Tax Incentives for Investment in Start-Ups

By Kim Reynolds & Steven Roberts

From 1 July 2016 a generous tax incentive has been made available for investment in Early Stage Innovation Companies (ESICs) by providing eligible investors with a tax offset and capital gains tax exemptions on their eligible investments.

The Government has designed the incentive to lure investors with business experience and available funds to assist entrepreneurs in developing successful innovation companies,  by investing in qualifying companies in an effort to promote a culture of entrepreneurship and innovation in the start-up environment.  In turn this will provide qualifying ESIC’s much needed initial capital to further develop and commercialise their concept.

Like any new incentive introduced, the devil is in the detail and can be minefield of red tape so advice should be sought before trying to apply these new incentives to ensure eligibility…

what is the incentive?

There are two key incentives available to eligible investors:

• Investors that acquire newly issued shares in an Australian ESIC can receive a 20% non-refundable carry-forward tax offset of the value of their investment.  For sophisticated investors there is a ceiling of $200,000 non-refundable carry-forward tax offset available annually (which equates to a $1,000,000 investment).  For non-sophisticated investors there is an annual investment limit of $50,000 (which equates to a $10,000 non-refundable tax offset); and

• Investors can disregard capital gains realised on shares acquired in qualifying ESICs that have been held for between one and ten years.  After year ten, the investor only pays capital gains on any appreciation to the shares from year 10 onwards.  However, if an investor makes a loss on the investment, the investor must disregard any capital loss crystallised on shares held for less than ten years.

who can access the tax incentive?

The tax incentive is available to all types of investors, other than ‘widely held companies’ and 100% subsidiaries of these companies.  The investor must also not be an affiliate of the qualifying ESIC.

what is a qualifying ESIC?

An Australian-incorporated company will qualify as an ESIC if it passes both limbs of a two limb test namely the ‘early stage’ and ‘innovation’ limbs.

the early stage limb

To pass the early stage limb, the company must pass each of the following:

• must have been incorporated in Australia within the last three income years (or incorporated between three and six years and incurred less than $1,000,000 in expenditure); and
• the company and any of its wholly-owned subsidiaries must have not incurred ‘total expenses’ of more than $1,000,000 in the previous income year; and
• the company and any of its wholly-owned subsidiaries must have derived assessable income of no more than $200,000 in the previous income year; and
• must not be listed on any stock exchange.

the innovation limb

 If the early stage limb is passed, a company has three options to satisfy the innovation limb.  The company may choose to:

• self-assess their circumstances against the principles-based test. This test reviews the companies’ ability for high potential for growth, scalability, can address a broader than local market, competitive advantage and innovative; or
• request a ruling from The Commissioner who will assess the company on the principles-based test and provide a determination to the company on qualification for the innovation limb; or
• apply their circumstances against the objective tests – the company must obtain at least 100 points for meeting certain objective innovation criteria.

Buyer beware though, it is recommended that an investment is only made in a company that has professionally undertaken the self-assessment process and has supporting documents or has a ruling from the Australian Taxation Office (ATO) as to its eligibility to qualify as an ESIC. There are also reporting requirements on ESIC’s that receive investment under this incentive.

An Important Message

While every effort has been made to provide valuable, useful information in this publication, this firm and any related suppliers or associated companies accept no responsibility or any form of liability from reliance upon or use of its contents.  Any suggestions should be considered carefully within your own particular circumstances, as they are intended as general information only.