IN BRIEF - CONCESSIONS AND TAX OFFSETS MAY BE AVAILABLE FOR ELIGIBLE BUSINESSES
As part of the increased focus in Australia on innovation through the Federal Government's National Innovation and Science Agenda, there have been a series of tax incentives which have been either introduced or modified in the last 24 months. The main incentives include concessions for venture capital entities, concessions for start-ups, and tax offsets for research and development, which are explained in this article.
CONCESSIONS FOR VENTURE CAPITAL ENTITIES
Certain limited partnerships are eligible for flow through taxation and the partners may be exempt from tax on capital and revenue gains made on the realisation of eligible venture capital investments.
The limited partnerships that qualify for the concessions are venture capital limited partnerships (VCLP), early stage venture capital limited partnerships (ESVCLP) and Australian venture capital fund of funds (AFOF). These entities are registered with Innovation and Science Australia under the Venture Capital Act 2002. The registration requirements are outlined below.
|Place of formation of limited partnership||Must be established in Australia or a foreign country in respect of which a double tax agreement is in force.||Must be established in Australia or a foreign country in respect of which a double tax agreement is in force.||Must be established in Australia.|
|Residence of general partners||All of the general partners must be residents of Australia or a foreign country in respect of which a double tax agreement is in force.||All of the general partners must be residents of Australia or a foreign country in respect of which a double tax agreement is in force.||All of the general partners must be Australian residents.|
|Minimum period of existence||At least 5 years and not more than 15 years.||At least 5 years and not more than 15 years.||At least 5 years and not more than 20 years.|
|The sum that the partner may be obliged to contribute to the limited partnership under the partnership agreement, called the committed capital||At least $10 million.||At least $10 million and not more than $200 million.
No partner's committed capital can exceed 30% of the partnership's committed capital, with some exceptions.
|Investment restrictions and requirements||Generally, all investments must be eligible venture capital
investments and all debt interests must be permitted loans.*
All activities must be related to making such investments.
|Generally, all investments must be eligible venture capital
investments and all debt interests must be permitted loans.
All activities must be related to making such investments.
All investments must be consistent with the partnership's approved investment plan which generally must focus on early stage venture capital.
|Generally, all investments must be an investment in a VCLP or
an ESVCLP and all debt interests must be permitted loans.
All activities must be related to making such investments.
*A permitted loan is broadly a loan to a company or unit trust that is repaid within six months (or such longer period allowed by Innovation and Science Australia). The company or unit trust must be an entity that can receive eligible venture capital investments and the limited partnership must hold at least a 10% equity interest in the entity.
There are a number of eligibility criteria for the tax exemptions for capital and revenue gains. Some of the criteria apply to the three forms of limited partnership while others apply to some of them only.
The common criteria include:
- the realisation event must occur in relation to an eligible venture capital investment (see below) that has been held for at least 12 months
- the limited partnership must have unconditional registration with Innovation and Science Australia at the time of the investment and realisation, and
- all registration requirements for the limited partnerships must be met at the time of realisation
The particular criteria include:
- for VCLP and AFOF, the partner claiming the exemption must be one of the following foreign resident entities:
- a tax-exempt foreign resident
- a foreign venture capital fund of funds whose committed capital in the partnership does not exceed 30% of the partnership's committed capital
- widely held foreign venture capital fund of funds, and
- a foreign resident whose committed capital in the partnership is not less than 10% of the partnership's committed capital
- for ESVCLP, if the partner claiming the exemption is a general partner, it must be a resident of Australia or a foreign country in respect of which a double tax agreement is in force, and both foreign and resident limited partners can claim the exemption
- the total value of the assets of the investment vehicle must not exceed $250 million for VCLP and AFOF and $50 million for ESVCLP
- there are additional investment requirements for ESVCLP being:
- the investment vehicle must not be listed when the limited partnership makes its first investment in the entity, and
- any investments acquired from existing investors must add to an investment already held in the entity or new securities will be issued in connection with the investment and the total of the investments in the entity do not exceed 20% of the partnership's committed capital, and
- for ESVCLP, there is only a partial exemption where the value of the assets of the investment vehicle exceeds $250 million at the end of any income year before the income year in which the gain arises if the gain arises later than six months after the end of the income year in which the value first exceeded $250 million
An eligible venture capital investment is an investment in shares, units, options or convertible notes in a company or unit trust that is at risk and does not represent more than 30% of the partnership's committed capital. The company or unit trust must:
- be located in Australia and this is satisfied if the company or unit trust is an Australian resident and has more than 50% of employees and assets located in Australia for the first 12 months of the investment
- not have a predominant activity (more than 75%) of property development or land ownership, finance, insurance, construction or acquisition of infrastructure or making passive investments, and
- not be listed on a stock exchange at the time of the investment or must cease to be listed within 12 months
A partner in an ESVCLP is able to access two further concessions:
- exemption from tax on its share of income derived from an eligible venture capital investment (for example, dividends). If the partner claiming the exemption is a general partner in the partnership, it must be either an Australian resident or a resident of a foreign country in respect of which a double tax agreement is in force, and
- partners in ESVCLP who became unconditionally registered on or after 7 December 2015 may be eligible for a 10% non-refundable carry-forward tax offset for capital invested
Investments in VCLP, ESVCLP and AFOF are complying investments for the significant investor visa.
