Tax Incentives for Early Stage Investors

Current as at 29 September 2020

We have written articles in previous editions of S & W Insight, about the tax concessions available to investors in early stage innovative companies. The question has been coming up again recently from a number of clients so it is time to revisit the issue so you are all aware of what is available to you as an investor.

Early stage innovation companies (ESIC) have always faced difficulty trying to attract seed capital and pre commercialisation equity to fund the early stages of their development. The government, from 1 July 2016, decided that these companies needed a hand. From that date the following Tax Incentives for early stage investors became available and they include generous tax offsets and modifications to the CGT treatment of eligible investments.

The Main Concessions available are as follows

–          Entities that acquire newly issues shares in an ESIC may receive a non refundable carry forward tax offset of 20% of the value of their investment (maximum offset cap is $200,000). Additionally an annual investment limit of $50,000 applies to retail non sophisticated investors. If they invest more than this in a particular year they do not get any offset, even on the first $50,000. This is done to limit the risk unsophisticated investors are exposed to. Investing in ESIC is risky and investors must go into it with their eyes open. Sophisticated investors can invest as much as they want to in the ESIC but the offset is limited to $200.000 pa.

–          Investors may disregard capital gains on shares in ESIC’s that have been held for between 1 and 10 years. Investors must disregard capital losses realised on these shares held for less than 10 years. Shares held for longer than 10 years are valued at the 10 year time and the capital gain up till that time is protected. Gains accrued after that time period are taxable.

What Investors Qualify for these Tax Incentives

–          The investor can be any entity, including companies, individuals, partnerships or trusts. The offset is not claimed in the partnership or trust but rather flows through to the beneficiaries or partners.

–          Can be claimed by non residents but the offset incentive will be less attractive to non residents who may not have an Australian tax liability.

–          The shares issued can’t be an acquisition of shares under an Employee Share Scheme.

–          The investor cannot claim the concession if the company is an Affiliate of his, or vice versa. That is, the ESIC cannot reasonably be expected to act in accordance, or in concert, with the investor’s wishes or vice versa. This is done to ensure that the concessions are only for new investments  not to subsidise existing investment. This will usually stop the person who starts or runs the company from getting these concessions.

–          Shareholders must not hold more than 30% of the equity in the ESIC. This is tested immediately after the investment is made. This is done to ensure investors spread their investments across more than one ESIC.

–          Disregarding the capital gain doesn’t work if the ESIC sells the business out of the company rather than the shareholders selling their shares. There is no concession to disregard the capital gain within the ESIC itself.

What is a Qualifying ESIC

–          It must be a company

–          It is at an early stage of its development. The company must have

§  Been incorporated in the last 3 years, or

§  It has not been incorporated in the last 3 years but it only registered an ABN in the last 3 years

§  If it hasn’t been registered with an ABN in the last 3 years, it was incorporated in the last 6 years and has not incurred > $1.0M in expenses in the last 3 years

o   It did not incur > $1.0M in expenses in the previous income year

o   It has assessable income of $200,000 or less in the previous income year

o   It is not listed on the Stock Exchange

–          It must pass the Innovation tests placed on companies by the ATO. These tests are quite complex and need a considered approach to ensure you satisfy them. Innovation is measured by reference to a 100 point innovation test.  A potential ESIC has 3 options to determine whether they satisfy these tests

§  Review the objective tests in the legislation to see if they pass

§  Self assess against the principles-based test in the legislation

§  Seek a ruling from the Commissioner about whether they satisfy the principles based test.

o   The company prove that they have the potential for high growth, have scalability, can address a broader than local market and have competitive advantages.

o   This is usually proved through the use of business plans, commercialisation strategies, competition analysis and other company documents. Below is the link to the ATO website which gives clarity on how to satisfy the innovation tests.

https://www.ato.gov.au/Business/Tax-incentives-for-innovation/In-detail/Tax-incentives-for-early-stage-investors/?page=2

 How is the Reporting done on ESIC shares.

–          The onus is on the ESIC itself to report what investments have been made into the ESIC and by who, during that year.

–          They need to report to the ATO 31 days after year end on the relevant form provided.

–          This is to keep record keeping consistent and streamlined and to assist the ATO in administering the system

These concessions are very significant and they will have a major effect on your decision as to what entity you should set yourself up as. If you are needing investment into the company at an early stage it is important that you take the conditions on these provisions into account when making your decision about a structure.

If you believe you may fit into these parameters please call us to discuss.

 

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