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Tax incentives for investing in ESICs

In March 2016, the Australian Government announced new tax incentives for innovation, aimed at encouraging new investment in Australian, ‘early-stage, innovation companies’ (ESICs). Under laws which came into effect on 1 July 2016, investors in a qualifying early-stage, innovation company may be entitled to concessional tax treatments and capital gains tax exemptions for their investments.

Designed to promote an entrepreneurial and risk-taking culture, the tax incentives aim to connect appropriate start-up companies with investors that have both the business experience and requisite funds to assist entrepreneurs in developing successful, innovative companies.

Tax incentives for eligible investors

The tax incentives provide eligible investors who purchase new shares in an ESIC with:

  • a 20% non-refundable carry-forward tax offset on amounts invested in qualifying ESICs, subject to a maximum offset cap amount of $200,000 per investor (and their combined affiliates), per year; and
  • a 10 year exemption on capital gains tax investments held as qualifying shares in an ESIC that are continuously held for between 1 – 10 years, provided that the shares do not constitute more than a 30% interest in the ESIC.

Qualifying for funding as an ESIC

For a start-up to qualify for funding as an ESIC, it must satisfy two “limbs”:

  1. The company is involved in innovation, by either:
    1. Satisfying a principles-based test through self-assessment; or
    2. Satisfying the gateway test through self-assessment; or
    3. Receiving a determination from the Australian Taxation Office
  2. The company is determined as early stage, against criteria related to expenditure, assessable income, stock exchange listing, and incorporation:
    1. Expenditure was $1,000,000 or less in the prior income year;
    2. Had assessable income of $200,000 or less in the prior income year;
    3. Is not listed on any stock exchange; and
    4. Was incorporated in Australia:
      1. In the last 3 years; or
      2. Prior to that, but received an Australian Business Number in the last 3 years; or
      3. In the last 6 years and total expenditure in the previous 3 tax returns does not exceed $1 million. 

Principles-based test

To qualify as an eligible innovation company under the principles-based test, the company must meet five requirements:

  1. The company must demonstrate a genuine focus on developing one or more new, or significantly improved, products, processes or services (innovation) for commercialisation;
  2. The business relating to that innovation must have high growth potential;
  3. The company must demonstrate the potential for successful scalability;
  4. The company must demonstrate potential to address a broader than local market, including global markets; and
  5. The company must demonstrate the potential for competitive advantages for that business.

Further detail on qualifying via the principles-based innovation test is available on the Australian Taxation Office website.

Gateway test

The gateway test, or 100-point innovation test, provides a more objective opportunity to qualify as an eligible innovation company.  To qualify, a company must obtain at least 100 points, which can be achieved by meeting certain objective innovation criteria.  Such activities include:

  • The company’s level of expenditure on Research and Development;
  • Whether the company has completed, or is undertaking an eligible accelerator programme; or
  • Whether the company has received an Accelerating Commercialisation grant.

A full list of qualifying activities for meeting the 100-point innovation test is available on the Australian Taxation Office website.

Qualifying for tax incentives

For an investor to qualify for the tax incentives, it must:

  1. Invest in a qualifying ESIC by purchasing new shares in an ESIC immediately after the shares are issued, and the shares must be issued on or after 1 July 2016;
  2. Not be a widely-held company or a wholly-owned subsidiary of a widely-held company; and
  3. Be either:
    1. A legal person controlled by an individual considered a sophisticated investor (pursuant to s708(8) of the Corporations Act 2001; or
    2. A non-sophisticated investor that has invested $50,000 or less in the income year.

Limits apply for non-sophisticated investors

Limits apply for investors who don’t meet the sophisticated investor test, i.e. investments in one or more qualifying ESICs in an income year must not exceed $50,000 in total.  If total investments exceed $50,000, an investor will not be eligible for either:

  • The early stage investor tax offset for any investments in that income year; or
  • The modified CGT treatment for any investments in that income year.

The limit is intended to ensure that tax incentives don’t encourage retail investors to be over-exposed to the intrinsic risk associated with investing in qualifying ESICs.

Reporting requirements

Companies are required to report information to the Australian Taxation Office by 31 July each year if new shares are issued to one or more investors during a financial year that could lead to an investor being entitled to access the early stage investor tax incentives.  ESICs will need to submit this information to the ATO electronically.

More information

The Australian Taxation Office website has further details about the ESIC incentives, and features example scenarios.  Read more about the ESIC program here.

We can help

Becoming ESIC ready can be a complex process.  If you would like more information about how the ESIC program may benefit you, contact our office on 07 3217 2477.