04 Aug Incentive for innovation and risk-taking – the ESIC tax incentives
The Federal Government recently implemented attractive tax incentives for investors in qualifying early stage innovation companies (ESIC).
The tax incentives provide eligible investors with:
- A 20% non-refundable carry-forward tax offset on amounts invested in qualifying ESICs. The offset is capped at $200,000 for each income year; and
- A 10 year exemption on capital gains tax for shares held in an ESIC for at least 12 months.
The tax offsets will allow eligible investors to immediately reduce their tax liability in the financial year they invested. The 10 year capital gains exemptions represents an unparalleled investment opportunity. The only other capital gains tax free investment in Australia is a principal place of residence.
We expect that these attractive tax incentives will drive further investment in early stage companies, so now is the time to consider undertaking a capital raising.
Qualifying as an ESIC
The availability of these tax incentives for investors depends on whether the company qualifies as an ESIC immediately after the shares are issued. Shares must be issued on or after 1 July 2016.
A company will qualify as an ESIC if it meets both the ‘early stage test’ and either the ‘100-point innovation test’ or the ‘principles-based innovation test’.
The ‘early stage test’ determines whether the company is early stage against criteria related to expenditure, assessable income, incorporation/registration and stock exchange listing. Most start-up companies will have no difficulty meeting these requirements.
Under the ‘100 point innovation test’, a company must obtain at least 100 points by meeting certain objective criteria. 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, and whether the company is undertaking/completed a genuine accelerator program that supports entrepreneurs.
Alternatively, under the ‘principles-based test’, the company must be able to demonstrate that it has developed a new or significantly improved innovation for commercialisation. The company must also be able to show that the business relating to the innovation has high growth potential within a wide addressable market, scalability, can access broader than local markets and has competitive advantages.
New Era Lawyers can provide further information on these tests and help you assess whether your company or a company you wish to invest in qualifies as an ESIC.
Qualifying as an investor
The tax incentives are available to both Australian residents and non-residents. However, the tax incentives won’t apply to you if:
- You didn’t purchase newly issued shares directly from the company.
- The shares are not equity interests in the company.
- You are a widely-held company or a wholly-owned subsidiary of a widely-held company. (A widely-held company is a company listed on a stock exchange or a company with more than 50 shareholders, subject to certain exceptions).
- You are not a sophisticated investor and your total investment in one or more ESICs for the income year is more than $50,000. If you are a sophisticated investor, the amount you can invest in an ESIC is not restricted. However, the tax offset is capped at $200,000 for each income year.
- You are an affiliate of the ESIC at the time the shares are issued. (You are an affiliate if you act, or could be expected to act, in accordance with the company’s directions or wishes in relation to its business affairs).
- You hold more than 30% of the equity interests in the ESIC (including entities connected with the ESIC) after you are issued with the shares.
- You acquired the shares under an employee share scheme.
The ESIC scheme adopts the Corporations Act tests for determining whether a person is a sophisticated investor.
One disappointing feature of the scheme is that the 30% equity interest ceiling will prevent most founders from being able to access the tax benefits associated with the scheme.
If you require any advice in relation to the application of the ESIC scheme, please do not hesitate to contact us.
General advice disclaimer
The information contained in this article is general in nature. It should not be taken as a recommendation to implement any particular tax strategies. You should seek legal advice which takes into account your personal circumstances and objectives before you make any decisions.