Edited version of private advice

Authorisation Number: 1052286331871

Date of advice: 8 August 2024

Ruling

Subject: Early stage innovation company - investor entitlement to tax offset

Question 1

Are the taxpayers entitled to a tax offset under section 360-15 of the Income Tax Assessment Act 1997 (ITAA 1997) for the year ending 30 June YYYY?

Answer

Yes.

Question 2

Are the taxpayers eligible for a tax offset equal to 20% of the total amount paid for the shares as calculated under section 360-25?

Answer

Yes.

Question 3

Does the issuing of those shares give rise to an entitlement to modified CGT treatment pursuant to section 360-50 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June YYYY

The scheme commenced on:

DD Month YYYY

Relevant facts and circumstances

1.      Company A is an Australian private company which was incorporated in Australia on DD Month YYYY.

2.      Company A issued shares to its shareholders ('the Shareholders') on DD Month YYYY.

3.      The Shareholders have been provided with advice that that Company A has satisfied the criteria of an Early-Stage Investment Company (ESIC) for the year ending 30 June YYYY.

4.      Each of Company A's shareholder's investment in the company was less than $50,000.

5.      None of Company A's shareholder hold more than 30% of the equity interests in Company A ('the ESIC') immediately after the initial issue of its shares in Company A on DD Month YYYY that carried any of the rights under subparagraphs 360-15(1)(f)(i), (ii) or (iii).

6.      The Shareholders have submitted that they do not have any degree of influence over the business affairs of Company A individually.

7.      The shares issued to the Shareholders in Company A were not issued under an employee share scheme.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 360-A

Income Tax Assessment Act 1997 subsection 328-130

Income Tax Assessment Act 1997 section 360-15

Income Tax Assessment Act 1997 section 360-20

Income Tax Assessment Act 1997 section 360-20

Income Tax Assessment Act 1997 section 360-40

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

Question 1

Are the taxpayers entitled to a tax offset under section 360-15 of the for the year ending 30 June YYYY?

Summary

The Shareholders are entitled to a tax offset under section 360-15 of the ITAA 1997 for the year ending 30 June YYYY.

Detailed Reasoning

Division 360 - early stage investors in innovation companies

Tax incentives for early stage investors in innovation companies

1.      Division 360 outlines the criteria for an investor purchasing new shares in a qualifying ESIC to be eligible for the following tax incentives:

•         non-refundable carry forward tax offset equal to 20% of the amount paid for their qualifying investments, 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 10 years may be disregarded. Capital losses on shares held less than 10 years must be disregarded

Entitlement to the tax offset - Section 360-15

2.      Section 360-15 provides that the tax incentives are available to all types of investors, regardless of their preferred method of investment (whether an investment is made directly as a corporation or individual or indirectly through a trust or partnership) other than 'widely held companies' (as defined in section 995-1) and 100 per cent subsidiaries of these companies provided certain conditions are met and restrictions do not apply.

3.      An individual would be entitled to a tax offset under subsection 360-15(1) in an income year, where all of the following requirements were met:

•         at a particular time during the income year, a company issues you with *equity interests that are*shares in the company - paragraph 360-15(b)

•         the company is an early stage innovation company (ESIC) under section 360-40 immediately after the company issues those shares to you - paragraph 360-15(c)

•         you and the company are not affiliates at the time those shares are issued - paragraph 360-15(d)

•         the issue of those shares is not an acquisition of "ESS interests" under an employee share scheme -- paragraph 360-15(e), and

•         immediately after those shares were issued, you do not hold more than 30% of the equity interests in the company nor an entity connected with the company - paragraph 360-15(f).

Limited entitlement for certain kinds of investors - Section360-20

4.      Section 360-20 provides that you do not satisfy paragraph 360-15(1)(b) if:

•         for each offer resulting in *equity interests that are shares in the company being to you during the income year, none of subsections 708(8), (10) or (11) of the Corporations Act 2001 removed the need for a disclosure document; and

•         a total of more than $50,000 was paid for the issue to you of the shares resulting from all of those offers.

