The ESIC Tax Incentive is an initiative by government to incentivise investment in early stage startups. ESIC can result in both tax offsets & modified CGT.
What is the ESIC Tax Incentive?
From 1 July 2016, if you invest in a qualifying early stage innovation company (ESIC), you may be eligible for tax incentives.
- The tax incentives provide eligible investors who purchase new shares in an ESIC with a:
- non-refundable carry forward tax offset of 20% for the amount paid for their qualifying investments. This is capped at a maximum tax offset amount of $200,000 for the investor and their affiliates combined in each income year.
- modified capital gains tax (CGT) treatment, under which capital gains on qualifying shares that are continuously held for at least 12 months and less than ten years may be disregarded. Capital losses on shares held less than ten years must be disregarded.
The maximum tax offset cap of $200,000 doesn’t limit the shares that qualify for the modified CGT treatment.
Investors that don’t meet the ‘sophisticated investor’ test under the Corporations Act 2001 won’t be eligible for any tax incentives if their total investment in qualifying ESICs in an income year is more than $50,000.
Qualifying for the ESIC tax incentives as an investor
To qualify for the tax incentives, investors must have purchased new shares in a company that meets the requirements of an ESIC immediately after the shares are issued. The shares must be issued on or after 1 July 2016.
If, after the company has satisfied these requirements, it ceases to be an ESIC, this won’t affect the investor’s entitlement to the early stage investor tax incentives for the shares.
- The early stage investor tax incentives aren’t available to you if:
- you didn’t purchase the shares in the ESIC directly from the company as newly issued shares
- the shares are not equity interests in the ESIC
- you are a widely held company or a wholly-owned subsidiary of a widely held company. A widely held company is either a company that is listed on an approved stock exchange or a company with more than 50 shareholders (unless certain requirements are met)
- your total investment in one or more ESICs for the income year is more than $50,000 and you didn’t meet the sophisticated investor test in relation to at least one of those share offerings
- you or the ESIC are affiliates of each other at the time the shares are issued. An individual or company is an affiliate of another entity where, in relation to their business affairs, the individual or company acts or could reasonably be expected to act in accordance with that entity’s directions or wishes or in concert with the entity
- you hold more than 30% of the equity interests in the ESIC (including any entities connected with the ESIC) immediately after you are issued with the new shares. An entity is connected with the ESIC if the entity either controls, or is controlled by, the ESIC, or both entities are controlled by the same third entity.
- you acquired the shares under an employee share scheme.
The early stage investor tax incentives are available to both Australian resident and non-resident investors.
How do I claim the ESIC tax offset?
You can claim the ESIC tax offset in your income tax return in the financial year that you obtained the shares. If you do not use all of your tax offset in that year, you can carry it forward for use in future income years.
If you are investing via trust or partnership, special rules apply so that the entitlement to the ESIC tax offset flows through to the member of the trust or partnership (or the ultimate member if there is a chain of trusts or partnerships).
If you are investing via a superannuation fund, the trustee of the fund and not the fund members, would be entitled to the tax incentives (tax offset and the modified CGT treatment).
As with other non-refundable carry-forward tax offsets, you should apply the ESIC tax offset only after applying any tax offsets that cannot be carried forward. This ensures that you do not lose the benefit of non-carried forward tax offsets. The order in which you should apply tax offsets is provided in subsection 63-10(1) of the Income Tax Assessment Act 1997.
Fullstack helps startups make a determination on their eligibility for the ESIC status and incorporates the tax break for investors in their tax situation. For a complimentary discussion about the ESIC tax concessions and how they could apply to you please reach out to our team.