This blog is about a tax offset that is not well known by most people, the Early Stage Investor Tax Offset, or ESITO for short.
This tax offset was first available from 1st July 2016 and was introduced to encourage investment in Australian Early Stage Innovation Companies.
The hope is that by offering tax incentives to investors, more investment will be made in innovation Companies who can, over the long term, reduce Australia’s reliance on the mining industry and open up new industries and income sources for Australia as a Country.
Companies involved in new innovations can often find it difficult to source funding for risky projects. They rely on investors willing to take a chance on a project, rather than banks who tend not to lend in those circumstances.
The difficulty is that, while the investors are often open to risk, they also may not see cash flows for many years, which can be a deterrent to providing capital to Early Stage Innovation Companies.
The Early Stage Investor Tax offset allows investors to receive a return on their investment (in the form of a tax offset) in the earlier years, thereby encouraging further investment in this area.
So How Does it Work?
The ESITO provides a 20% tax offset to an individual or entity who buys shares in an Early Stage Innovation Company (ESIC).
So, for example, if an investor buys $1,000,000 worth of shares in an ESIC, they can receive a $200,000 non-refundable, carry forward tax offset that they can use to reduce tax payable on their income.
How Does a Company Qualify as an Early Stage Innovation Company?
Without going into all the details, there are three main areas that a Company must satisfy to be able to offer the ESITOs to shareholders:
- Must be an Australian Company under the Corporations Act
- Must pass the ‘early stage test’ – which involves running a business within Australia which has limited income and expenses and is not listed on any stock exchange.
- Must meet either the 100 point innovation test or a principles-based innovation test. This part is about proving the Company’s business is involved in innovations, research and development.
Who can invest in an Early Stage Investment Company?
Given that these investment tend to be risky, the ATO does not want to encourage investors to invest too much if they cannot afford the potential loss.
As such there are limits on the amounts that can be invested in order to receive the offset.
Sophisticated Investors are not limited on the amount they can invest in an ESIC, but the tax offset they are entitled to is capped at $200,000 annually.
Sophisticated Investors must meet certain income, asset and/or experience criteria to be issued with a ‘Sophisticated Investor’ certificate that allows larger investments in financial products.
For investors who do not hold a Sophisticated Investor Certificate, investments in qualifying ESICs must be less than $50,000 per year (or they will not receive the tax offsets).
What happens when you sell the shares in an Early Stage Innovation Company?
The ATO has special rules for calculating capital gains and losses on shares in ESICs.
These rules further provide incentives for investors to buy shares in an ESIC and hold them for a minimum 12 months. Shares held for more than 12 months are CGT free until 10 years after the initial purchase at which time they become subject to CGT with the cost base of the shares being market value at the 10th anniversary date.
However the losses on shares in ESICs are limited and if a loss is made on the shares no tax loss will be allowed. This does make sense in that the offsets claimed during the years the shares were held provide the tax relief that the losses would otherwise have provided.
Further Information
If you would like further information on Early Stage Investor Tax Offsets and Early Stage Innovation Companies have a look at the ATO website at:
Or contact your Accountant at FAJ on 9335 5211 if we can be of assistance.
Other related blogs:
How to provide tax incentives for early stage investors
Author: Heather Cox
Email: [email protected]
