Tax Incentives for Investing in Start Ups

TAX INCENTIVES FOR INVESTING IN START UPS

With a few months to go until 30 June when investors Unlike the Start-up Offset, the Tax-free Exit is not can claim the new start-up tax concessions and 31 July capped. So even if you cap out on the Start-up when start-ups need to report information to the ATO, Offset, the Tax-free Exit will still be available for it’s good timing to revisit the state of play and some of other investments that qualify under the new rules. the key conditions. How do investors qualify? It was around this time last year that there was a lot of buzz around new tax incentives for investments Depending on the investor type, limits can apply. These in innovative start-up companies. New tax laws were are discussed below, but before we get there some red passed and equity issued by start-ups had the green flags include: light from 1 July 2016. ▪▪ If the start-up didn’t qualify under the new rules While a start-up can help investors by providing immediately after they issued you shares (see information that they qualify under the new rules, the ‘How do start-ups qualify?’ below); tax law puts the onus on investors to do their homework ▪▪ The shares issued to you are not ‘equity interests’ and make sure all the boxes are ticked. Like all things under the tax law (eg certain equity in the legal tax-related, there are quite a few boxes to tick - for both form of preference shares would not be tax equity); investors and start-ups! ▪▪ You and the start-up are ‘affiliates’ under the tax So what’s on offer? law. This could be the case if it is expected that the ▪▪ 20% non-refundable carry-forward tax offset – let’s start-up would operate in the way that you want call this the Start-up Offset. or direct; In simplified terms, this means you can reduce ▪▪ After you get your shares you own more than 30% each dollar of tax payable by each dollar of the of the start-up; or Start-up Offset available. It can only reduce your ▪▪ Your shares were issued under a share plan. tax bill to zero and therefore, can’t result in a tax refund but you can save what’s left over for next Assuming there are no red flags, the limits that can year. The amount of Start-up Offset is capped at apply to different investors include: $200k, so this one applies to the first $1m that you invest in a start-up/s. ▪▪ No limit: The rules are aimed at investors that meet the ‘sophisticated investor’ criteria under ▪▪ No capital gains tax (CGT) for investments held the corporations law, which is why they are often between one and ten years – let’s call this the Tax- called the ‘Angel investor tax incentives’. If you’re in free Exit. this category you get the full benefit of the Start-up Offset and CGT-free Exit.

Adelaide | Alice Springs | Brisbane | Canberra | Darwin | Hobart | Melbourne | Norwest | Perth | Sydney hwlebsworth.com.au 1 ▪▪ Some limits: If you are not a ‘sophisticated investor’, ▪▪ Can’t be listed on any Australian or foreign stock you can still benefit but the maximum investment exchange; and you can make each year in eligible start-ups is $50k. So your maximum Start-up Offset is $10k and those ▪▪ Must either be: investments are CGT-free for the next 10 years. ▪▪ Incorporated in Australia or registered in the ▪▪ Not available: If you’re a ‘widely held’ investor Australian Business Register within the last (broadly, listed companies or their wholly- three income years (tested from the income owned subs, or companies with more than 50 year which your shares are issued); or shareholders), these rules don’t apply to you. ▪▪ Incorporated in Australia in the last six income It’s important to remember that it doesn’t matter if years (same testing time as above) and the you’re an Australian resident or foreign investor, or if company and its wholly-owned subs had you invest via a partnership or trust, the Start-up Offset expenses of $1m or less across the last three of and CGT-free Exit can still be available. those income years. Like all 100 point tests, you need to follow a table and How do starts ups qualify? add up the points which apply. Things that give points The start-up needs to satisfy the requirements to be an to start-ups include expenditure on R&D, receiving ‘early stage innovation company’ (the acronym being certain grants, completing or undertaking an eligible ‘ESIC’). Relevantly, it is not an on-going test so it doesn’t accelerator programme, or third parties having invested matter if it no longer meets the ESIC requirements after at least $50k in the start-up. the shares are issued, but the critical testing point is the The principles based test, as it suggests is subjective and time the shares get issued to you. generally if this is being relied on, best practice would The relevant tests the start-up must pass are: be to seek a ruling from the Australian Taxation Office (ATO) for certainty. ▪▪ the early stage test; and Reporting obligations ▪▪ either the: Start-ups that think they have issued equity that is ▪▪ 100 point innovation test; or eligible under the new rules are required to report ▪▪ principles based innovation test. certain information to the ATO, with the first report due by 31 July 2017. To satisfy the early stage test, the start-up (including any of its subsidiaries): The exact format for reporting is yet to be confirmed, but start-ups should be aware of the information they ▪▪ Must have assessable income of $200k or less in the need to report and investors should know that this is previous income year (certain commercialization required to be reported to the ATO. grants are ignored and this requirement is met if the start-up had no income); and For investors, you claim the Start-up Offset and CGT- free Exit in your tax return and it is evidenced in the way ▪▪ Must have total expenses of $1m or less in the that you prepare your return. previous income year; and

Adelaide | Alice Springs | Brisbane | Canberra | Darwin | Hobart | Melbourne | Norwest | Perth | Sydney hwlebsworth.com.au 2 Take away points ▪▪ As with all matters related to the law, it is recommended that both start-ups and investors ▪▪ The start-up tax concessions are not as simple as seek professional advice on the application of these they may first appear and the conditions must be new rules in the tax law. satisfied at the time you are issued shares.

▪▪ Start-ups should be clear on whether they This article was written by Nima Sedaghat, Partner, qualify or not and investors should perform their HWL Ebsworth Lawyers. diligence before investing and not assume that the concessions are available to them.

NIMA SEDAGHAT ROWAN MCDONALD PARTNER, SYDNEY PARTNER, SYDNEY P +61 2 9334 8921 P +61 2 9334 8948 M +61 402 931 525 M +61 439 843 803 E [email protected] E [email protected]

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