exercising a right you acquired under an employee share scheme.

*Widely held company is defined as a company listed on an approved stock exchange or a company with more than 50 shareholders.

**Sophisticated investor – certificate issued by the qualified accountant certifying the asset $2.5million test or gross income test of $250,000 is satisfied.

Investment held via a trust or partnership

Where the investor is a trust or partnership, special rules apply so that the entitlement to the tax offset and modified CGT treatment flows through to the member of the trust or partnership.  The trust or partnership is treated as the individual investor and each member calculates its share of the tax offset based on its membership interest in the trust or partnership.

For example, if you had two unitholders of a unit trust and unitholder 1 owns 80% of the units and unitholder 2 owns 20% of the units at the end of the income year, the tax offset would be apportioned accordingly. The unit trust would be entitled to claim an early-stage investor tax offset of up to $200,000 in the income year. Unitholder 1’s share of the tax offset would be $160,000 (80% of $200,000) and unit holder 2’s share of the tax offset would be $40,000 (20% of $200,000).

Whether a unit trust or discretionary trust, this offset is passed down to either the individual or company that is the beneficiary of the trust.

The trustee must also give written notice to the beneficiaries advising each of them of their entitlement to the tax offset within 3 months after the end of the income year.

Qualifying as an early-stage innovation company

To qualify for the incentives the company must qualify as an early-stage innovation company immediately after the shares are issued to the investor.

A company will qualify as an ESIC if it is not a foreign company under the Corporations Act 2001 and meets both the early-stage test and either the 100- point innovation test or the principles- based innovation test.

The principles innovation test is a subjective test so it is simpler for the company to satisfy the 100 point innovation test rather than the principles-based innovation test.

Early-Stage Test

To meet the early-stage test, the company must meet four requirements. These requirements are tested at the time immediately after the company issues the shares to the investor.

If a company does not meet all the requirements at that time, the investor will not qualify for the tax incentives in relation to those shares.

The four requirements are:

  • The company must have been incorporated or registered in the Australian Business Register.
  • The company (plus any wholly owned subsidiaries of the company) must have total expenses of $1 million or less in the previous income year.
  • The company (plus any wholly owned subsidiaries of the company) 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

and either:

the 100-point innovation test, whereby the company must obtain at least 100 points by meeting certain objective innovation criteria or the principles-based innovation test.

 The following table is an extract from the tax legislation outlining the 100 points;

Innovation points potentially available at that time in the current year

Column 1Column 2
ItemPointsInnovation criteria
175At least 50% of the company’s total expenses for the previous income year is expenditure that the company can notionally deduct for that income year under section 355-205 (about R&D expenditure).
275The company has received an Accelerating Commercialisation Grant under the program administered by the Commonwealth known as the Entrepreneurs’ Programme.
350At least 15%, but less than 50%, of the company’s total expenses for the previous income year is expenditure that the company can notionally deduct for that income year under section 355-205 (about R&D expenditure).
450(a) the company has completed or is undertaking an accelerator program that:
(i) provides time-limited support for entrepreneurs with start-up businesses; and
(ii) is provided to entrepreneurs that are selected in an open, independent, and competitive manner;
and
(b) the entity providing that program has been providing that, or other accelerator programs for entrepreneurs, for at least 6 months;
and
(c) such programs have been completed by at least one cohort of entrepreneurs.
550(a)    a total of at least $50,000 has been paid for *equity interests that are *shares in the company;
and
(b)    the company issued those shares to one or more entities that:
(i)         were not *associates of the company immediately before the issue of those shares;
and
(ii)       (ii) did not *acquire those shares primarily to assist another entity become entitled to a *tax offset (or a modified CGT treatment) under this Subdivision;
and
(c) the company issued those shares at least one day before the test time.
650(a) the company has rights (including equitable rights) under a *Commonwealth law as:

(i) the patentee, or a licensee, of a standard patent; or

(ii) the owner, or a licensee, of a plant breeder’s right;
granted in Australia within the last 5 years (ending at the test time);
or
(b) the company has equivalent rights under a *foreign law.
725Unless item 6 applies to the company at the test time:
(a) the company has rights (including equitable rights) under a *Commonwealth law as:
(i)        the patentee, or a licensee, of an innovation patent granted and certified in Australia;
or
 
(ii)      the owner, or a licensee, of a registered design registered in Australia;
 
within the last 5 years (ending at the test time);
or
b) the company has equivalent rights under a *foreign law.
825The company has a written agreement with:
(a)      an institution or body listed in Schedule 1 to the Higher Education Funding Act 1988 (about institutions or bodies eligible for special research assistance);
or
(b)      an entity registered under section 29A of the Industry Research and Development Act 1986 (about research service providers);
to co-develop and commercialise a new, or significantly improved, product, process, service or marketing or organisational method.

Important Points to Note for –

Investors

  • Need to satisfy themselves the company qualifies as an ESIC, and they qualify as a sophisticated investor (or not exceed the investment cap)
  • When selling the shares – claim the tax offset through their income tax return
  • Offsets can be carried forward to future income years.
  • Can disregard any capital gain provided they are held for at least one year and less than 10 years.
  • A notable trap in this space is ensuring the company qualifies as an ESIC

ESIC Companies

  • Need to satisfy themselves they qualify as an ESIC and can self-assess or get a ruling from the ATO. The standard turnaround time for the private ruling application ruling process is 28 days provided the ATO has all the necessary information.
  • When selling the shares, must report the qualifying share sale to the ATO within 1 month after the end of the income year.

Please note the above article is general tax advice and it is important you speak to your EQ8 representative to consider your individual circumstances