The startup tax incentives explained: What you need to know

By Gary Shapiro

A bill proposing a series on new tax incentives for innovation was introduced to parliament last week aiming to encourage new investment in Australian early-stage innovation companies by providing qualifying investors, who invest in such companies, with a tax offset and a capital gains tax exemption for their investments.

The tax incentive for early stage investors is designed to promote an entrepreneurial and risk-taking culture by connecting relevant startup companies with investors. The aim is to bridge the funding gap between pre-concept stage financing and support financing through the ESVCLP and VCLP regimes for companies further along the development pathway.

The legislation can be quite confusing and time consuming to go through, so to make it easier it is summarised below.

Summary of the benefit

There are two main benefits of the proposed legislation:

1. Entities that acquire newly issued shares in an Australian innovative company may receive a non-refundable carry-forward tax offset of 20% of the value of their investment subject to a maximum offset cap amount of $200,000. A total annual investment limit of $50,000 applies to retail investors.
2. In addition, investors may disregard capital gains realised on shares in qualifying ESICs that have been held for between one and 10 years. Investors must disregard any capital losses realised on these shares held for less than ten years.

If the Bill becomes law it is proposed that these amendments apply in relation to shares issued on or after 1 July 2016 and would not be retrospective.

Which investors qualify for the tax incentives?

The tax incentives introduced by these amendments are available to all types of investors regardless of their preferred method of investment, other than ‘widely held companies’ and 100% subsidiaries of these companies.

What type of investment qualifies?

Qualifying shares are newly issued equity interests that are shares in a qualifying innovative company. These rules ensure that the tax incentives are targeted at new investors in a qualifying startup rather than shares issued under an employee share arrangement or in relation to interests with a debt character, such as preference shares.

Investors that acquire equity interests from the conversion of convertible notes are not precluded from qualifying for the tax offset, where the company issuing those equity interests is a qualifying ESIC at the time of the conversion into shares.

What is a qualifying startup?

Generally, an Australian-incorporated company will qualify as an early-stage innovation company (ESIC) if it meets the tests of being at an early-stage of its development (the early stage limb) and it is developing new or significantly improved innovations with the purpose of commercialisation to generate an economic return (the innovation limb).

The early stage limb

A company must pass four tests to satisfy the early-stage limb of the qualifying ESIC test:

1. The company must have been incorporated in Australia within the last three income years
2. 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
3. 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
4. The company must not be listed on any stock exchange

The innovation limb

In order for companies to determine if they satisfy the innovation limb of the qualifying ESIC test companies may choose to:

1. Apply their circumstances against the objective tests – must have at least 100 points as judged by the criteria here
2. Self-assess their circumstances against the principles-based test. The company needs to be genuinely focused on developing its new or significantly improved innovation for commercialisation and must have the potential for high-growth, scalability, can address a broader than local market and has competitive advantages
3. Seek a ruling from the Commissioner about whether their circumstances satisfy the principles-based test

What are the reporting requirements for the ESIC?

ESICs that receive investments from one or more investor entities in a financial year will need to provide information about those entities to the Commissioner 31 days after the end of the financial year. For most companies, this would be 31 July of the following financial year. ESICs will need to provide this information in the ‘approved form’.

When does it come into effect?

If the bill becomes law it is proposed that these amendments apply in relation to shares issued on or after July 1st, 2016.

It is very encouraging to see the government introduce these measures in order to foster investment in early-stage innovation companies in Australia.

The definition of an ESIC or startup is interesting and likely something that will generate further discussion.

Let’s hope this bill gets passed and passed soon so that startups currently raising or planning on raising in the near future are not adversely affected by investors waiting to utilise these benefits.

Gary Shapiro is a Director at Rimon Advisory and Rimon Investments.