Introduction
As a firm that specialises in providing legal assistance to innovative businesses, Allied Legal is often consulted about the tax incentives that are offered to investors in early stage innovation companies (ESIC). The ESIC regime provides both short and long-term tax incentives to investors who acquire shares directly from ESICs, assisting in the funding of those companies.
Tax incentives
Broadly, the tax incentives provide eligible investors with:
- a 20 per cent non‑refundable carry-forward tax offset on amounts invested in qualifying ESICs, with the offset capped at $200,000 per investor per year (on an affiliate-inclusive basis); and
- a 10 year exemption on capital gains tax for investments held as shares in an ESIC for at least 12 months, provided that the shares held do not constitute more than a 30 per cent interest in the ESIC.
The tax incentives are designed to promote this culture by connecting relevant startup companies with investors that have both the requisite funds and business experience to assist entrepreneurs in developing successful innovative companies, particularly at the pre-commercialisation phase where a concept is in development, but the company requires additional investment to assist with commercialisation.
To target the incentives to innovative activities, the startup receiving the funding must satisfy two limbs
- The first limb determines that the company is early stage, against criteria related to expenditure, assessable income, stock exchange listing and incorporation.
- The second limb determines that the company is involved in innovation, by allowing the company to self‑assess against either a principles-based or gateway test, or by receiving a determination from the Australian Tax Office.
The Investor
An investor will qualify for the incentives if it:
- invests in a qualifying ESIC (see below);
- is not a widely-held company; and
- is either:
- a legal person controlled by an individual considered a sophisticated investor pursuant to subsection 708(8) of the Corporations Act 2001; or
- a non-sophisticated investor that has invested $50,000 or less in the income year.
Qualifying as an ESIC
A company will be a qualifying ESIC at the time of investment if it:
- had expenditure of $1,000,000 or less in the prior income year;
- had assessable income of $200,000 or less in the prior income year;
- is not listed on any stock exchange;
- was incorporated in Australia:
- in the last 3 years; or
- prior to that but received an Australian Business Number in the last 3 years; or
- in the last 6 years and total expenditure in the previous three tax returns does not exceed $1 million; and
- is involved in innovation, by either
- satisfying the principles-based test through self-assessment; or
- satisfying the gateway test through self-assessment; or
- receiving a determination from the Australian Taxation Office.
Principles-based test
The principles-based test provides guidance to help determine if a company will be an ESIC, through self‑assessment of whether:
- it is genuinely focused on developing for commercialisation one or more new, or significantly improved, products, processes, services or marketing or organisational methods;
- the business relating to those products, processes, services or methods has a high growth potential;
- it can demonstrate that it has the potential to be able to successfully scale that business;
- It can demonstrate that it has the potential to address a broader than local market, including into global markets, through that business; and
- it can demonstrate that it has the potential to be able to have competitive advantages for that business.
Gateway test – must achieve at least 100 points
The gateway test contains a more objective set of tests to provide additional assistance to identify an early stage innovation company. If a total of 100 points is achieved, the company will be considered an eligible innovation company for the purposes of this measure.
Points will be given for a range of activities including: a company’s level of expenditure on research and development; whether the company has received an Accelerating Commercialisation grant; whether the company is undertaking/completed a genuine accelerator program that supports entrepreneurs; received at least $50,000 from a third-party financial investor; is an applicant on one or more enforceable intellectual property rights on an innovation through a standard or innovation patent; or has a written agreement with a listed/registered entity under the Higher Education Funding Act 1988 or the Industry Research and Development Act 1986.
Need Help? Contact Us
We regularly assist startups and investors evaluate their eligibility for the ESIC regime. Give us a call on 03 8691 3111 or email us at hello@alliedlegal.com.au to enquire about our expertise in this space.
Want to learn about legal issues associated with Fintech startups? https://www.alliedlegal.com.au/blog/fintech-startup-have-you-considered-everything/
Source
The information in this article has been extracted from https://treasury.gov.au/national-innovation-and-science-agenda/tax-incentives-for-early-stage-investors. We note we have extracted passages without change.