Sophisticated Investors- sections 708(8) or (10) or (11) of the Corporations Act 2001

5.      There are no restrictions on the amount an entity may invest if the entity meets the requirements of the Sophisticated Investor Test as described in section 708 of the Corporations Act 2001 (Corporations Act) in relation to a relevant offer of shares at any time in the income year. The sophisticated investor test is used for investment opportunities that have reduced disclosure requirements, on the basis that investors that meet this criteria are more likely to be able to evaluate offers of securities and other financial products without needing the protection of a disclosure document.

6.      An entity maybe a sophisticated investor if they meet one of the following requirements:

            i.        you have paid at least $500,000 for the qualifying shares (either as a single offer or including any amounts you previously have paid for shares of the same class that you hold in the same company), or

             ii.      hold a certificate issued by a qualified accountant that confirms the entity (or the controller of a company or trust) meet certain asset and income requirements, or

           iii.       you are offered the qualifying shares through a financial services licensee who is satisfied that you have previous investment experience that allows you to assess the offer and you sign a written acknowledgement that the licensee hasn't given you a disclosure document in relation to the offer, or

           iv.      you meet the requirements of being a 'professional investor' under the Corporations Act 2001 (such as a financial services licensee), or

            v.       you have or control gross assets of at least $10 million (including any assets held by an associate or a trust that you manage).

Other Investors

7.      For other (non-sophisticated) investors a total annual investment limit of $50,000 applies. These investors will not be entitled to a tax offset if their investment exceeds this maximum threshold.

Amount of the tax offset - Section 360-25

8.      Entities that acquire newly issued shares in an Australian ESIC may receive a non-refundable carry-forward tax offset of 20 per cent of the value of their investment subject to a maximum offset cap amount of $200,000 provided they satisfy certain conditions.

The investor and the ESIC must not be affiliates of each other - Section 328-130

9.      To qualify for the tax offset, the ESIC must not be an affiliate of the investor entity, nor can the investor entity be an affiliate of the ESIC at the time the relevant shares are issued. That is, the ESIC must not act, or reasonably be expected to act, in accordance with the investor's directions or wishes, or in concert with the investor, in relation to the affairs of the business of the ESIC and vice versa.

30 per cent equity interest restriction - Section 328-125

10.   To qualify for the tax offset, the investor entity must not hold more than 30 per cent of the equity interests of an ESIC, including any entities 'connected with' the ESIC, tested immediately after the time relevant equity interests are issued.

Modified CGT Treatment - Section 360-50

11.   An investor that acquires shares in a qualifying ESIC will be taken to hold these shares on capital account and the disposal of these shares would give rise to a capital gain or a capital loss as per paragraph 360-50(2).

12.   The specific CGT consequence arising for these shares depends on:

•         when the investor entity deals with the shares (and the relevant CGT event happens), and

•         whether the investor entity realises a capital gain or a capital loss from that event.

Application to your circumstances

Entitlement to the tax offset - subsections 360-15(1) and (3)

13.   As the tax incentives are available to all types of investors other than 'widely held companies' (as defined in section 995-1) and 100 per cent subsidiaries, the Shareholders would be entitled to a tax offset, provided that they all satisfy the criteria under paragraphs 360-15(1)(b) to (f) and the requirements under section 360-20.

Issued with equity interests which are shares in the company - paragraph 360-15(1)(b)

14.   The Shareholders were issued with equity interests that were shares in Company A on DD MM YYYY. Therefore, they satisfy subparagraph 360-15(1)(b).

Subsection 360-40(1) applies to the ESIC- paragraph 360-15(1)(c)

15.   The Shareholders have been provided with advice that Company A has met the criteria of an ESIC. Therefore, paragraph 360-15(1)(c) is satisfied.

The shareholders and Company A must not be affiliates of each other - paragraph 360-15(1)(d), and subsections 328-130(1) and 328-130(2).

16.   Paragraph 360-15(1)(d) requires that at the time you are issued with shares in the company, neither you nor the company is an affiliate of each other. According to the Explanatory Memorandum for this provision indicates that this is because the 'tax offset is designed to encourage new investment in ESICs rather than merely subsidising the existing investment.' It also indicates that 'a director-owner of an ESIC would be precluded from qualifying for a tax offset, as the ESIC would be an affiliate of the director-owner.'

