Edited version of private advice

Authorisation Number: 1051966614685

Date of advice: 29 March 2022

Ruling

Subject: Entitlement to modified CGT treatment - investors in innovation companies

Question

Does the sale of ESIC qualified shares to a related entity, (through provision of a loan) satisfy the requirements of subsection 360-50(4) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This private ruling applies for the following period:

Year ending 30 June XXXX

The scheme commences on:

1 July XXXX

Relevant facts and circumstances

Trust A is a discretionary trust.

Coy A is the trustee of Trust A.

On a certain date, Trust A acquired X number of qualifying ordinary shares (QOS) in an Early Stage Innovation Company (ESIC), Coy B.

Trust A is proposing to sell a number of shares held in the ESIC company to a related party, Trust B

The sale price will be based on the market value of the shares and formalised by way of executed share transfer form with both parties.

Trust A will provide Trust B with a loan to purchase the ESIC ordinary shares for $ XX amount.

Trust A's deed permits the provision of loans and Trust B's deed permits the ability to borrow. The loan will be supported by a formal loan agreement stipulating the rights and obligations of each entity.

Relevant legislative provisions

Income Assessment Act 1997, Division 360

Income Assessment Act 1997, Section 360-15

Income Assessment Act 1997, Subsection 360-15(1)

Income Assessment Act 1997, Subsection 360-15(2)

Income Assessment Act 1997, paragraph 960-130(1)(3)

Income Assessment Act 1997, Section 360-50

Income Assessment Act 1997, Subsection 360-50(1)

Income Assessment Act 1997, Subsection 360-50(2)

Income Assessment Act 1997, Subsection 360-50(3)

Income Assessment Act 1997, Subsection 360-50(4)

Income Assessment Act 1997, Subsection 360-50(5)

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise stated.

Question

Does the sale of ESIC qualified shares to a related entity (through provision of a loan) satisfy the requirements of subsection 360-50(4)?

Summary

Any capital gain or loss arising from the sale of shares Trust A acquired in qualifying ESIC to a related entity (through provision of a loan) will be disregarded under subsection 360-50(4).

Detailed reasoning

Tax incentives for early stage investors in innovation companies

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

(a)          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

(b)          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

Modified CGT Treatment - section 360-50

Section 360-50 states:

360-50(1)

This section applies if the issuing of a *share to an entity gives rise to an entitlement to a *tax offset under this Subdivision.

Note: This section applies to any share that gives rise to the entitlement, regardless of whether subsection 360-25(2) reduces the amount of the tax offset.

360-50(2)

The entity is taken to hold the *share on capital account.

360-50(3)

The entity must disregard any *capital loss it makes from any *CGT event happening in relation to the *share if:

(a) the entity has continuously held the share since its issue; and

(b) the CGT event happens before the tenth anniversary of the issue of the share.

360-50(4)

The entity may disregard any *capital gain it makes from any *CGT event happening in relation to the *share if:

(a) the entity has continuously held the share since its issue; and

(b) the CGT event happens on or after the first anniversary, but before the tenth anniversary, of the issue of the share.

360-50(5)

If the entity has continuously held the *share since its issue, the *first element of its *cost base and *reduced cost base becomes, on the tenth anniversary of its issue, its *market value on that anniversary.

An investor that acquires shares in a qualifying ESIC will be taken to hold these shares on capital account[1] and the disposal of these shares would give rise to a capital gain or a capital loss.

The specific CGT consequence arising for these shares depends on:

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

(b)          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 (2)

As the tax incentives are available to all types of investors other than 'widely held companies' (as defined in subsection 995-1(1)) and 100 per cent subsidiaries, Trust A will satisfy the requirements in section 360-15.

Entitlement to modified CGT Treatment

In looking at the subsections in section 360-50:

(a)          subsection 360-50(1) requires the issuing of the share to give rise to an entitlement to a tax offset under section 360-15

(b)          subsection 360-50(2) states the entity is taken to hold the shares on capital account

(c)           subsection 360-50(3) requires any capital loss made in relation to the share to be disregarded

(d)          subsection 360-50(4) says that any capital gain made from the sale of the shares may be disregarded if sold before the tenth anniversary of the issue of the share, and

(e)          subsection 360-50(5) says that if the entity has continuously held the shares since its issue , the first element of the cost base or reduced cost base becomes on its tenth anniversary its market value.

The shares were issued to Trust A on XX/XX/XXXX and Trust A is proposing to dispose of some of the shares issued before its tenth anniversary. Trust A self-assessed its eligibility to the ESIC tax offset set out in section 360-15. Therefore, any capital made from the sale of these shares may be disregarded under subsection 360-50(4).

[1] Subsection 360-50(2).