They are not widely known but there are a couple of significant tax incentives available to investors who are looking to invest in new and innovative businesses writes H&R Block Director of Tax Communications Marrk Chapman.
Early stage investors
If you invest in a qualifying early stage innovation company (ESIC), you may be eligible for tax incentives for early stage investors.
This incentive is designed to promote investment in potentially high growth start-ups where there is also a high degree of risk. The theory is that the generous tax incentives will provide encouragement to invest, where otherwise investors might look at the potential risks and decide not to proceed.
The incentives provide eligible investors who purchase new shares with a:
- non-refundable carry forward tax offset equal to 20% of the value of their qualifying investments (capped at a maximum tax offset amount of $200,000)
- modified capital gains tax (CGT) treatment, under which
- capital gains made or accrued on qualifying shares that are continuously held for at least 12 months and less than 10 years are exempt from CGT
- capital losses made or accrued on shares held less than ten years are also disregarded.
An early stage investor must meet either the:
- ‘sophisticated investor’ test under the Corporations Act 2001 or,
- their total investment in ESIC must be $50,000 or less for that income year.
A sophisticated investor has:
- Gross annual income of $250,000 or more in each of the previous two years, or
- Net assets of at least $2.5 million
Under the Corporations Act 2001, ‘sophisticated investors’ don’t have to be provided with a prospectus or product disclosure statement, when being offered shares in a ESIC.
A sophisticated investor is not restricted as to the amount that they can invest in an ESIC in an income year but the tax offset is capped at a maximum amount of $200,000 for each income year.
A company will qualify as an ESIC if it meets both:
- the early stage test (ie, it has less than $200,000 in revenue and less than $1m in expenses)
- 100-point innovation test or principles-based innovation test
The investor must determine whether they are eligible for the early stage investor tax incentives, which means that the onus is on the investor to confirm that the company qualifies as an ESIC at the relevant test time. If a company is later found not to be an ESIC and the investor has already claimed the tax incentives, the investor will need to amend their claims.
Example:
Bernard, a sophisticated investor, pays $4 million for new shares in ESICs during the 2023–24 income year.
Although 20% of the total amount Barnard has paid for the ESIC shares is $800,000, his entitlement to the early stage investor tax offset is capped at $200,000 (provided the other eligibility requirements for the incentives are met).
Bernard has an income tax liability of $50,000 for the 2023-24 income year. He uses $50,000 of the early stage investor tax offset to reduce his tax payable to zero. Bernard can carry forward the remaining $150,000 in early stage investor tax offset to future income years.
The modified CGT treatment applies to all of the shares that he purchased.
Venture capital investors
Venture capital is a mechanism that finances a business at start-up and during the growth stages. The invested funds are used to develop an idea to a stage where there is commercial potential before which it can be difficult to attract normal commercial investment.
Venture capital investors typically invest in venture capital projects through intermediaries such as limited partnerships or funds of funds to diversify their portfolio of venture capital assets in the most cost-effective manner and to access specialist venture capital management.
The Early Stage Venture Capital Limited (LSE:CAPD) Partnership (ESVCLP) program is designed to increase venture capital investment in Australia by providing beneficial tax treatment to eligible local and foreign investors.
ESVCLP tax incentives and concessions include:
- Tax-Free Gains: Investors can receive tax-free gains on investments held for at least ten years.
- Income Tax Offsets: Investors in ESVCLPs may be eligible for an income tax offset equal to 10% of the value of their ESVCLP interests, up to a maximum of $200,000.
- Capital Gains Tax Discount: Investors can access a 10% CGT discount for capital gains derived from ESVCLP interests held for at least twelve months.
Talk to your tax professional to understand how these schemes can benefit you.