Tax-exempt foreign residents
A tax-exempt foreign resident who is registered with Innovation and Science Australia is also entitled to the exemptions from capital and revenue gains made on the realisation of eligible venture capital investments that have been held for at least 12 months.
Non-resident tax-exempt superannuation funds
A venture capital entity is exempt from tax on capital and revenue gains arising from the realisation of venture capital equity that it has held at risk for at least 12 months. A venture capital entity is a superannuation fund that is a resident of Canada, France, Germany, Japan, UK or the USA (and not a resident of Australia) that is exempt from tax in its country of residence. The venture capital entity must be registered with Innovation and Science Australia.
Venture capital equity is a share in an Australian resident company or a fixed interest in an Australian resident trust that is acquired by the venture capital entity by issue or allotment. Just before the acquisition of the venture capital equity, the sum of the assets of the investment vehicle and its connected companies and trusts and the amount of the investment by the venture capital entity must not exceed $50 million. The exemption is not available if the primary activity of the investment vehicle is property development or land ownership.
CONCESSIONS FOR START-UPS
Tax offset and modified capital gains tax treatment
Investors in an Australian Early Stage Innovation Company (ESIC), which is broadly a company that is at an early stage of establishment whose activities are focused on the development of new or significantly improved innovations for commercialisation, are provided with a non-refundable carry-forward tax offset equal to 20% of the amount paid for the investment, subject to a cap, and a capital gains tax exemption for shares that have been held for between one and ten years.
Further information on these concessions is contained in our article New tax incentives for start-up investors.
Employee share schemes
From an employee's perspective, the usual tax treatment for employee share schemes is that any discount on acquisition of shares or rights is subject to income tax and any subsequent increase in value is subject to capital gains tax.
If the employee share scheme relates to shares or rights in a start-up company:
- the discount will not be taxed at all, and
- for capital gains tax purposes:
- shares are deemed to have been acquired for market value and the cost base of rights is equal to the cost of acquisition and sale, and
- shares acquired from the exercise of rights are deemed to be acquired when the rights are acquired - this means that the employee will be eligible for the 50% discount 12 months after the rights are acquired
The conditions which must be satisfied include:
- the securities of the company and its related companies are not listed on an approved stock exchange at the end of the income year before the shares or rights were acquired
- the company and its related companies have been in existence for less than 10 years at the end of the income year before the shares or rights were acquired
- the company has an aggregated turnover of not more than $50 million for the income year before the shares or rights were acquired
- for shares, the discount is not more than 15% of its market value, and for rights, the exercise price is greater than or equal to the market value of an ordinary share in the company at the time that the rights are acquired
- the employer is an Australian resident company
- all of the interests available for acquisition under the employee share scheme relate to ordinary shares
- the employee share scheme prohibits the disposal of shares or rights (or shares acquired as a result of exercising the rights) for at least three years or when employment ends
- immediately after acquiring the shares or rights, the employee does not hold a beneficial interest in more than 10% of the shares in the company and is not in a position to cast more than 10% of the maximum number of votes that might be cast at a general meeting of the company, and
- for shares only, at the time that the employee acquires the shares, at least 75% of the permanent employees who have completed at least three years of service and who are Australian residents are or have been, entitled to acquire shares or rights under an employee share scheme operated by the employer
TAX OFFSETS FOR RESEARCH AND DEVELOPMENT (R&D)
There are two types of tax offset available for R&D entities that carry on eligible R&D activities:
- a 43.5% refundable tax offset for R&D entities with an aggregated turnover of less than $20 million for the income year, other than R&D entities that are controlled by one or more tax exempt entities, and
- a 38.5% non-refundable carry-forward tax offset for all other R&D entities
The tax offsets are available for expenditure on R&D activities, the decline in value of assets used for conducting R&D activities, feedstock expenditure and certain other items. The tax offsets are not available for interest, expenditure that is not at risk, core technology expenditure, expenditure included in the cost of a depreciating asset (decline in value may be eligible) and expenditure incurred to acquire or construct a building.
Generally, the tax offsets are available for expenditure for an income year between $20,000 and $100 million. Expenditure in excess of $100 million qualifies for a reduced tax offset rate of 30% which is equal to the standard corporate tax rate.
R&D entity definition and eligible R&D activities
An R&D entity is a company incorporated in Australia, a company incorporated outside Australia that is an Australian tax resident, a company incorporated outside Australia that is a resident of a country with a double tax agreement with Australia and carries on R&D activities through a permanent establishment in Australia.
Eligible R&D activities are classified as either core or supporting. Core R&D activities are experimental activities whose outcome is not known or cannot be determined in advance, but can only be determined by applying a systematic progression of work that is based on established scientific principles and proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions. The activity must be conducted for the purpose of generating new knowledge (including in the form of new or improved materials, products, devices, processes or services). There are a number of exclusions from core R&D activities, including market research, sales promotion and management studies.
Supporting R&D activities are those that are directly related to core R&D activities or, for certain activities, have been undertaken for the dominant purpose of supporting core R&D activities.
Generally, only activities conducted in Australia will qualify as eligible R&D activities. However, R&D activities conducted overseas also qualify in limited circumstances where the activities cannot be undertaken in Australia.
The eligible R&D activities must be registered with AusIndustry within 10 months of the end of the income year.Carlos Gouveia
Colin Biggers & Paisley
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.