A big challenge which innovative startups face is attracting capital investment when what they are doing is so new that it also is, by definition, a gamble. At the start, you may qualify for a NSW State Government Grant.1 But your startup business structure is important for private investors to become involved in longer-term funding of innovation. When setting up your small business structure, one type to consider is an Early Stage Innovation Company enabling you to qualify for ongoing tax breaks from the Australian government.
Now the Income Tax Assessment Act 2 (the main Tax Act) won’t bring you investors, but it can be amended to give a tax break to small investors taking a big gamble (‘angel investors’) who are willing to place that bet. Watch out Mum and Dad, your twenty-somethings will be mentioning this at Sunday lunch while talking dreamily about that pet-tattooing salon they’re going to open!
So that you can tell them that you’re no angel and the new law won’t apply to pet-tattooing salons, let’s quickly go through its main points. With this amendment Act (Tax Laws Amendment (Tax Incentives for Innovation) Act 2016), adding to the main Tax Act, investments made on or after 1 July 2016 may qualify for-
- A 20% tax-deduction, which can be carried forward, on up to $50,000 investment in equity interests that are shares in a company (so, actual part-ownership of the company up to 30% of the company’s value).
- Completely avoiding Capital Gains Tax if the equity that you own is sold after one year and before ten years of investment and the company has remained innovative. You cannot, however, write off capital losses.
WHO WILL QUALIFY AS AN ‘EARLY STAGE INNOVATION COMPANY’?
The tax breaks only apply to a small subset of companies and investors. The definition of an ‘Early Stage Innovation Company’ (ESIC) is of course long and bureaucratic, but it boils down to these main points. If:
- The company is a genuine innovation business for commercialisation of products, services, processes, marketing or organisational methods,3 and
- The business has a competitive edge, and high-growth success potential in a national or global market, and
- The company was legally incorporated in the last 6 years, but not listed on the ASX, and
- The company is not a subsidiary, affiliate, trust, partnership or employee share scheme, and
- Its total spending in the last 3 years was less than $1m, and
- Its total spending in the previous income year was less than $1m, and
- Its total assessable income in the previous year was less than $200,000,
then it may qualify as an ESIC if it also ticks some of a whole list of boxes in the Act, which are about the company doing something new and interesting, and investing time and/or money in R&D.
If you have already gone through the red tape and been accepted for some of the government small business programs, that may also give you automatic acceptance as an ESIC.
WHICH INVESTORS QUALIFY?
Ordinary investors qualify up to $50,000 of investment in a company. (This limit does not apply if you are a “sophisticated investor” as per the Corporations Act test.) They can then deduct 20% of the cost from their taxable income. It can be carried over to a later year.
Some investors, basically very cashed-up ones who can prove they’re up for a very big gamble, may be allowed to invest more than $50,000 and still use the new law (but the total tax offsets for all its ESICs investments must not exceed $200,000).
This amendment to the Tax Act also provides for tax offsets for Early Stage Venture Capital Limited Partnerships (‘ESVCLP tax offset’), to reduce the effective costs of such investments through a separate tax offset regime.
Engineering or technical advice is often necessary to prove that you are a genuine innovation business, particularly if the product is so high-tech that no ordinary mortal could understand how it is made. Even where the product is more ordinary – commercial, accounting and legal advice are usually necessary to work through the complexities of your situation.
Also, stay tuned for the forest of Regulations which will inevitably follow the Act!
- Funding Roadmap, NSW Department of Industry, Building Partnership Grants
- Income Tax Assessment Act 1997 (Cth).
- The government can specify by regulations the kinds of businesses or activities which will not qualify as an “early stage innovation”.