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To encourage investment in Australian innovative companies, the Government implemented incentives for investing in early-stage innovation companies (ESICs) starting from 1 July 2016.
The tax incentives provide eligible investors who purchase new shares in an ESIC with a:
- Non-refundable carry forward tax offset equal to 20% of the eligible investment.
- Modified capital gains tax (CGT) treatment where capital gains on qualifying shares that are continuously held for 12 months and less than 10 years may be disregarded. Capital losses on shares held less than 10 years must be disregarded.
If you meet the 'sophisticated investor' test under the Corporations Act 2001, there is no investment limit, but the offset is capped at $200,000. If you do not meet the 'sophisticated investor' test, the maximum investment is $50,000.
In order to claim the ESIC tax incentives, there are a number of conditions that must be satisfied, including:
- The Australian company invested in is an ESIC
- The shares purchased are new shares in a company that meets the requirements of an ESIC immediately after the shares are issued
- The shares are not acquired under an employee share scheme
- The investor is not a trust, partnership, widely held company, or a 100% subsidiary of a widely held company.
- The shares are issued on or after 1 July 2016.
- The investor nor the ESIC are an affiliate of each other
- Immediately after the investment, the investor does not hold or carry the right to more than 30% of the distributions of income, distributions or capital, or votes.
For a company to qualify as an eligible ESIC, it generally needs to demonstrate characteristics such as being an innovative company in its early stages, possessing high-growth potential, having a geographically diverse offering, and exhibiting scalability.
There are two tests that a company must satisfy in order to qualify as an ESIC. They are:
- The early-stage test; and
- The innovation test, being either the:
- 100-point test, or
- Principles-based test.
The early-stage test
This test determines the early-stage status of a company based on factors such as its previous year's income and expenses, as well as its date of incorporation or registration. These criteria provide evidence to assess whether a company falls within the 'early stages' category. The criteria can be found here.
The 100-point test
In order to meet the requirements of the 100-point test, a company must accumulate a minimum of 100 points by fulfilling specific criteria that are recognized as indicative of an innovative company. Refer to this table provided by the ATO to view the specific criteria.
The principles-based test
The purpose of the principles-based test is to determine whether a company is engaged in the development of a new or significantly improved innovation with the intention to commercialise it and generate income. Additionally, the test evaluates the company's high-growth potential and its ability to scale within a wide market. Given the subjective nature of applying this test, it is considered good practice (and our recommendation) to obtain a Private Binding Ruling (PBR) from the Australian Taxation Office (ATO) to confirm the company's eligibility.
How can RSM help you with ESIC?
RSM offers assistance in assessing the eligibility of entities as ESICs. Our services also include supporting clients in obtaining private binding rulings, ensuring investor confidence, and mitigating the risk of strained investor relations caused by erroneous claims of being an ESIC.
