Edited version of private advice

Authorisation Number: 1051819717137

Date of advice: 6 July 2021

Ruling

Subject: Early stage innovation company investor

Question 1

Is Company A, entitled to modified capital gains treatment for any CGT event in relation to shares held in Company X and Company Y, prior to the tenth anniversary of the issues of the shares, under Subdivision 360-A of the Income Tax Assessment Act 1997?

Answer

Yes

Question 2

If Company A continuously holds its shareholding in each of Company X and Company Y, will the first element of the cost base and reduced cost base of those shareholdings become, on the tenth anniversary of their issue, their market value on that anniversary under subsection 360-50(5) of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following period:

Year Ending XX XX 20XX

The scheme commences on:

XX XX 20XX

Relevant facts and circumstances

1.       Company B is an Australian private company with XXX fully paid ordinary shares held by shareholders. Company B was incorporated on XX XX 20XX.

2.       Company B is the head company of a consolidated group of which Company A is a member. Company A is an Australian private company which was incorporated on XX XX 20XX. Company A has XX fully paid $xx ordinary shares on issue, both shares are owned by Company B.

3.       Company B acquired its shareholding in Company A in XX 20XX.

4.       Company B acquired its shareholding in Company A from Company C as part of a previous restructure (Previous Restructure).

5.       During and following the Previous Restructure, Company A has retained ownership of the company assets.

Shares owned in ESIC Companies

6.       In XX 20XX, Company A disposed of all its investments other than investments in two ESIC companies, namely:

•             Company X which was registered as an early stage innovation company (ESIC) under Division 360 of the Income Tax Assessment Act 1997 (ITAA 1997) during the year ended XX XX 20XX. Company A acquired shares in Company X during the year ended XX XX 20XX and continues to hold XXX ordinary shares representing less than 30% of the equity interests in the ESIC. These shares are held on capital account.

•             Company Y which was registered as an ESIC under Division 360 of the ITAA 1997 in the year ended XX XX 20XX. Company A acquired shares in Company Y during the year ended XX XX 20XX and continues to hold XXX ordinary shares representing less than 30% of the equity interests in the ESIC. These shares are held on capital account.

7.       Company A has stated that neither it, nor its beneficiaries are affiliates of Company X or Company Y or their directors.

8.       Company A has stated that they are not excluded under section 350-20 of the ITAA 1997.

9.       The shares were not issued under an employee share scheme.

10.    Company X and Company Y have provided Company A with relevant information including confirmation that they meet the criteria of the ESIC tests under subsection 360-40(1) of the ITAA 1997 for the year ending XX XX 20XX and XX XX 20XX respectively.

11.    The shares were issued at the time Company A was part of the Company C consolidated group. The head company of the group claimed Early Stage Investor offsets in the consolidated group tax returns consistent with the Single Entity Rule.

Information provided

12.    You have provided information in a number of documents in relation to your application.

13.    We have referred to the relevant information within these documents in applying the relevant tests to your circumstances.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 360-A

Reasons for decision

Question 1

Summary

Company A is seeking a ruling to determine its eligibility to the modified CGT treatment described under subdivision 360-A of the ITAA 1997 for the year ending XX XX 20XX.

Company X and Company Y have provided Company A with relevant information including confirmation that they meet the criteria of the Early Stage Innovation Company tests under subsection 360-40(1) of the ITAA 1997 for the year ending XX XX 20XX and XX XX 20XX respectively.

The following reasoning applies to Company A's circumstances for the year ending XX XX 20XX and any year while Company A holds the shares.

Detailed reasoning

Tax incentives for early stage investors in innovation companies

14.    Division 360 of the ITAA 1997 outlines the criteria for an investor purchasing new shares in a qualifying ESIC to be eligible to 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

•             investors that are entitled to the tax offset will also be entitled to modified CGT treatment. 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.

Entitlement to the tax offset - Section 360-15

15.    Section 360-15 of the ITAA 1997 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.

Limited entitlement for certain kinds of investors - Section 360-20

16.    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.

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

17.    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.

18.    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.

19.    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 you 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 that you manage).

Other Investors

20.    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.

