Founders Guide to the Innovation Tax Incentive Legislation

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This week, the Australian Senate passed the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016. Sounds great, but what does it all mean to us, the founders of early stage startups in Australia? I spoke to Marc Loftus, Partner at BDO Perth, on the details behind the legislation and what they mean.

//SN: Hi Marc, thanks for your time. The Senate passed this legislation this week, which is exciting news in the early stage investing market. Can you let me know in layman terms, what are the benefits for an investor under this legislation?

In a nutshell the concessional tax treatments available to investors include:

  • A 20 per cent non-refundable tax offset on investment capped at $200,000 per investor, per year.
  • A 10 year capital gains tax exemption for investments held for 12 months or more.

If we consider an example:

For an eligible investor who invests $1,000,000 in a qualifying company, they will receive an upfront $200,000 tax offset, leaving them only $800,000 out of pocket. Further sweetened by a tax free capital gain should the innovation succeed and the investment be disposed of (after it has been held for a minimum of 1 year).

This as compared to the case of an ordinary equity investment of $1,000,000, where the investor is $1 million out of pocket upon initial investment and subject to a discounted capital gain, taxed at the investor’s prevailing marginal rate should the project succeed.

Marc Loftus
Marc Loftus

The downside:

In the event that the innovative project fails, pursuant to this law the investor will still be $800,000 out of pocket, however there will be no capital losses available to offset against any carry forward capital gains that the taxpayer may have (i.e. there is no tax benefit to the investor).

//SN: OK, so as a startup founder, what can I do to ensure my startup meets the ‘Early Stage Innovation Company’ ruling?

I would encourage start-ups to be pro-active in establishing whether they qualify as an Early Stage Innovation Company (ESIC) to ensure you’re ready to take receipt of funds from investors and drive your project to the next level.

Meeting the four objective tests in respect to fulfilling the ‘early stage’ component is relatively straight forward:

  • The company has been recently incorporated or registered in the Australian Business Register, generally within the last three income years (in limited circumstances, 6 years)
  • The company and any of its wholly-owned subsidiaries must have not incurred total expenses of more than $1 million
  • The company and any of its wholly-owned subsidiaries must have derived assessable income of $200,000 or less in the previous income year
  • The company must not be listed on a stock exchange (either in Australia or overseas).

However the criteria to evaluate ‘innovation’ are more complex, containing a combination of tests:

  • a principles based test to measure innovation which requires that the company is developing a new or significantly improved type of innovation such as a product, process, service, marketing or organisational method and can demonstrate that the business relating

to that innovation:

  • Has the potential for high growth
  • Has scalability
  • Can address a broader than local market
  • Has competitive advantages.

OR

  • A ‘100 point point innovation test’ where the company has to accumulate points according to a table of objective innovation criteria.

//SN: Let’s say I don’t have any existing R&D or ‘Accelerating Commercialization’ grants (we don’t at 6Q for example), how do I get a ruling that my startup is an ESIC?

The criteria to evaluate innovation pursuant to this legislation contemplates the use of either the principles based test OR the ‘100 point innovation test’ the latter of which considers elements including R & D claims, the receipt of an ‘Accelerating Commercialisation Grant’ and the completion or  participating in an eligible ‘accelerator programme’.

If you haven’t taken part in activities such as this, you may want to consider looking to the principles based test or alternatively should you not wish to self-assess you can apply to the Australian Tax Office to get a ruling on the matter.

BDO are well placed to assist you in preparing an application for a private ruling, with further information, application forms and guidance around private rulings to be found on the ATO’s website.

//SN: What impact do you believe this change of policy will impact early stage startups over the next 12 months? Will it be boom time for the ideas boom?

The next 12 months will see a rapid increase in the amount and sources of capital available to start-ups, driving the technology and innovation sectors in Australia, both of which are critical to the future prosperity of our country. BDO are excited to be able to assist start-ups in making the best of this opportunity.

//SN: Thanks for your time, Marc, in helping us all understand what this new legislation means. Exciting time ahead for those seeking investment, it seems!