Does your Business need a capital injection – Tax incentives for early-stage investors

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You may have encountered articles in the financial press discussing the tax benefits offered to early-stage investors, introduced on 1 July 2016. In the following paragraphs, we provide essential information on the functioning of these concessions, intending to determine if they present a viable opportunity for you with the guidance of a tax advisor.

The Australian Government currently provides various concessions to support innovative companies. These include Research and Development Tax Incentives and various Venture Capital (VC) concessions. Typically, however, VC funds tend to focus on companies that have already developed a concept and try attracting capital to grow the business. This doesn’t help the early-stage innovation companies (ESIC) who face difficulty attracting seed capital and pre-commercialisation equity to fund the early stages of their development. From this have borne the following Tax Incentives for early-stage investors. 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 issued 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). 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; 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 ESICs 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 gains are protected until that time. Gains accrued after that time period are taxable.

What Investors Qualify for These Tax Incentives

  • Investors 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.
  • Non-residents can claim it, 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 concert, with the investor’s wishes or vice versa. This ensures that the concessions are only for new investments, not to subsidise existing investments. This usually stops 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 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.
    • It did not incur > $1.0M in expenses in the previous income year
    • It has an assessable income of $200,000 or less in the previous income year
    • It is not listed on the Stock Exchange
  • It must pass the Innovation tests placed on companies by the ATO. These tests are complex and need a considered approach to satisfy you. 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.
    • The company proves they have the potential for high growth, has scalability, can address a broader than local market and have competitive advantages.
    • This is usually proved through business plans, commercialisation strategies, competition analysis and other company documents. Attached is the link to the Explanatory Memorandum of the legislation, which will guide you on how to satisfy the innovation tests.

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 must 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 significant and will majorly affect your decision as to what entity you should set yourself up as. If you need investment in the company at an early stage, you must consider the conditions of these provisions when making your decision about a structure.

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

Kreston Stanley Williamson Team

*Correct as of January 2017

Disclaimer – Kreston Stanley Williamson has produced this article to serve its clients and associates. The information contained in the article is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas in this article, you must seek advice about your circumstances. Liability is limited by a scheme approved under professional standards legislation.

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