Edited version of private advice

Authorisation Number: 1051966723343

Date of advice: 29 March 2022

Ruling

Subject: Early Stage Innovation Company - Tax offset and modified CGT treatment

Question 1

Is Company X entitled to a tax offset under section 360-15 of the Income Tax Assessment Act (ITAA 1997) for the year ended 30 June 20xx?

Answer

Yes

Question 2

Is Company X entitled to a tax offset in accordance with section 360-25 of the ITAA 1997 for the year ended 30 June 20xx for the shares Company X acquired in Company Y on Date X and Date Y?

Answer

Yes

Question 3

Does section 360-50 of the ITAA 1997 modified CGT treatment apply to the shares issued to Company X by Company Y?

Answer

Yes

This ruling applies for the following periods:

Income year ended 30 June 20xx

Income year ended 30 June 20xx

The scheme commences on:

DD MM 2019

Relevant facts and circumstances

The Commissioner issued a private binding ruling to Company Y in the 20xx income year, in which the Commissioner ruled that, for the period commencing and ending on dates within the 20xx income year, Company Y met the criteria of an Early Stage Innovation Company under subsection 360-40(1) of the ITAA 1997.

On a date with in the 20xx income year, Trust A was established.

On a date within the 20xx income year, Company X acquired a number of units in Trust A for $1 per unit.

On a date within the 20xx income year, Company X acquired a further number of units in Trust A for $1 per unit.

At a point in time within the 20xx income year, the assets of Trust A were transferred to Company Y and, in consideration for which, on Date X Company Y issued ordinary shares to all of the unitholders of Trust A. Each unitholder received the same number of shares in Company Y as the units they held in Trust A.

As at Date X, Company X's shares in Company Y represented X% of the ordinary shares in Company Y, which was less than 30%.

Trust A was vested and wound up shortly after all the assets of Trust A were transferred to Company Y. Upon the vesting of Trust A and the transfer of all of its assets, Trust A ceased to exist and the interest of Company X in Trust A (as represented by its units) came to an end.

On Date Y, Company X acquired further shares in Company Y for a specified amount. At the same time that Company Y issued the shares to Company X, Company Y also issued new ordinary shares to other investors.

As at Date Y, immediately after Company X acquired the shares, Company X's total ordinary shares in Company Y represented Y% of the ordinary shares in Company Y, which was lower than 30%.

None of the other shareholders of Company Y as at Date X or Date Y were affiliates of Company X, the directors of Company X or the shareholders of Company X within the meaning of section 328-130 of the ITAA 1997 and none were connected with Company X within the meaning of section 328-125 of the ITAA 1997.

None of the directors or shareholders of Company X were either affiliates of Company Y or the directors of Company Y within the meaning of section 328-130 of the ITAA 1997 and none were connected with Company Y or the directors of Company Y within the meaning of section 328-125 of the ITAA 1997.

Neither the Company X directors nor the Company X shareholders had any active involvement in the operations or the business of Company Y as at Date X, Date Y or afterwards. Company X's investment in Trust A and subsequently Company Y was a passive investment.

Other than Company X being a shareholder of Company Y, there was no commercial relationship between Company X and Company Y as at Date X or Date Y.

Company X holds a sophisticated investor certificate dated on a date within the 20xx income year, compliant with paragraph 708(8)(c) of the Corporations Act 2001.

Relevant legislative provisions

section 360-15 of the Income Tax Assessment Act 1997

section 360-20 of the Income Tax Assessment Act 1997

section 360-25 of the Income Tax Assessment Act 1997

section 360-50 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Summary

Company X is entitled to a tax offset under section 360-15 of the ITAA 1997 for the year ended 30 June 20xx.

Detailed reasoning

Division 360 of the ITAA 1997 outlines the criteria for an investor purchasing new shares in a qualifying Early Stage Innovation Company (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

•                    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

You have asked if Company X is entitled to a tax offset under section 360-15 of the ITAA 1997 for the year ended 30 June 20xx.

