The Government's National Innovation & Science Agenda (Innovation Agenda), released on 7 December 2015, sets out a number of proposed changes aimed at improving the regulatory and tax landscape for start-ups in Australia. These changes are designed to promote Australia as a hub of innovation and entrepreneurship and give Australian start-ups an additional helping hand in attracting and retaining the best talent on a global scale.
While the changes are all still in proposal form and legislation is yet to be drafted, there are a number of key proposed changes that will make investing in start-ups more attractive and begin to rejuvenate the Australian innovation landscape.
In 2007, the Government introduced the Early Stage Venture Capital Limited Partnership (ESVCLP) program which is designed to encourage investment in start-ups. An ESVCLP is a venture capital fund, structured as a limited partnership and registered with Innovation Australia. Due to the flexibility of the ‘flow-through’ taxation position and the limited liability of investors, such a structure is desirable to venture capital investors, including international investors.
There are a number of tax benefits already available for taxpayers that invest in start-ups through an ESVCLP. Such concessions include:
- ESVCLPs not being liable to income tax; and
- certain tax exemptions for those partners that invest through an ESVCLP.
The concessional treatment is to incentivise those investing in innovative companies at the early and growth stages of the start-up life-cycle.
As part of the Innovation Agenda, it is proposed that the regime be amended to attract further investment. The changes will make ESVCLPs a more widely applicable investment vehicle and even more concessional from a tax perspective.
These changes include:
- Partners in an ESVCLP receiving a 10% tax offset on capital invested;
- Lifting the maximum ESVCLP fund size to AU$200 million (currently AU$100 million);
- Removing the obligations for ESVCLPs to divest their interest in a company once an investee company has more than AU$250 million in assets.
The changes for ESVCLPs are proposed to take effect from 1 July 2016 and will likely attract additional funds to the venture capital sector as a result.
FURTHER REFORMS TO EMPLOYEE SHARE SCHEMES
From 1 July 2015, the Government introduced changes to the Employee Share Scheme rules (ESS) in Division 83A of the Income Tax Assessment Act 1997 which were designed to make Australia's taxation of ESS interests more concessional and competitive by international standards (to see our releases on these changes click here).
The Innovation Agenda proposes further changes to ESS in Australia, the details of which are expected to be introduced in the first half of 2016.
Where a company seeks to obtain funding from members of the public, it typically must prepare and lodge disclosure documents with ASIC. While ESSs are often subject to a class order giving partial relief in respect of disclosure requirements, such relief does not always apply. The new changes will limit the requirement for disclosure documents given to employees under an ESS.
These new changes, while they do not provide further tax concessions, provide benefit to companies as compliance costs associated with ESS will be lessened as the disclosure requirements are relaxed and costly preparation of disclosure documents may no longer be necessary. This will enable companies to streamline the implementation of ESS, building on the benefits brought in by the ESS reforms earlier this year.
There are a number of tax measures which are aimed at either increasing the attractiveness of investing in start-ups or reducing the risks associated with a start-up business. The proposed changes include:
- Allowing start-ups access to tax losses that may have previously been lost due to the strict 'same business test' being failed. A new 'predominantly similar business test' will be available;
- Allowing companies to self-assess the effective life of acquired intangible assets that are currently fixed by statute; and
- Providing concessional tax treatment to early stage investors in start-ups.
We summarise these measures below.
INCREASING ACCESS TO COMPANY LOSSES
Currently, where a company enters into new transactions or business activities it can only access tax losses it had previously accumulated where it satisfies the 'same business test'. Given the rigidity of the test, many innovative companies making losses were deterred from seeking new opportunities as it could result in the forfeiture of those losses that may be valuable in the future when they become profitable.
The Innovation Agenda proposes the introduction of a new and more flexible 'predominantly similar business test'. The new test is expected to be introduced in the first half of 2016. The Government anticipates that a relaxed test will promote entrepreneurship from many companies as they will be able to seek new and diverse opportunities without the same risks being associated.
While the Innovation Agenda does not specify whether the 'predominantly similar business test' will be applicable to all companies or just start-ups, we anticipate that it will be limited to start-up companies and used mainly as an innovation incentive.
SELF-ASSESSMENT OF EFFECTIVE LIFE OF INTANGIBLE ASSETS
For depreciation purposes, the vast majority of assets' effective lives are determined by the taxpayer. This means that the tax treatment of the asset is aligned with the number of years that asset is anticipated to remain useful to a business. On the other hand, however, the effective lives of many intangible assets are fixed by statute. Without the flexibility of self-assessment, the benefit of depreciation can be reduced and the cost of investment in such assets can be increased.
Intangible assets (e.g. copyright in software code) are critical to innovation. As a result of the non- concessional treatment applied to such assets in a depreciation context, investment in companies that hold innovative intangible assets may have been limited.
From 1 July 2016, the Government proposes to enable businesses to have the option to self-assess the effective lives of their intangible assets with statutorily fixed lives. This will enable companies to claim a larger tax deduction over a shorter period than they would have been able to under the old arrangements. As a result, investment in innovative companies with a large proportion of intangible assets is likely to increase.
TAX CONCESSIONS FOR EARLY STAGE INVESTORS
The Government is seeking to boost investment in innovative, high-growth potential start-ups. As a result, as part of the Innovation Agenda, it has announced plans to introduce generous tax concessions for early-stage investors from 1 July 2016.
The concessions will only apply to investments in companies that:
- undertake an eligible business (yet to be defined);
- were incorporated within the last three income years;
- are not listed on any stock exchange; and
- have expenditure of less than AU$1 million and income of less than AU$200,000 in the previous income year.
What will be considered an eligible business for these purposes will be determined in consultation with industry. Given the restrictive criteria for eligible investment, it is a clear indication that the Government wants to promote investment in a company from its formative stages.
The proposed tax incentives that are available for investors include:
- a 20% tax offset on investments (capped at AU$200,000 per investor per year); and
- a 10 year exemption on capital gains tax for investments held over three years.
These incentives are designed at making Australia a far more attractive place to invest in start-ups and innovation. This measure is based on the UK's successful Seed Enterprise Investment Scheme, which resulted in over AU$500 million of early stage investment for almost 2,900 companies in its first two years.
The Australian Government has declared that it is now time for the 'Innovation Boom'. Through its newly released Innovation Agenda, it has pledged initiatives that are worth AU$1.1 billion over four years.
An integral part of the new initiatives is promoting investment in innovation and start-ups. This is done substantially by way of tax incentives. The concessions that will be made available for investments in start-ups through ESVCLPs and the proposed generous treatment for early stage investors will certainly promote innovation in Australia and hopefully enable entrepreneurial Australian businesses to remain in Australia instead of searching for better treatment elsewhere.
The Innovation Agenda states that "there has never been a more exciting time to be an Australian", this may or may not be the case, however, what is clear is that there has never been a more exciting time to be or invest in an Australian start-up.