By Martin Sestakov | Senior Consultant – Private Client Services
In July 2016, the Government made a big push to encourage investment in our country’s youngest and most promising companies. It launched the Early Stage Innovation Company (ESIC) initiative which offers tax incentives to angel investors.
Though it’s been more than 18 months, the program has yet to take off in popularity, and few companies and investors have taken advantage of the scheme – a detriment to both investors and innovators.
If you operate a start-up or fledgling company or are interested in expanding your investment portfolio, the ESIC tax incentive can be a valuable program to leverage. Achieving ESIC status is a huge selling point for a young company, as it may entice investors who might not otherwise be interested. Let’s look deeper into what the initiative offers.
Why use the ESIC tax incentive?
The ESIC tax incentive is designed to encourage investment into early-stage companies by offering two benefits. First, investors will receive a non-refundable, carry-forward tax offset equal to 20 percent of the amount paid for their qualifying investments. This offset is capped at $200,000 per investor (and their affiliates) for a single financial year.
A qualifying ESIC investor will also get modified capital gains tax (CGT) treatment for their investment into the ESIC, which allows them to forgo capital gains taxes if they hold their shares for at least 12 months and sell before up to a maximum of 10 years. If the investment is sold after 10 years, any gain will be taxed subject to the existing CGT regime. It’s important to note that investors cannot claim losses on ESIC investments as with regular investments – you can’t get the double benefit of paying no tax on a potential gain and claiming a deduction on a loss.
Investors who don’t pass the “sophisticated investor” test under the Corporations Act of 2001 can only contribute a maximum of $50,000 (an offset of $10,000). If they invest more, they will lose eligibility for ESIC offsets and CGT treatment. Those who qualify as “sophisticated” investors can contribute up to $1 million (an offset of $200,000).
The ESIC qualification process is done in three phases:
- The early-stage test. This is to determine whether a company fundamentally qualifies for ESIC. It must meet four basic requirements:
- It must be incorporated/registered with the Australian Business Register;
- It must have total expenses of $1 million or less in the previous income year;
- It must have assessable income of $200,000 or less in the previous income year; and
- Its equity interests may not be listed for quotation in any official stock exchange.
Once these four requirements are passed, your company can move onto the 100-point or principle-based innovation tests.
- The 100-point innovation test. This test asks a number of straight-forward, yes-no self-assessment questions. Should your company pass this test, you qualify for ESIC status. The tests surround eligibility for the R&D Tax Incentive (let’s insert a link here), whether or not your company has received investment from a third party previously, and whether you have intellectual property protection.If the organisation does not qualify for enough points on the 100-point test, you may move for qualification under the principle-based innovation test.
- Principle-based innovation test / private-binding ruling. This test requires a detailed analysis based on the principles below which seek to detail your company’s innovations and financial data. At CharterNet, we work with our clients directly to help draft this analysis and submit it to the Australian Tax Office (ATO) in the form of a binding private ruling.
The purpose of the scheme is that the ATO wants to encourage investment in companies that can improve the Australian economy and make our country a bigger player in the global markets. As such, the tax office is generally looking to see that:
- Your organisation is genuinely focused on developing one or more new or significantly improved innovations for commercialisation.
- Your innovation has potential for high growth and success.
- Your organisation is scalable.
- Your innovations could reach beyond local markets and potentially garner global appeal.
- Your organisation has competitive advantages over others in your field.
Often, the ATO will come back with clarifying questions. Once these are answered, the ATO will make a final ruling as to the organisation’s ESIC status.
After a company has been confirmed for ESIC status, it’s time to prepare an ESIC report. This is an online document that notifies the ATO which investors have given money to the company. The ATO will use the report to match against individual/company tax returns and verify their tax incentive qualification.
If you’re interested in qualifying your company for ESIC status, it’s important to use a specialist firm that’s well-versed in this scheme. Avoid small firms or one-man-bands. They’re likely unaware that this scheme even exists and won’t have the skills and experience to ensure you’re successfully approved in a timely manner. There are a lot of complicated requirements, tests, eligibility rules, and the ATO expects those to be heeded every step of the way. You don’t want to jeopardise your chances by using the wrong adviser.
Using a more experienced firm improves your chances of qualification and gives you added value as well. At CharterNet, we have had experience in applying for ESIC status for a number of companies and therefore understand how to navigate this complex landscape.
Contact us today to arrange an initial discussion.