Start-up investor tax breaks: ESIC Hub’s Stephen Crowe on how yours can qualify

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Concessional tax treatments become available for investors in “early-stage innovation companies”, or ESICs.

The concessions include a 20 per cent tax offset on investment, capped at $200,000 per investor, per year, and a 10-year capital gains tax exemption for profits on equity investments held for at least 12 months.

So, an investor making a $500,000 investment in an ESIC can save $100,000 income tax in that year. If the investor sells their investment five years later for $2 million, the full capital gain of $1,500,000 is exempt from capital gains tax.

The $200,000 maximum tax saving is only available to sophisticated investors under the Corporations Law.

Other investors can also benefit, though their maximum annual investment amount is $50,000 to attract a tax saving. This is to ensure less-sophisticated investors are not over-exposed to this asset class.

Investments made through self-managed super funds, trusts, partnerships and companies can qualify. However, companies that are publicly listed or have more than 50 shareholders do not.

Investors cannot own more than 30 per cent of an ESIC and shares issued under employee-share schemes are also precluded. Investors can be non-resident.

Why’s the government targeting early-stage companies?

The government estimates 4500 early-stage companies are missing out on equity finance each year and is targeting $1 billion to be raised in the early years of the scheme, which continues indefinitely. The government wants to incentivise investors to direct their funds towards innovative, high-growth Australian companies.

What’s in this for early-stage companies?

From July 1, the smart money will head towards ESICs, which will provide the best tax incentives for investors. It’s more important than ever that early-stage companies wanting capital tick the right boxes for their structure and that investors handing over funding have their eyes wide open.

An early-stage company unsure of its ESIC status will quickly become a questionable proposition for an investor. So, early-stage companies should take steps to be ESIC- ready so they can accelerate capital raisings.

What do early-stage companies need to do to show they are ESIC ready?

First, they need to show they are early stage. They must:

• Be incorporated in Australia or registered in the Australian Business Register within the past three years

• Have expenditure and income of $1 million and $200,000 or less respectively in the previous income year

• If incorporated in Australia between three and six years ago, they (and any 100 per cent subsidiaries) must have total expenses of $1 million or less over the last three years

• Not be listed on any stock exchange.

Second, the ESIC needs to show it is involved in innovation. This can be done through meeting a points system, meeting what the government is calling a principles-based system, or receiving an ATO determination.

The points system will require an ESIC to receive 100 points to qualify based on its:

• R&D tax expenditure history

• Intellectual property rights

• History of raising equity capital from non-associates

• Involvement in selected industry programs, and

• Formal associations with higher education institutes or registered research providers.

Under the principles-based system, companies will be asked questions such as:

• Does the business have high growth potential?

• Is the company focused on commercialising?

• Can the company demonstrate that it has the potential to be able to successfully scale?

• Does the company have the potential to address global markets?

What about investors? To qualify for the tax savings, investors must ensure their equity investment is a qualifying ESIC. They need to obtain a qualifying ESIC certificate.

The ticking of boxes may seem like another complex task in the day of an entrepreneur, innovator or researcher but the incentives will be worth it. In the competition for funding, getting ESIC-ready will be one step an early-stage company cannot afford to neglect.

Stephen Crowe is the founder of ESIC Hub, an Australian-owned independent service connecting start-ups and investors.

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