Bill containing tax incentives to encourage new investment in Australian early stage innovation companies, and improvements to existing venture capital investment rules introduced to Parliament

The Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 (Bill) was introduced in the House of Representatives on 16 March 2016. The Bill seeks to implement some of the Government’s $1.1 billion “National Innovation and Science Agenda” announced on 7 December 2015 (see our December update), which among other measures, contains proposed tax incentives to drive the Government’s agenda to create a more innovative and entrepreneurial culture in Australia.

In summary, the Bill contains measures which will:

  • encourage new investment in Australian ‘Early Stage Innovation Companies’ (ESIC) with high growth potential by providing 20% tax offsets on investments, and relief from capital gains tax (CGT), for certain investors; and
  • improve access to the concessions provided under the Early Stage Venture Capital Limited Partnership (ESVCLP) and Venture Capital Limited Partnership (VCLP) regimes, and make the regime more attractive by providing 10% tax offset on contributions.

Interestingly, aside from public consultation as part of the 7 December announcement, the proposed measures have been introduced directly to Parliament without the typical public consultation process via exposure draft legislation. This indicates the Federal Government’s eagerness to ensure these measures are enacted before the proposed effective date of 1 July 2016.

In detail

Early Stage Investors in Innovation Companies

Investors that acquire newly issued shares (but not an Employee Share Scheme interest) in an Australian ESIC are able to qualify for:

  • a non-refundable carry-forward tax offset of 20% of the value of their investment subject to a maximum offset cap of $200,000 (non-sophisticated investors will be subject to a total annual investment limit of $50,000); and
  • deemed capital account treatment on the shares and exemption from CGT on gains realised on those shares that have been continuously held for between 1 to 10 years. However, any capital losses are also disregarded. An investor that has held the shares for greater than 10 years will receive a cost base equal to the market value of those shares on the 10 year anniversary date of acquisition.

The rules will apply to shares issued on or after the later of 1 July 2016 or Royal Assent.

Other key qualifications

Eligible investors must satisfy the following conditions:

  • an investor can be any type of entity (including a company, trust or partnership), but not a ‘widely held company’ or a wholly owned subsidiary of a widely held company;
  • the ESIC must not be an ‘affiliate’ of the investor entity (e.g. the ESIC will be an affiliate of the investor entity if it acts, or could reasonably be expected to act, in accordance with the investor entity’s directions or wishes in relation to the affairs of the business of the ESIC); and
  • the investor entity must hold no more than 30% of the equity interest in the ESIC, or any entities connected with the ESIC.

A company will qualify as an ESIC if:

  • it is incorporated in Australia;
  • it satisfies the ‘early stage’ limb which includes the following conditions:
    • it has been incorporated, or registered in the Australian Business Register, within the last 3 income years, or it was incorporated within the last 6 income years and it (and its wholly owned subsidiaries) must have incurred total expenses of $1 million or less across all of the last 3 of those income years;
    • it, and any of its wholly-owned subsidiaries has total expenses of no more than $1 million, and assessable income of no more than $200,000 in the previous income year;
    • it is not listed on any stock exchange; and
  • it satisfies the ‘principle-based’ definition of ‘innovation’ by either:
    • self-assessing their circumstances against the principle-based test;
    • applying an objective points-based assessment against a list of prescribed criteria; or
    • obtain a positive ruling from the Commissioner about whether the principle based test is satisfied.

Venture Capital Investment

  • Limited partners in ESVCLPs will be eligible for 10% non-refundable carry-forward tax offset on contributions made by the partner to the ESVCLP during an income year.
  • The tax offset will apply in respect of ESVCLP that are unconditionally registered after 7 December 2015, and to contributions made after 1 July 2016 (transitional rules may be available for contributions made prior to this date).
  • Other notable proposals to improve access to the venture capital investment regimes include:
    • increasing the maximum allowable fund size for ESVCLPs from $100m to $200m;
    • removing the requirement that an ESVCLP divest an investment in an entity once the entity’s assets exceeds $250m (however, only a partial CGT exemption will be available if the entity is not divested within 6 months after the end of the income year which the investee’s market value exceeds $250m);
    • allowing entities in which a ESVCLP, VCLP or Australian venture capital fund of funds has invested (the investee entity) to invest in other entities, provided the investee entity controls the other entity, and the other entity satisfies the ‘eligible venture capital investment’ requirement;
    • limiting compulsory auditor appointment requirements to certain public or large companies/unit trusts; and
    • allowing an Managed Investment Trust (MIT) to invest in an ESVCLP or VCLP without triggering the public trading trust provisions, provided that the MIT and its associates have no more than 30% of committed capital of the VCLP or ESVCLP, and the MIT is not a general partner.