17.   The meaning of affiliate is set out in section 328-130. Under subsection 328-130(1) an individual or company is an affiliate of an entity where that individual or company acts, or could reasonably be expected to act:

a.   in accordance with the entity's directions or wishes in relation to the affairs of that individual or company's business; or

b.   in concert with the entity in relation to the affairs of the individual or company's business.

18.   Subsection 328-130(2) states that an individual or company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

19.   The following factors may have a bearing on whether an individual or company is an affiliate of an entity to the extent that they show that 2 or more entities acting in concert:

a.   family or close personal relationships

b.   financial relationships or dependencies

c.   relationships created through links such as common directors, partners, or shareholders

d.   the degree to which the entities consult with each other on business matters, or

e.   whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity.

20.   Based on the information provided, Company A and the Shareholders are not affiliates of each other and paragraph 360-15(1)(d) is satisfied.

Employee share scheme - paragraph360-15(1)(e)

21.   The shares issued to the Shareholders were not issued under an employee share scheme. Therefore, paragraph 360-15(1)(e) is satisfied.

30 per cent equity interest restriction - paragraph 360-15(1)(f)

22.   To qualify for the tax offset, the investor entity must not hold more than 30 per cent of the equity interests of an ESIC, including any entities 'connected with' (paragraph 328-125) the ESIC, tested immediately after the time relevant equity interests are issued.

23.   None of the Shareholders hold more than 30% of the equity interests in Company A ('the ESIC') immediately after the issue of its shares that carried any of the rights under subparagraphs 360-15(1)(f)(i), (ii) or (iii).

24.   Therefore, the Shareholders satisfies paragraph 360-15(f).

Limited entitlement for certain kinds of investors - Section 360-20(1)(a) and (b)

25.   Restrictions apply to the amount and entitlement of the offset as provided in paragraphs 360(20)(1) and (b) which relate to a type of investor.

26.   Under the Corporations Act, 'sophisticated investors' who meet certain requirements don't have to be provided with a disclosure document, such as a prospectus or product disclosure statement, when being offered shares in a company. Our document entitled Tax incentives for early stage investors, available on our website ato.gov.au using quick code QC 48899, includes examples of when an entity may be a sophisticated investor. This includes an example where an entity (including a trust) has 'paid at least $500,000 for the qualifying shares (either as a single offer or including any amounts you have previously paid for the same class that you hold in the same company)'.

27.   The Shareholders have advised that their investments were less than $50,000 in the year ending 30 June YYYY, therefore the restrictions in section 360-20 will not apply.

Conclusion on subsections 360-15(1) and 360-15(3)

28.   The Shareholders are entitled to a tax offset under section 360-15 for the year ending 30 June YYYY.

Question 2

Is each of the Shareholders eligible for a tax offset equal to 20% of the total amount paid for the shares as calculated under section 360-25?

Summary

Each of the Shareholders is eligible for a tax offset equal to 20% of the total amount paid for the shares as calculated under section 360-25

Detailed Reasoning

29.   As discussed in Question 1, the Shareholders are entitled to a tax offset in under section 360-15 for the year ending 30 June YYYY.

30.   The notional tax offset amount of each shareholder's is defined to the amount calculated under section 360-25, i.e. 20% of the amount paid for the shares issued to them.

Question 3

Does the issuing of those shares give rise to an entitlement to modified CGT treatment pursuant to section 360-50 of the ITAA 1997?

Summary

Section 360-50 applies to the shares issued by Company A to the Shareholders on DD MM YYYY.

Detailed reasoning

1.      As discussed in Question 1, section 360-50 outlines the modified capital gain tax treatment of shares acquired in a qualifying ESIC.

2.      The Shareholders are entitled to a tax offset under section 360-15 of the ITAA 1997 for the shares issued by Company B on DD YY MMMM, therefore, section 360-50 applies to those shares.

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