If you operate an early stage innovation company (ESIC) that is looking to raise equity capital from investors, then those investors may be eligible to receive attractive tax incentives. These ‘early investor tax incentives’ include non-refundable carry forward tax offsets and exemptions on capital gains tax, however certain criteria must be satisfied before the tax incentives become available.
Qualifying as an ESIC
For your company to be an ESIC to which the tax incentives apply, the company must:
• have been incorporated in Australia within the last three income years (this may be extended to the last six income years if the company had expenses of less than $1million during the last three income years);
• be at an early stage in its development (which is assessed against four statutory tests); and
• be developing new or significantly improved innovations for commercial purposes (which can be self-assessed using a ‘100-point innovation test’ or can be determined by the ATO using a ‘principles-based innovation test’).
An equity capital raising undertaken by your ESIC will only attract the tax incentives if the investment satisfies a number of conditions.
• The investor must have purchased newly issued shares directly from your ESIC. Preference shares and other debt-like investments are not covered. Convertible notes, however, may be eligible for the tax incentives provided that your company qualifies as an ESIC and satisfies the other criteria at the time the notes are converted into shares.
• The investor must not hold more than 30% of the shares in your ESIC or any entity connected with your ESIC immediately after the new shares are issued.
• Your ESIC and the investor must not be affiliates of each other (i.e. where they could reasonably be expected to act in accordance with the directions of the other – such as a director of your ESIC).
• The investor must not be acquiring the shares as an employee or contractor under an employee share scheme.
What are the tax incentives?
Investors who satisfy the criteria and purchase new shares in your ESIC may be eligible to receive:
• a non-refundable carry forward tax offset of 20% of the amount paid by the investor in purchasing the shares (the tax offset is capped at a maximum of $200,000 in each income year); and
• an exemption from any capital gains tax (CGT) on those shares if the shares are continuously held for at least 12 months but less than ten years (however capital losses on the share held less than ten years must be disregarded). The $200,000 cap on the tax offset incentive does not limit the shares that qualify for this modified CGT treatment.
Sophisticated investors vs other investors
To take full advantage of these tax incentives, investors in your ESIC must be ‘sophisticated investors’ under the Corporations Act. This said, more limited early stage investment tax incentives are available for investors that are not sophisticated investors.
At Motus Legal, we specialise in helping our clients with capital raising at all stages of their development, so come talk to us if you are considering raising capital. As always, specialist tax advice should be sought - and we can work your tax advisor to get that right.