Making your business attractive for tax free investing

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In the continued boost to small business and start-ups, new tax concessions came into effect from 1 July 2016 which are set to stimulate investment in innovative companies as part of the federal government’s “Ideas Boom” under the National Innovation and Science Agenda. Just one of the agenda items as part of the “Ideas Boom”, the Early Stage Innovation Company (ESIC) tax concession is to encourage both innovation and investment in Australian companies.

In only two months we’ve seen a growing number of prospectuses aimed at tempting investors under the concessions. Broadly, the tax concession benefits for investors are generous and include:

  • Rebate of 20% of an investment (capped at $200k)
  • Rebate allowed to be carried forward if not all used
  • Rebate can be allocated to beneficiaries if in a trust
  • Modified CGT rules apply to the investment:
    • Hold between 12 months and 10 years – disregard any capital gain
    • Hold longer than 10 years – cost base becomes the market value at the tenth anniversary
  • Tax concessions available to both Australian tax residents and non-residents.

Small business and start-ups that want to leverage the new concessions to attract investment to grow and innovate should keep in mind how they package their offer to investors. To be fully compliant and eligible for the concessions, investors will need to:

  1. Purchase new shares in the ESIC.
  2. The ESIC cannot be associated to the investors.
  3. Cannot own more than 30% of the ESIC.
  4. Investors will need to check the Private Tax Ruling on the ESIC. While it’s not mandatory that an ESIC attain a private ruling, one is likely to be requested so investors can ensure they are able to take advantage of the tax concessions. If your ESIC doesn’t have one, you may want to get one.
  5. For investors who are not deemed to be a “Sophisticated Investor” (gross income over $250k for the past two years or net assets of over $2.5M), their investment will need to be limited to $50k in one or more ESICs in total per annum.
  6. Keep in mind that capital losses are disregarded within the first 10 years of the investment.
  7. Be aware that capital gains within the first 12 months are included as assessable income.

By their very nature an ESIC would be considered a highly speculative investment category – a technology based investment in a rapidly changing world. These are not main stream investments so this style of investing is not for everyone. Often the product being developed by the ESIC is yet to find a market or generate any cash flow, and is unlikely to do so for several years.

The biggest issue for any investor to consider with any investment is the return the investment will make over the long term. Small business and start-ups need to consider how they package the return in order to be compliant and attractive from a tax perspective as well as to deliver a return on investment which is achievable and attractive.

To qualify as an ESIC, a company will need to meet both:

  • the ‘early stage test’ and either the
    • 100-point innovation test or
    • the principles-based innovation test.

According to the ATO, “In practice, if a company undertakes activities that meet the 100-point innovation test, this is likely to be the simplest way to determine its eligibility, when compared to the principles-based innovation test.” Details are available here.

While every business is not Facebook, if you take the Facebook example you can see how powerful these concessions can become. Facebook started in February 2004 and was initially capitalised with US$12,000 from one of the early investors. In 2005, a further US$13.7M was invested into the company. The company floated in a public listing in February 2012 and ten years after being created, the value of the company was US$64.32 Billion. Currently the company is worth US$124.88 Billion. Imagine applying the above concessions to these amazing growth statistics of Facebook!

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