The innovation incentive that could be powering the next generation of market leaders.
Australia has never been short on ambition when it comes to nurturing its start-up ecosystem, but it has often come up short on incentivising investors to back our talent. Whilst a R&D regime exists that may provide cash re-investment into innovative activities via a refundable tax offset, it does not in itself directly drive investment into new industries. The regulator in charge of the R&D regime, AusIndustry, has also in recent times taken a somewhat tougher approach to innovators in the technology space, particularly software development, putting pressure on the sector as a whole.
Perhaps tax incentives for property investment, which are currently at the forefront of political debate, has been the opposing force that stands in the way. Would a future removal or winding back some of these tax concessions pave the way for a redirection of investment funding to the innovation eco-system and in particular the fast moving technology space?
The Tax Concession for Investors
This brings us to the Early Stage Innovation Company (ESIC) tax concession regime, which stands apart from most other tax concessions. It is a provision that is structurally designed and structurally limited to do a very specific thing. It exists purely to incentivise private capital investment into pre-commercialisation research and development companies.
Having successfully guided clients through private rulings with the Australian Taxation Office, we have seen first-hand how powerfully these concessions work when the rules are properly understood. Sophisticated investors, family offices and private investors should be paying far closer attention to this space than they currently are.
The ESIC regime aims to deliver two distinct concessions.
- A non-refundable tax offset equal to 20% of the amount invested, capped at $200,000 per investor per income year (for Sophisticated Investors). This offset reduces the investor’s income tax payable, unlike, for example capital losses which are limited in their use. While it cannot generate a cash refund, if it exceeds tax payable in a given year, it can be carried forward to future income years.
- Shares in a qualifying ESIC entity are exempt from capital gains tax for up to 10 years, provided they have been held for at least 12 months.
As an investor, these incentives are powerful, but the devil is in the detail. There are specific eligibility criteria for the company itself and a second layer of criteria for investors.
What Companies need to do
Broadly companies need to pass both the early stage test and one of the 100-point innovation test and principles based innovation test.
The early stage test requirement are:
- The company must have been incorporated or registered in the Australian Business Register.
- The company (plus any wholly-owned subsidiaries of the company) must have total expenses of $1 million or less in the previous income year.
- The company (plus any wholly-owned subsidiaries of the company) must have assessable income of $200,000 or less in the previous income year.
- The company’s equity interests are not listed on any stock exchange.
Where this is satisfied, a company can then qualify by obtaining at least 100 points by meeting the criteria set out in the table below.
| Points | Criteria |
| 75 points | At least 50% of the company’s total expenses for the previous income year are eligible notional deductions for the research and development tax incentive. |
| 75 points | The company has received an Accelerating Commercialisation Grant at any time. The amount of this grant is also excluded from the company’s assessable income for the purposes of the early-stage test. |
| 50 points | At least 15% but less than 50% of the company’s total expenses for the previous income year are eligible notional deductions for the research and development tax incentive. |
| 50 points | The company has completed or is undertaking an eligible accelerator program that provides time-limited support for entrepreneurs with a start-up business. This support may involve providing mentorship, training, education and access to networks. The program must be provided to entrepreneurs that are selected in an open, independent and competitive manner. It is likely that an entity that has been selected through this process would also meet the principles-based innovation test. The entity providing the program must have been providing eligible programs for at least 6 months, and the programs must have been completed by at least one cohort of entrepreneurs. |
| 50 points | One or more third parties have previously paid a total of at least $50,000 for the issue of new shares in the company. These points are only available if: • the third party was not an associate of the company immediately before it was issued with the shares • the company issued the third party with the shares at least one day before the test time • the third party did not purchase those shares primarily to assist another entity to become entitled to early-stage investor tax incentives. Examples of entities that would be an associate of a company include: • a partner of the company or a partnership in which the company is a partner • a trustee of a trust estate under which the company or associate benefits • another entity (including a person) that, acting alone or with another entity or entities, sufficiently influences the company • an entity (including a person) that, either alone or together with associates, holds a majority voting interest in the company • a second company that is sufficiently influenced by the company or the company’s associates • a second company in which a majority voting interest is held by the company or the company’s associates. |
| 50 points | A company has enforceable rights on an innovation through: • a standard patent granted in Australia in the last 5 years • a plant breeder’s right that has been granted in Australia in the last 5 years, or • an equivalent intellectual property right granted in another country in the last 5 years. A company that holds a licence to intellectual property owned by another party is able to obtain these points. |
| 25 points | A company has enforceable rights on an innovation through: • an innovation patent granted in Australia in the last 5 years • design right granted in Australia in the last 5 years, or • an equivalent intellectual property right granted in another country in the last 5 years. A company that holds a licence to intellectual property owned by another party can obtain these points. These points are only available if the company did not receive 50 points for holding a standard patent, plant breeder’s right or equivalent right overseas under the previous criterion. |
| 25 points | The company has a written agreement to co-develop and commercialise an innovation with: • an institution or body listed in Schedule 1 to the Higher Education Funding Act 1988, or • an entity registered as a Research Service Provider under section 29A of the Industry Research and Development Act 1986. |
Alternatively, if you do not meet this test, you can apply the principles based test, which has 5 requirements, being that:
- The company must be genuinely focused on developing one or more new or significantly improved innovations for commercialisation.
- The business relating to that innovation must have a high growth potential.
- The company must demonstrate that it has the potential to be able to successfully scale up that business.
- The company must demonstrate that it has the potential to be able to address a broader than local market, including global markets, through that business.
- The company must demonstrate that it has the potential to be able to have competitive advantages for that business.
Typically these tests must be assessed and satisfied in the first 3 income years of incorporation, but noting that it can be extended to 6 income years with additional limitations.
Unfortunately, we often see consideration of these rules long after the required time period has elapsed.
Start-up companies involved in innovative activities are therefore encouraged to consider their eligibility for these concessions as early as possible, as qualification can have a real benefit in raising capital in a competitive, higher risk environment.
Please reach out to your local Moore Advisor for a tailored review of your circumstances.
