The Early Stage Innovation Company (ESIC) tax incentive is perhaps one of the most generous, yet least known of tax incentives available in Australia today.
The Australian Government’s tax incentive for early-stage investors is designed to encourage risk-taking investors to connect with early-stage innovation companies (ESICs), providing them with the start-up funds & business experience they seek.
Introduced on 1 July 2016, it enables start-ups who are in the process of capital raising to mention ESIC as a key benefit in their fundraising documentation.
What is the ESIC Tax Incentive?
The ESIC tax offset available has 2 components:
- Sophisticated investors can access up to a 20 per cent non-refundable carry-forward tax offset on amounts invested in qualifying innovation companies (ESICs) up to a cap of $200,000 per investor per year.
- Investors can also access a modified capital gains tax treatment for investments in qualifying shares in an ESIC held for between 12 months and 10 years, provided that the shares held do not constitute more than a 30 per cent interest in the ESIC.
What is defined as a qualifying early-stage innovation company (ESIC)?
In order for a company to be considered eligible under the scheme, it must meet all of the criteria below:
- The company must have been incorporated or registered in the Australian Business Register within the last three years (last six years if additional criteria is met*).
- The company (plus any wholly-owned subsidiaries) must have total expenses of $1 million or less in the previous income year*.
- The company (plus any wholly-owned subsidiaries) must have revenue of $0-$200k in the previous income year.
- The company is not listed on any stock exchange, either in Australia or abroad.
* The ESIC rules may still apply for a company incorporated between three and six years ago and had less than $1m of expenditure in total over the past three years.
Qualifying for Tax Incentives
To qualify for the tax incentives, investors must have purchased new shares in a company that meets the requirements of an ESIC immediately after the shares are issued. The shares must be issued on or after 1 July 2016.
AusIndustry provides two different qualification test under ESIC. A company may choose to apply under either and will choose the most appropriate test for them based on their unique circumstances.
The first test is the 100-Point Innovation test and the second test is the Principles-Based Innovation Test.
100-Point Innovation Test
A company must assess itself against a list of criteria (assigned weighted points) and achieve at least 100 points in order to qualify as an ESIC under this test.
The full list of the criteria & the points available for meeting each criteria under the 100-Point Innovation Test, can be found here.
Principles-Based Innovation Test
Under this alternative test to the 100-Point test, a company may choose to either self-assess or request a private binding ruling from the ATO on whether it qualifies as an ESIC.
Given the subjective nature of the test, it is recommended a private binding ruling be sought to confirm the ATO’s views.
Further details on this test can be found here.
Example: Calculating the early stage investor tax offset
Savannah, a sophisticated investor, pays $4 million for new shares in ESICs during the 2016–17 income year.
Although 20% of the total amount Savannah has paid for the ESIC shares is $800,000, her entitlement to the early stage investor tax offset is capped at $200,000 (provided the other eligibility requirements for the incentives are met).
Savannah has an income tax liability of $50,000 for the 2016–17 income year. She uses $50,000 of the early stage investor tax offset to reduce her tax payable to zero. Savannah can carry forward the remaining $150,000 in early-stage investor tax offset to future income years.
The modified CGT treatment applies to all of the shares that she purchased. (Credit: AusIndustry)
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