Tax Incentives for Early Stage Investors

In May 2016 the federal government passed legislation implementing new tax incentives designed to foster investment in innovative start-up businesses as part of its “National Innovation and Science Agenda”.

The new tax incentives, which apply to qualifying investments in Early Stage Innovation Companies (ESICs) from 1 July 2016, offer eligible investors who purchase newly issued shares:

• A 20% non-refundable carry-forward tax offset on value of their investment, capped at a maximum offset of $200,000 per investor, per year; and
• A modified Capital Gains Tax (CGT) treatment which exempts Capital Gains made on shares held between 1 and 10 years. After 10 years the cost base of the shares for CGT purposes is deemed to be their market value as at the 10 year anniversary of issue, effectively meaning that any appreciation in value up to that date is not taxed. It should be noted however that capital losses made or accrued on shares held for less than 10 years are also disregarded.

So, what is an ESIC?

For an investor to be entitled to these tax incentives, the company must qualify as an ESIC immediately after their shares are issued. A company will qualify as an ESIC if it meets both:

• The Early Stage Test; and
• Either of the 100-Point Innovation Test or Principles-Based Innovation Test.

The Early Stage Test criteria relate to incorporation time, expenditure, assessable income and stock exchange listing.

The next tests require the company to self assess its involvement in innovation - by either passing the 100-point innovation test which allocates points for meeting certain prescribed criteria (for example having an enforceable right on an innovation through a patent) or the more subjective principles based test (under which it must demonstrate it meets 5 specific requirements including being genuinely focused on developing at least one new innovation for commercialisation).

Eligibility as an Investor

Investors who are a “sophisticated investor” for the purposes of the Corporations Act 2001 have no upper limit as to the amount of money they invest in an ESIC in a given year, but the value of the early stage investor tax offset they may receive in each year is capped at $200,000.

An annual investment limit of $50,000 applies to non-sophisticated investors, breaching this cap will cause the investor to be ineligible for both the early stage investor tax offset and modified CGT treatment.

There are further restrictions including that the investor cannot be an affiliate of the ESIC at the time the shares are issued, and may not hold more than 30 per cent of the equity interests of an ESIC (including any entities ‘connected with’ it).

As these incentives are potentially very attractive, early stage innovative businesses and their investors should consider whether the nature of their activities may make them eligible to benefit under the new rules and ensure that their business is structured appropriately. The above is a very general overview and there is of course much more to consider.

To discuss these tax incentives or just your business in general, contact BLG Business Advisers today online or by calling (02) 4229 2211.