The Early Stage Innovation Company (ESIC) tax concession encourages both innovation and tax-free investment in Australian companies.
To boost growth for small business and start-ups, new tax concessions were introduced 1 July. The move is set to stimulate tax-free investment in innovative companies as part of the federal government’s “Ideas Boom” project under the National Innovation and Science Agenda.
Specifically, the Early Stage Innovation Company (ESIC) tax concession sets to encourage both innovation and tax-free investment in Australian companies.
Broadly, the tax benefits for investors include:
- Rebate of 20% of an investment (capped at $200,000)
- 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 wanting to leverage the new concessions should keep in mind how they package their offer to investors. To be fully compliant and eligible for the concessions, investors will need to ensure:
- They purchase new shares in the ESIC.
- The ESIC cannot be associated to the investors.
- They do not own more than 30% of the ESIC.
- They check the Private Tax Ruling on the ESIC.
It’s not mandatory that an ESIC attain a private ruling. One is likely to be requested so investors can ensure they can take advantage of the tax concessions. If your ESIC doesn’t have one, be sure to get one.
If they are not deemed to be a “sophisticated investor” (gross income over $250,000 for the past two years or net assets of over $2.5 million), the investment will be limited to an annual total of $50,000 in one or more ESICs.
Keep in mind: capital losses are disregarded within the first 10 years of the investment.
Investors are aware that capital gains within the first 12 months are included as assessable income.
By their very nature, an ESIC is deemed a highly speculative investment category – a technology-based investment in a rapidly changing world. These are not mainstream investments so it is not for everyone. Often, the product being developed by the ESIC is yet to find a market or generate any cashflow, 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 (ROI) will make over the long term. Small business and start-ups need to consider how they package the ROI in order to be compliant and attractive from a tax perspective, while delivering an ROI that 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.
Let us take Facebook as an example to see how powerful these concessions can become. Facebook started in February 2004. It had an initial capital of US$12,000 from one of its early investors. In 2005, US$13.7 million 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!
Steve Gagel, Director, Prosperity Advisers Group
