A celebration is seemingly in order, as the Early Stage Innovation Company (ESIC) tax incentives are turning one! It is a significant milestone for the progressive legislation and an even more significant one for those savvy investors and start-ups that have taken advantage of the lucrative tax benefits it has to offer.
The legislation’s first birthday means it is the first year eligible investors will be able to claim tax offsets for investments into eligible innovative start-up companies upon lodgement of their 2016/17 income tax return.
ESIC eligible investors who have invested in ESIC eligible companies during the 2016/17 financial year are now entitled to claim an upfront 20 percent, non-refundable tax offset on their investments (capped at $200,000 per investor, per year). It is also worth noting that, as well as the upfront tax offset, investors are also eligible for a 10-year capital gains tax exemption for investments held for 12-months or more.
However, despite the generous tax breaks on offer, it appears that many companies are yet to pursue eligibility. This may be due to many companies not fully comprehending the Government’s ESIC tax incentives and the associated eligibility criteria.
So how do I qualify as an ESIC?
In the first instance to qualify as an ESIC your organisation will need to satisfy the ‘early stage’ requirements. Broadly, being an unlisted company, less than 3 years old, with expenses of less than $1 million and assessable income of less than $200,000 in their last financial year will mean that you satisfy the first stage of the eligibility criteria.
Most start-ups have no issues meeting the early stage requirements. However, where it gets a little trickier is determining if your business is ‘engaged in innovation’.
This is established via either a principles-based test or a points-based test under self-assessment. The principles-based test is used to measure the following innovation factors relating to the business:
- Does your business genuinely focus on developing improved innovations for commercialisation?
- Does it have the potential for high growth?
- Is it scalable?
- Can it address a broader than local market?
- Does it have a competitive advantage?
As an alternative to satisfying this principles-based test, the legislation also introduces a ‘100 point innovation test’ whereby the company accumulates points according to a table of objective innovation criteria.
In addition, companies who don’t wish to self-assess their innovation factors against these two tests may seek a ruling from the ATO as to whether they can satisfy the innovation requirements.
Tips for success
To be successful in achieving ESIC status, companies need to have a good understanding of their business model and how that model differs from that of their competitors. It is also important companies have a clear plan on how they intend to scale the business. It is helpful for the business to understand these things under any circumstances, but being able to clearly articulate their unique point of difference will go a long way in securing ESIC status.
Those companies that are thinking about applying for ESIC eligibility must remember that it is, to a large degree, assessed relative to the prior year’s financial metrics. Therefore, with the end of the financial year now passed it is paramount that potentially ESIC eligible companies have their company and reporting structures ready as soon as possible in order to be ESIC eligible for investment in 2017/18.
It is also important for investors in ESIC eligible companies to realise that, in order for them to claim their investment in the 16/17 Financial Year, their shares must have been issued before 30 June 2017. For those investors who are considering investing in an ESIC eligible start-up in the 17/18 Financial Year it is important that they start thinking about putting the right investment structures in place now to facilitate a smooth transaction.
Need help?
If you are unsure if you company will meet the ESIC eligibility criteria, or you would like more information on how to prepare your organisation as to ensure future eligibility, it is worth reaching out to a tax professional, well versed in dealing with the legislation.
BDO have helped numerous organisations navigate the ESIC legislation, as well as being one of only a handful of firms to have successfully applied for a private ruling from the ATO. If your company needs guidance, or would like more information about any of the above points, please feel free to contact us.
