The Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 was passed by both houses of Parliament and received Royal Assent on 5 May 2016.
This bill is designed to promote investment in qualifying start-ups by providing the following tax concessions for investors:
- 20% non-refundable tax offset on investments, capped at $200,000 per investor per year, and
- Concessional capital gains tax treatment on the eventual sale of the shares in the start-up.
The new arrangements apply from 1 July 2016
Tax offset for investment
The incentives are available for investors in eligible companies, known as an Early Stage Innovation Company (or “ESIC”), if that company:
- Meets the conditions outlined in the legislation with regard to Innovation and commercialisation risk ( with a requirement to meet a 100 point innovation test);
- Was incorporated during the last 3 income years or, if incorporated between 3 and 6 years, did not incur more than $1mil in total in the last 3 income years;
- Has total expenses of $1 mil or less and has assessable income of $200,000 or less in the previous income year, and
- Is not listed on any stock exchange
The tax incentives are available to all types of investors, regardless of the entity type and residency, however there are a number of conditions and restrictions, including:
- The $200,000 non-refundable tax offset is only available for “sophisticated investors” as defined in section 708 of the Corporations Act 2001. Other investors (“non-sophisticated” investors) are limited to investing amounts of $50,000 in any one income year;
- The investment must be in new shares issued, not shares acquired from an existing investor;
- The issue of the shares cannot constitute an acquisition of ESS interests under an Employee Share Scheme;
- The tax incentive will not be available for any investors who are considered to be able to exercise a level of control or influence over the decision making of the ESIC or its associated entities; and
- An investor cannot hold more than 30 per cent of the equity interests in the ESIC, or any entities ‘connected with’ the ESIC.
The maximum offset for an investor entity and its affiliates in any income year is $200,000 less the sum of any previously claimed tax offsets carried forward into the income year
The tax offset is non-refundable, so it is of no immediate benefit to an entity without an income tax liability. However, the tax offset may be carried forward to future years.
CGT treatment on the sale of shares in qualifying ESICs
There are CGT concessions for investors that have continuously held a qualifying share in an ESIC, as follows:
- For shares held between 12 months and less than ten years – the investor may disregard a capital gain arising from the share. Capital losses are also disregarded.
- For shares held for at least ten years – the cost base of the shares will be adjusted to the market value on the ten year anniversary date. As such only the incremental gains (or losses) in value after 10 years will be taxable.
However, where the shares are held for less than 12 months, an investor will taxed on any capital gain as normal but must disregard any capital losses. This measure is designed to ensure that an investment is for the long term and that the tax incentives are not manipulated..
ESIC reporting requirements
ESICs that receive investment funding will need to provide information about those investors to the Tax Commissioner 31 days after the end of the financial year. The form and content of the information is yet to be clarified.
The Explanatory Memorandum to the Legislation clearly states that the Tax Commissioner will seek to apply the anti-avoidance provisions of the tax law if investors enter into an artificial scheme to qualify for the tax offset or the modified CGT treatment for shares in a qualifying ESIC, or contrived an arrangement to qualify for both the tax offset and any subsequent CGT outcome.
The government must be commended for introducing legislation that provides incentives for investors in early stage innovation companies. However as always, the devil of the concession is in the detail.
Business owners and significant equity partner are, in effect, excluded from these tax concessions.
Non sophisticated investors are limited to a tax concession of 20% of $50,000. Is this to limit to risk of small investors being taken for a ride? It is unclear.
For sophisticated investors (those with assets in excess of $2.5mil or income in the last two years of at least $250,000) will they need to obtain a Qualified Accountant’s Certificate to hold on file as they self assess their investor status for the tax rebate? Will they need to provide an Accountants Certificate to the ESIC for year-end compliance and reporting purposes? This, too, is unclear. What is likely, however, is that investors claiming the tax rebate are more likely to get a phone call from the Tax Office than those that do not.
And if you invest in an ESIC and it does not succeed? Are you better off being able to have taken the capital loss or the 20% concession? The answer will be the 20% concession…until you want the loss.
In the end the legislation will succeed in opening up avenues of funding for start-ups in Australia. The opportunity should be grasped with both hands by start-ups and their investors.