Tax incentive for ‘early stage investors’ – 20% non-refundable off-set up to $200,000pa & CGT exemption after 3 year then uplift after 10 years

Tax incentive for ‘early stage investors’ – what is it?

The Government has announced that it will introduce a tax incentive for startup investors which will provide concessional tax treatment for investments made in qualifying innovative startup companies with high growth potential.

The new tax incentive will provide investors with:

• a 20 per cent non‑refundable tax offset based on the amount invested either directly in the qualifying startup or indirectly through a fund, up to an offset cap per investor of $200,000 per year.
  • The non‑refundable tax offset would be available once the funds are committed and subscribed;
• for direct investment, a capital gains tax (CGT) exemption on those investments, provided they are held in the qualifying company for at least three years; and
• for indirect investment through a fund, a CGT exemption on distributed capital gains provided the underlying investment was held for at least three years.

This measure is based on the UK’s successful Seed Enterprise Investment Scheme, which resulted in over $500 million of early stage investment for almost 2,900 companies in its first two years.

The new tax incentive for startup investors helps to offset the high costs that confront potential investors and the innovative startup companies themselves, thereby increasing the level of equity investment in innovative startups.

It is intended that, in time, this intervention will help to stimulate a critical mass of innovative businesses, early‑stage financers and those with high‑quality entrepreneurial skills in a thriving innovation environment that will sustain itself.

Consultation – The Government is committed to hearing the views of interested stakeholders on the measures included in the National Science and Innovation Agenda, including the new tax incentive for early stage investors.

The Government will commence consultations with stakeholders early in 2016. To register your interest to participate in the consultations, please email startuptaxincentive@treasury.gov.au.

Key definitions – The Government proposes the following eligibility criteria for the tax incentive, which will be developed in consultation with stakeholders and is subject to change.

A qualifying investor is one who:

• invests into either a qualifying fund or a qualifying startup; and
• is limited to making a maximum eligible investment of $1,000,000 in any single qualifying startup or qualifying fund.

A qualifying fund is a:

• collective investment vehicle which:
  • is a flow‑through vehicle for income tax purposes; and
  • invests exclusively in qualifying startups.

A qualifying startup is:

• an Australian company, which:
  • was incorporated during the last 3 income years;
  • had expenditure of ≤ $1,000,000 in the prior income year;
  • had assessable income of ≤ $200,000 in the prior income year;
  • is not an entity listed on any stock exchange; and
  • carries on a business that is defined to be eligible (where eligibility will be targeted to small, innovative companies which are likely to have difficulty accessing equity financing).

Tax treatment of investments

Direct investment

• A qualifying investor would receive a full CGT exemption in respect of its direct investment in a qualifying startup, provided the investment is held for a minimum period of 3 years.
• Shares held in a qualifying startup would be CGT exempt for 10 years, at which time the cost base of the shares in the qualifying startup would be reset at market value.
• Where shares in the qualifying startup are sold prior to the minimum 3 year holding period, the CGT exemption would be forfeited.

Indirect investment

• A qualifying investor that has invested through a qualifying fund would receive a full CGT exemption for distributed capital gains in respect of their underlying qualifying startup investment, provided the investment is held by the qualifying fund for a minimum period of 3 years.
• Where shares in the qualifying fund are sold prior to the minimum 3 year holding period, the CGT exemption would be forfeited.

Frequently Asked Questions

Why is the tax incentive limited to investments in certain companies?  

The targeting is designed to focus on innovative startup companies with high growth potential, as distinct from low-risk, low-growth companies.

Innovative startup companies with high growth potential tend to involve a high degree of risk early in their lifecycle, which can deter investors and lead to less investment in developing innovative new ideas.

Why has the Government decided to go with a tax offset, rather than a tax deduction (as per the UK SEIS & EIS schemes)? 

A tax offset is a fairer way to incentivise behaviour as it provides all investors with the same level of benefit irrespective of their marginal tax rate. This limits the amount and complexity of advice required.

A tax offset also avoids unintended consequences that could arise through a deduction, which reduces an individual’s taxable income. For example, reducing an individual’s tax payable might affect child support payment obligations or HECS/HELP repayment obligations, as these are calculated using an individual’s taxable income as opposed to gross income.

A tax offset would thereby maintain integrity and fairness of the broader system.

When does the tax incentive start?

The tax incentive will have effect from the date of Royal Assent of the enabling legislation; that is, the date when the legislation becomes law.

This is designed to increase certainty for investors and avoid retrospectivity. Definitions for an eligible innovative startup company, as well as details of the new fund type that will be required to invest exclusively in innovative startup companies, are to be determined in consultation with stakeholders, which is expected to occur in early‑2016.

[Treasury website]