Does your start-up qualify for an ESIC tax-offset?

Coming into force on 1 July 2016, the Tax Laws Amendment (Tax Incentives for Innovation) Act 2016 (Cth) (Innovation Act) amends the Income Tax Assessment Act 1997 (Cth) (ITAA) to provide tax incentives for investors in eligible Early Stage Innovation Companies (ESIC’s).

What is an ESIC?

An ESIC is a start-up with high growth potential.  The Federal government views such businesses to be a potential avenue for innovation and subsequently have laid out measures to encourage entrepreneurship and risk-taking.

What are the benefits of this tax-offset for an ESIC?

The tax-offset is designed to ensure emerging businesses are connected with investors that have the requisite funds and business experience to assist innovation being realised.  Under the new section 360-25 of the ITAA, these tax incentives will provide eligible investors with:

• a 20% up-front non-refundable carry-forward tax offset on amounts invested in qualifying ESICs, with the offset capped at $200,000 per investor per year; and
• an exemption on capital gains tax (CGT) for investments held as shares in an ESIC for at least twelve (12) months but under ten (10) years, provided that the shares held do not constitute more than a 30% interest in the ESIC.

Note that pursuant to the new section 360-15 of the ITAA, members of a partnership or trust can also be entitled to this 20% tax offset. Furthermore, under the new section 360-50 of the ITAA, capital losses will not qualify if an ESIC, for example, fails.

Who can be an eligible investor?

The tax incentives are available to all types of investors, regardless of whether the investment is made directly as an entity (within the meaning of section 960-100 of the ITAA) or indirectly through a trust or partnership.  There are no restrictions on an investor’s residency.

However, under the new section 360-15 of the ITAA, an investor is not an eligible investor if:

• the investor is a ‘widely held company’ as defined in section 995.1 of the ITAA;
• the investor is a 100 per cent subsidiary of a ‘widely held company’; or
• the investor is an ‘affiliate’ of the ESIC (as defined in section 328-130 of the ITAA), or the ESIC is an ‘affiliate’ of the investor.

Moreover, though non-sophisticated investors (see section 708 Corporations Act 2001 (Cth)) are eligible investors, they are limited to investing amounts of $50,000 and below in an income year.

Is your start-up a qualifying ESIC?

To qualify, you will need to answer “Yes” to all of the following questions:

Determining if your company is in its “early stages” under the new section 360-40(1)(a) – (d) of the ITAA	Yes	No
1.  Was your company incorporated in Australia in the last three (3) years?	□	□
2.  Are your company’s total expenses last year less than/equal to $1 million?	□	□
3.  Is your company’s assessable income last year less than/equal to $200,000?	□	□
4.  Is your company not listed on any stock exchange?	□	□

Determining if your company promotes “innovation”	Yes	No
5.  Pursuant to the new sections 360-40(1)(e) of the ITAA, does your company: 5.1  focus on developing innovative products, processes or services?; 5.2  show potential for high growth?; 5.3  show potential for successful scalability? (that is, can your company handle a growing amount of work as it grows?); 5.4  show potential to address markets larger than local markets?; and 5.5  have a competitive advantage? OR	□ □ □ □ □	□ □ □ □ □
6.  Pursuant to the new section 360-45(1) of the ITAA, has your company generated 100 points, as seen in the table below, from any of the these activities: 6.1  high levels of R&D; 6.2  receiving an Accelerating Commercialisation Grant; 6.3  participation in the accelerator programs for entrepreneurs; or 6.4  ownership of IP rights granted within the past five years. OR	□ □ □ □	□ □ □ □
7.  Under the new section 360-45(2) of the ITAA, has your company accumulated the points prescribed by regulations if the prescribed innovation criteria for those points apply at that time?	□	□

Determining if the investor is eligible under the new section 360-15 of the ITAA	Yes	No
8.  Is the investor not a widely held company?	□	□
9.  Has the investor been issued shares in a qualifying ESIC?	□	□
10.  Is the investor not affiliated with the ESIC (neither party could reasonably be expected to act in accordance with the other’s wishes)?	□	□
11.  After acquisition, does the investor hold 30% of shares or less in the ESIC/an entity connected with the ESIC?	□	□

Points for various innovation criteria

Item	Points	Summarised Innovation Criteria
1	75	At least 50% of the company’s expenses can be considered as R&D (subject to section 355-205 of the Tax Laws Amendment (Research and Development) Act 2011 (No. 93, 2011) Sch 1) (R&D Act).
2	75	The company has received an Accelerating Commercialisation Grant under the Entrepreneurs’ Program.
3	50	Between 15% and 50% of the company’s expenses can be considered as R&D (subject to section 355-205 of the R&D Act).
4	50	The company has completed/is undergoing an accelerator program that has been active for at least six months.
5	50	At least $50,000 in total has been paid for company shares and those shares have been distributed to shareholders that are not associates of the company and have not acquired these shares so that another company can claim this tax-offset.
6	50	The company has Australian and international rights to a standard patent or a plant breeder’s rights in the past 5 years.
7	25	Unless Item 6 applies, the company has Australian and international rights to an innovation patent or a registered design in the past 5 years
8	25	The company has a written agreement to co-develop a new/improved product or process with either an institution under the Higher Education Funding Act 1988 (Cth) Schedule 1 or an entity under the Industry Research and Development Act 1986 section 29A.

Links and further references

Legislation

Income Tax Assessment Act 1936 (Cth)

Income Tax Assessment Act 1997 (Cth)

Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016

Tax Laws Amendment (Tax Incentives for Innovation) Act 2016 (Cth)

Other links

ESIC Directory

Further information about start-ups and tax law

If you need advice on whether your startup meets the eligibility requirements for an ESIC tax-offset, please contact us for a confidential and obligation free and discussion.

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

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