Australia: Key implications of the Innovation Statement for startups

Last Updated: 15 December 2015
Article by Darren Pereira and Eleanor Grounds

Most Read Contributor in Australia, September 2017

On 8 December 2015, the Federal Government announced the National Innovation and Science Agenda, also referred to as the 'Innovation Statement'. The Innovation Statement is targeted at startup enterprises and their investors, with the aims of encouraging investment, providing greater flexibility and better mechanisms to continue growth and development of startups. Below are five key reforms proposed by the Innovation Statement that we consider will be of interest to our clients involved in startups, including founders, employees and investors.

  1. Changes to bankruptcy laws

Under current bankruptcy laws, investors in a failed venture have to wait three years before being involved in a new business. The Innovation Statement considers that this has been a major contributor to the reluctance of early stage (angel) investors to get involved in startups. The Innovation Statement will seek to overcome this by:

  • reducing the default bankruptcy period from three years to one year;
  • introducing a "safe harbour" from personal liability in insolvent trading for directors who appoint a restructuring adviser to develop a turnaround plan for the company;
  • making 'ipso facto' clauses (which allow contracts to be terminated solely due to an insolvency event) unenforceable if a company is undertaking a restructure.

These are important changes which we consider will have significant implications for businesses and investors. A proposal paper on the implementation of these changes will be released in the first half of 2016, with legislation expected to be introduced and passed in mid-2017.

  1. Tax incentives for investors

The Innovation Statement provides for tax offsets that will be made available to encourage investors to support innovative startups:

  • investors will receive a 20 per cent non-refundable tax offset on investment to be capped at $200,000 per investor, per year; and
  • a 10 year capital gains tax exemption will also be available to investors who hold their investments for at least three years.

The incentive will be available for investments in companies that:

  • undertake an eligible business (the scope of which is to be determined);
  • were incorporated during the last three income tax years;
  • are not listed on any stock exchange; and
  • have expenditure of less than $1 million and income of less than $200,000 for the previous income tax year.

These changes are expected to commence from 1 July 2016.

  1. Changes to Venture Capital Limited Partnerships

The Innovation Statement proposes to reform Venture Capital Limited Partnerships (VCLPs) to make them more internationally competitive and attract greater levels of venture capital investment. In particular, some of the restrictions applying to Early Stage Venture Capital Limited Partnerships (ESVCLPs) will be relaxed, including:

  • partners in a new ESVCLP will receive a 10 per cent non-refundable tax offset on capital invested during the year;
  • the maximum fund size for new ESVCLPs will be increased from $100 million to $200 million; and
  • ESVCLP will no longer have to divest from a company when its value exceeds $250 million.

These new arrangements are expected to commence from 1 July 2016.

  1. Increasing access to company losses

Companies who suffer a loss are often discouraged from exploring other profit-making avenues for fear they will be denied access to valuable tax losses from the previous year. The Innovation Statement introduces more flexibility in accessing company losses, as follows:

  • currently, the "same business test" allows companies to claim a tax deduction on losses only if they are continuing with the same business model. This poses a real issue for startups who are trying to change their strategy and "pivot" their business;
  • the "same business test" will be relaxed to allow companies to access prior-year losses when they have entered into new transactions or business activities. This effectively writes off a business' previous operations as an R&D cost;
  • the "same business test" will be replaced by a more flexible "predominantly similar business test"; and
  • under the new "predominantly similar business test" companies will have access to prior-year losses where their new business model uses similar assets and generates income from similar sources as their previous business model. This will reduce the tax exposure of startups who decide to change their strategy and "pivot" their operation after learning more about the market in which they operate.

The "predominantly similar business test" will apply to losses made in the current and future income tax years.

  1. Reforms to employee share schemes

The Innovation Statement acknowledges that Employee Share Schemes (ESS) are particularly advantageous to startups as they can avoid paying high salaries in the early stages of their operations, when they are the most cash-poor. Unfortunately, current disclosure requirements discourage startups from using an ESS as it may lead to the release of commercially sensitive information into the public domain. The Innovation Statement proposes that:

  • the requirement that disclosure documents given to employees under an ESS must be made available to the public will be limited; and
  • there will be consultation with industry on ways to make ESS more user-friendly for startups.

Legislation implementing these reforms is expected to be introduced in the first half of 2016.

We will keep you updated on developments on all of these and other proposed reforms.

This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.

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Eleanor Grounds
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