Prime Minister Malcolm Turnbull announced on 7 December 2015 the $1.1 billion "National Innovation and Science Agenda". With a stated vision of sparking an "ideas boom", the scheme looks to promote investment in business-based research, development and innovation over the next four years.
In the announcement, the PM unveiled a combination of tax incentives and offsets, concessions to existing insolvency laws, new funding announcements and collaborative efforts centred on creating a more innovative and entrepreneurial Australia.
The key tax measures that have been announced are as follows:
- A 20% non-refundable tax offset for investors in an eligible start-up, capped at $200,000 per year;
- A 10 year capital gains tax (CGT) exemption for early stage investors who invest in an eligible start-up and hold that investment for more than three years;
- A 10% tax offset will be available for capital invested in Early Stage Venture Capital Limited Partnerships (ESVCLPs);
- The increase of the maximum fund size for new ESVCLPs from $100 million to $200 million;
- The replacement of the "same business test" for tax losses with a more relaxed "predominantly same business test";
- Changes to the options for calculating the tax effective life of intangible assets; and
- Minor reforms to Employee Share Schemes for startups.
These proposed tax changes have been warmly received by industry participants, as they address and correct a number of tax issues faced by venture capital participants and the underlying businesses in receipt of venture capital funding. However, we expect that they will pose a complication for managers in the process of seeding new investment funds, as they create a lack of tax certainty which may impact fundraising in the short to medium term. In our view, the most practical solution to this issue is for the Government to backdate the proposed changes so that they apply from the date of the announcement.
Detailed comments on tax initiatives
Tax incentives for investors
Based on the successful UK Seed Enterprise Investment Scheme, new measures have been announced that specifically encourage investment in innovative startup companies. Each of these initiatives apply to eligible companies that have incorporated in the last three income years, aren’t listed on any stock exchange, and have expenditure less than $1 million and income less than $200,000 in the previous income year (eligible startups). The new arrangements include:
- A 20% non-refundable tax offset for investors in an eligible start-up, capped at $200,000 per year.
- A 10 year CGT exemption for early stage investors who invest in an eligible start-up for more than three years.
Pursuant to the passing of the enabling legislation, these measures should commence 1 July 2016. While these changes are welcome, the delay in their commencement has the potential to leave investors and entrepreneurs in uncertain territory until the legislation is enacted, and potentially leaves investees having limited access to capital for the period up to 1 July 2016. For this reason, the Government should consider backdating the measures to the date of the announcement.
The new arrangements for ESVCLPs are aimed at relaxing eligibility requirements, allowing a broader range of investments and investors. They should take effect from 1 July 2016, pending the passing of amendments into law. The changes include:
- A new 10% tax offset available for capital invested in ESVCLPs.
- The maximum fund size for new ESVCLPs will be increased from $100 million to $200 million.
- The requirement that ESVCLPs should divest from a business when its value exceeds $250 million will be removed.
Similar to above, the Government should consider backdating the commencement of these measures to the date of the announcement in order to give investors and fund managers greater certainty for the first half of 2016.
The current tax loss utilisation test, "the same business test", will be replaced with a more flexible "predominantly similar business test" for certain businesses. Broadly, the existing test denies a company claiming a deduction for prior year losses if it has changed its business activities after a change of ownership. The new test should relax this requirement for businesses that receive new equity injections or diversify revenue streams, allowing them to access prior year losses even if they make minor changes to their operations. It is difficult to gauge the precise impact of this new test until draft legislation is released.
The new test is expected to apply to losses made in the current income and future income years, with the current tests continuing to apply to existing losses.
This is a welcome change as the existing test deals inadequately with the rapid changes in a startup’s business life and over the various investment rounds. The forfeiture of genuine tax losses as the startup starts turning cash flow positive is a major impediment to the growth of the business.
Intangible asset depreciation
Businesses will now have the option to either use the existing statutory tax effective life for acquired intangible assets or to self-assess. The option to self-assess is intended to more appropriately calculate the tax effective life of acquired trade marks, copyrights, patents and business models. This new alternative will be available for assets acquired from 1 July 2016.
Employee Share Scheme (ESS)
Although already recently subject to widespread changes for startups, further reforms have been announced to the ESS for startups. Broadly, the requirement for disclosure documents to be made publicly available will be limited, allowing non-disclosing companies to protect commercially sensitive information. The ESS will also be made more "user-friendly" for innovative companies. Legislation for these changes is expected in the first half of 2016.