You’ve developed an innovative product or service that will transform your business and industry, but implementation requires more money than you can currently access.
You have two choices – ‘boot-strapping’ (getting by with very little capital and restricting spending to whatever trickles in by way of funding) which we all know significantly diminishes your chances of success and threatens to delay the project; or raising some capital – historically from family and friends – which risks those relationships if things don’t quite go to plan (and let’s face it – that’s most of the time).
The Australian Government has identified that innovation is fundamental to future economic growth and job growth, and that small business owners will be a significant driver of this innovation.
The Government has established a number of initiatives, including very significant tax incentives, to support business who have the mindset, vision, ideas, and plans to innovate.
How do the tax incentives work?
Investors may be eligible for tax incentives to purchase new shares1 in your business if your business meets the requirements of an Early Stage Innovation Company (ESIC).
In broad terms, the incentives are in two parts:
1. A tax offset of up to $200,0002
2. CGT-free status for up to 10 years
Whilst the tax offset might be the one that grabs your eye because it reduces an investors’ tax payable in the year they make the investment, in practice most investors are attracted by the potential of a ‘big bang’ event down the track. So, the opportunity to make CGT-free gains of significant proportion is actually the thing that attracts them most.
How can you qualify as an ESIC?
The Australian Tax Office (ATO) has established several “tests”3 for companies to qualify as an ESIC.
A company will qualify as an ESIC if it meets both:
- the early stage test, and
- either the:
o 100-point innovation test, or
o principles-based innovation test.
All tests are applied at the point in time immediately after the company issues the shares to the investor.
Early Stage Test
Your company needs to be incorporated or registered in the Australian Business Register, not be listed on any stock exchange, have total expenses of $1 million or less in the previous income year, and have assessable income of $200,000 or less in the previous income year.
100 Point Innovation Test
The ATO has established a range of objective innovation criteria3 , which are weighted between 25 points and 75 points. To qualify, your company must achieve at least 100 points against these criteria (a similar concept to the 100-point identity check for financial transactions).
These criteria include (but are not limited to) eligibility for R&D tax incentives, completion of an eligible start-up accelerator programme, and rights to an innovation patent or standard patent.
The 100-point test is self-assessed and is likely to be a simpler way to determine its ESIC eligibility than the principles-based innovation test.
Principles-Based Innovation Test
A company can instead choose to request a ruling from the ATO on whether it qualifies as an ESIC applying the principles-based innovation test.
The principles-based innovation test3 requires companies to demonstrate they are commercialising an innovation (which may be a product, process, service, marketing or organisational method) which has high potential in relation to growth, market expansion, scalability and creating competitive advantage.
If you have potential investors who share your excitement for your vision and plans, these tax incentives may be the encouragement they need to fund your business’ innovation.
BridgePoint has significant experience advising on the application of the ESIC rules. If you and your potential investors want to bring your innovation to fruition, contact Bridgepoint on 1300 656 141 to help you navigate the ATO’s ESIC eligibility tests.
1 ‘Sophisticated Investors’ can invest as much as they like and their investment will qualify for a 20% tax-offset up to a maximum of $200,000. Other investors are limited to investing $50,000 in any given year. Other rules also apply.
2 The shares must be issued on or after 1 July 2016
3 Refer to the ATO website for more details about these tests.