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

21.    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.

22.    The meaning of affiliate is set out in section 328-130 of the ITAA 1997. 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.

23.    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.

24.    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 two 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.

30 per cent equity interest restriction - Section 328-125

25.    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

26.    Section 360-50 of the ITAA 1997 applies if the issuing of a share to an entity gives rise to an entitlement to a tax offset under Subdivision 360-A.

27.    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).

28.    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

Shares held for more than 12 months and less than ten years

29.    An investor that has continuously held a qualifying share for between 12 months and less than ten years may disregard a capital gain arising from the share however it must disregard any capital loss as persubsections 360-50(3) and (4).

Shares held for 10 years or more

30.    An investor that has continuously held a qualifying share for at least ten years will receive a market value, as determined on the ten-year anniversary date, as the first element of the cost base and reduced cost base of the share. This ensures that any incremental gains (or losses) in value after 10 years will be taxable as persubsection 360-50(5).

Application to your circumstances

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

31.    As the tax incentives are available to all types of investors other than a trust or partnership, 'widely held companies' (as defined in section 995-1 of the ITAA 1997) and 100 per cent subsidiaries, Company A is the relevant entity and satisfies paragraphs 360-15(1) of the ITAA 1997.

The investor and the ESIC must not be affiliates of each other - Sections 328-130(1), and 328-130(2), 360-15(1), (2) and (3).

Company X

32.    Company X met the criteria of an ESIC in the year ending XX XX 20XX. Company A acquired shares in Company X during the year ended XX XX 20XX and continues to hold XXX ordinary shares. Company A has stated there is no affiliation between Company X and Company A.

33.    There is no indication that Company X would act, or would 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. Therefore, Company A satisfies paragraphs 328-130(1), 328-130(2) and 360-15(1), (2) and (3) of the ITAA 1997.

Company Y

34.    Company Y met the criteria of an ESIC in the year ending XX XX 20XX. Company A acquired shares in Company Y during the year ended XX XX 20XX and continues to hold XXX ordinary shares. Company A has stated there is no affiliation between Company Y and Company A.

35.    There is no indication that Company Y would act, or would 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. Therefore, Company A satisfies paragraphs 328-130(1), 328-130(2) and 360-15(1), (2) and (3) of the ITAA 1997.

Employee Share Scheme - 360-15(1)(e)

Company X

36.    The share issue by Company X is not issued under an employee share scheme and therefore the paragraph 360-15(1)(e) of the ITAA 1997 is satisfied.

Company Y

37.    The share issue by Company Y is not issued under an employee share scheme and therefore the paragraph 360-15(1)(e) of the ITAA 1997 is satisfied.

30 per cent equity interest restriction - Section 360-15(1)(f) and (2) and 328-125

38.    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 of the ITAA 1997) the ESIC, tested immediately after the time relevant equity interests are issued.

Company X

39.    Company A acquired shares in Company X during the year ended XX XX 20XX and continues to hold XXX ordinary shares representing less than 30% of the equity interests in the ESIC, tested immediately after the time relevant equity interests are issued.

40.    Company A has stated that they will not hold greater than 30% of the ordinary equity in Company X and there is no evidence to indicate they hold or will hold more than 30% of the equity interests in Company X (or with another entity if the ESIC controls the other entity (or vice versa) or both are controlled by the same third entity). Therefore, Company A will satisfy paragraph 360-15(1)(f) and subsection 360-15(2).

Company Y

41.    Company A acquired shares in Company Y during the year ended XX XX 20XX and continues to hold XXX ordinary shares representing less than 30% of the equity interests in the ESIC, tested immediately after the time relevant equity interests are issued.

42.    Company A has stated that they will not hold greater than 30% of the ordinary equity in Company Y and there is no evidence to indicate they hold or will hold more than 30% of the equity interests in Company Y (or with another entity if the ESIC controls the other entity (or vice versa) or both are controlled by the same third entity). Therefore, Company A will satisfy paragraph 360-15(1)(f) and subsection 360-15(2) of the ITAA 1997.

