A version of this article appears in StartupSmart
A Bill proposing a series on new tax incentives for innovation was introduced to parliament last week to encourage new investment in Australian early stage innovation companies (ESICs) with high growth potential by providing qualifying investors, who invest in such companies, with a tax offset and a capital gains tax (CGT) exemption for their investments.
The Australian Government currently provides tax concessions to support innovative Australian companies through the Research and Development (R&D) Tax Incentive, Early Stage Venture Capital Limited Partnership (ESVCLP) and Venture Capital Limited Partnership (VCLP) regimes.
The tax incentive for early stage investors (TIFESI) is designed to promote an entrepreneurial and risk taking culture by connecting relevant start-up companies with investors and aim to bridge the funding gap between pre-concept stage financing and support (typically provided through self-funding, friends and family and government offsets such as the refundable R&D tax offset) and financing through the ESVCLP and VCLP regimes for companies further along the development pathway.
The legislation can be quite confusing and time consuming to go through, so to make it easier it is summarised below. For those interested, the Bill and Explanatory memorandum can be found here.
Summary of the benefit
There are two main benefits of the proposed legislation:
If the Bill becomes law it is proposed that these amendments apply in relation to shares issued on or after 1 July 2016 and would not be retrospective.
Which investors qualify for the tax incentives?
There are some relationship restrictions on the investors:
What type of investment qualifies?
What is a qualifying ESIC?
Generally, an Australian-incorporated company will qualify as an ESIC if it meets the tests of being at an early stage of its development (the early stage limb) and it is developing new or significantly improved innovations with the purpose of commercialisation to generate an economic return (the innovation limb).
The early stage limb
A company must pass four tests to satisfy the early stage limb of the qualifying ESIC test. Each of these tests is discussed below:
The innovation limb
In order for companies to determine if they satisfy the innovation limb of the qualifying ESIC test companies may choose to:
The principles-based test
To meet the principles-based test, a qualifying ESIC will need to be genuinely focused on developing its new or significantly improved innovation for the purpose of commercialisation and show that the business relating to that innovation:
To further define these 7 requirements:
As an alternative to satisfying the principle-based test for a qualifying ESIC, a company may be a qualifying ESIC if it has at least 100 points for meeting objective innovation criteria as listed below:
|At least 50 per cent of its total expenses for the previous income year constitute expenses which are eligible for the tax offset for R&D activities.
|The company has received an Accelerating Commercialisation Grant.
|At least 15%, but less than 50%, of its total expenses for the previous income year constitute expenses which are eligible for the tax offset for R&D activities.
|It is undertaking or has completed an eligible accelerator programme.
|A third party has previously invested at least $50,000.
|It has one or more enforceable rights on an innovation through a standard patent or plant breeder’s right that has been granted in Australia or an equivalent intellectual property right granted in another country.
|It has one or more enforceable rights on an innovation through an innovation patent or design right or an equivalent intellectual property right granted in another country.
|It has a collaborative agreement with research organisation or university to commercialise an innovation
What are the reporting requirements for the ESIC?
ESICs that receive investments from one or more investor entities in a financial year will need to provide information about those entities to the Commissioner 31 days after the end of the financial year. For most companies, this would be 31 July of the following financial year. ESICs will need to provide this information in the ‘approved form’.
When does it come into affect?
If the Bill becomes law it is proposed that these amendments apply in relation to shares issued on or after 1 July 2016.
Venture capital investment
As part of the same Bill, Schedule 2 amends the early stage venture capital limited partnership (ESVCLP) and venture capital limited partnership (VCLP) regimes to improve access to venture capital investment and make the regimes more attractive to investors. The amendments provide an additional tax incentive for limited partners in new ESVCLPs, relax restrictions on ESVCLP investments and fund size and clarify the legal framework for venture capital investment in Australia.
It is very encouraging to see the government introduce these measures in order to foster investment in early stage innovation companies in Australia. Their definition of an ESIC or start-up is interesting and likely something that will generate further discussion.
Let’s hope that this Bill gets passed and passed soon so that start-ups currently raising, or planning on raising in the near future, are not adversely affected by investors waiting to utilise these benefits.
by Gary Shapiro