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

43.    Restrictions apply to the amount of and entitlement to the offset as provided in paragraphs 360(20)(1) and (b) of the ITAA 1997 which relate to a type of investor.

44.    Company A has submitted that they are not excluded under section 350-20 of the ITAA 1997 in relation the shares held in Company X or Company Y.

Entitlement to modified CGT Treatment - section 360-50(1) and (2)

45.    360-50(1) of the ITAA 1997 applies to shares that give rise to an entitlement to the offset and the shares are treated as being held on capital account as per paragraph 360-50(2) of the ITAA 1997.

46.    When shares were issued to Company A it was a member of a consolidated group and the head company of the group claimed Early Stage Investor offsets consistent with the Single Entity Rule. Subsection 360-50(1) does not require that Company A is the entity that claims an offset.

47.    As the shares gave rise to an entitlement to the offset and Company A holds the shares on capital account, subsections 360-50(1) and (2) are satisfied.

48.    The specific CGT consequence arising for these shares will depend 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 as described in paragraphs 360-50(3)(a) and (b),360-50(4)(a) and(b) and 360-50(5).

Conclusion

49.    The investor, Company A has demonstrated that they satisfy the requirements under Subdivision 360-A of the ITAA 1997 for the shares held in Company X and Company Y and are entitled to modified capital gains treatment for shares issued by the qualifying ESICs for the year ending XX XX 20XX and any year while Company A holds the shares.

Question 2

Summary

If the investor, Company A continuously holds its shareholding in each of Company X and Company Y, for at least ten years they will receive a market value, as determined on the ten-year anniversary date, as the first element of the cost base and reduced cost base of the shares under subsection 360-50(5) of the ITAA 1997.

Modified CGT Treatment - section 360-50

50.    Section 360-50 of the ITAA 1997 applies if the issuing of a share to an entity gives rise to an entitlement to a tax offset under Subdivision 360-A.

51.    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).

52.    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.

Shares held for more than 12 months and less than ten years

53.    An investor that has continuously held a qualifying share for between 12 months and less than ten years may disregard a capital gain arising from the share however it must disregard any capital loss as per subsections 360-50(3) and (4).

Shares held for 10 years or more

54.    If an investor that has continuously held a qualifying share since its issue, for at least ten years, the market value, as determined on the ten-year anniversary date, becomes the first element of the cost base and reduced cost base of the share. This ensures that any incremental gains (or losses) in value after 10 years will be taxable as per subsection 360-50(5).

Application to your circumstances

Tax incentives for early stage investors in innovation companies

55.    The investor, Company A has demonstrated that they satisfy the requirements under Subdivision 360-A for the shares held in Company X and Company Y. They are consequently entitled to modified capital gains treatment under subsection 360-50.

Entitlement to modified CGT Treatment

56.    360-50(1) of the ITAA 1997 applies to shares that give rise to an entitlement to the offset and the shares are treated as being held on capital account as per paragraph 360-50(2) of the ITAA 1997.

57.    When shares were issued to Company A it was a member of a consolidated group and the head company of the group claimed Early Stage Investor offsets consistent with the Single Entity Rule. Subsection 360-50(1) does not require that Company A is the entity that claims an offset.

58.    As the shares gave rise to an entitlement to the offset and Company A holds the shares on capital account, subsections 360-50(1) and (2) are satisfied.

59.    The specific CGT consequence arising for these shares will depend 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 as described in paragraphs 360-50(3)(a) and (b),360-50(4)(a) and(b) and 360-50(5) of the ITAA 1997.

60.    If Company A continuously holds its qualifying shares in Company X and Company Y for at least ten years, their market value, as determined on the ten-year anniversary date, will become the first element of the cost base and reduced cost base of the share as per subsection 360-50(5).

Conclusion

61.    The investor, Company A has demonstrated that they satisfy the requirements under Subdivision 360-A for the shares held in Company X and Company Y. Company A are consequently entitled to modified capital gains treatment under Section 360-50. Therefore, if Company A continuously holds its shareholding in each of Company X and Company Y, for at least ten years, their market value, as determined on the ten-year anniversary date, will become the first element of the cost base and reduced cost base of the shares under subsection 360-50(5).