Subsection 360-15(1) of the ITAA 1997 provides the requirements of the entitlement to the tax offset as the following:

(1) You are entitled to a tax offset for an income year if:

(a)  you are none of the following:

(i)    a trust or a partnership;

(ia) an ESVCLP;

(ii)   a widely held company or a 100% subsidiary of a widely held company; and

(b)  at a particular time during the income year, a company issues you with equity interest that are shares in the company; and

(c)   subsection 360-40(1) (about early stage innovation companies) applies to the company immediately after that time; and

(d)  neither you nor the company is an affiliate of each other at that time; and

(e)  the issue of those shares is not an acquisition of ESS interests under an employee share scheme; and

(f)    immediately after the issue of those shares, you do not hold equity interests in the company, or in an entity connected with the company, that carry the right to:

(i)    receive more than 30% of any distribution of income by the company or the entity; or

(ii)   receive more than 30 % of any distribution of capital by the company or the entity; or

(iii)  exercise, or control the exercise of, more than 30 % of the total voting power in the company or the entity.

Limited entitlement for certain kinds of investors

Section 360-20 of the ITAA 1997 provides limited entitlement for certain kinds of investors. It provides:

(1) You do not satisfy paragraph 360-15(1)(b) if:

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

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

(2) For the purposes of this section, assume that Chapter 6D of the Corporations Act 2001 applies to those offers.

Sophisticated Investors

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.

An entity is a sophisticated investor if they meet one of the following requirements:

1. 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
2. hold a certificate issued by a qualified accountant that confirms you meet certain asset and income requirements, or a company or trust controlled by a person holding the certificate, or
3. you are offered the qualifying share 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
4. you meet the requirements of being a 'professional investor' under the Corporations Act (such as a financial services licensee), or
5. you have or control gross assets of at least $10 million (including any assets held by an associate or that you manage).

Application to your circumstances

Company X is not a trust, partner, ESCVLP or a widely held company. Company X acquired the shares in Company Y beneficially.

Company X was issued with ordinary shares in Company Y on Date X and Date Y and the shares, being ordinary shares in Company Y, were equity interests.

Immediately after the shares were issued to Company X, subsection 360-40(1) of the ITAA 1997 applied to Company Y as at Date X and Date Y as confirmed in the Company Y Private Binding Ruling. Company Y Private Binding Ruling confirms that subsection 360-40(1) applies to Company Y for the whole of the relevant period, which includes Date X and Date Y.

As at Date X and Date Y, none of the other shareholders of Company Y were affiliates of Company X, the directors of Company X or the shareholders of Company X within the meaning of section 328-130 of the ITAA 1997 and none were connected with Company X within the meaning of section 328-125 of the ITAA 1997.

As at Date X and Date Y, none of the directors or shareholders of Company X were either affiliates of Company Y or the directors of Company Y within the meaning of section 328-130 of the ITAA 1997 and none were connected with Company Y or the directors of Company Y within the meaning of section 328-125 of the ITAA 1997.

The shares issued on Date X and Date Y to Company X were not acquired by Company X under an employee share scheme.

For the shares Company X acquired in Company Y on Date X, immediately after the issue of the ordinary shares, Company X held equity interests that carried the right to receive X% of any distribution of income by Company Y, receive X% of any distribution of capital by Company Y, or exercise, or control the exercise of, X% of the total voting power in Company Y. X% is below the 30% threshold.

For the shares Company X acquired in Company Y on Date Y, immediately after the issue of the ordinary shares, Company X held equity interests that carried the right to receive Y% of any distribution of income by Company Y, receive Y% of any distribution of capital by Company Y, or exercise, or control the exercise of, Y% of the total voting power in Company Y. Y% is below the 30% threshold.

All the requirements provided under subsection 360-15(1) of the ITAA 1997 have been satisfied for Company X to be entitled to a tax offset under section 360-15 of the ITAA 1997 for the year ended 30 June 20xx.

An entity is a sophisticated investor if they hold a certificate issued by a qualified accountant that confirms you meet certain asset and income requirements, or a company or trust controlled by a person holding the certificate. Company X holds a sophisticated investor certificate dated within the relevant period, compliant with paragraph 708(8)(c) of the Corporations Act.

Section 360-20 of the ITAA 1997 does not deem the requirement in paragraph 360-15(1)(b) to not be satisfied as section 708(8) of the Corporations Act removed the need for Company Y to provide a disclosure document for the shares issued to Company X.

Conclusion

Company X is entitled to a tax offset under section 360-15 of the ITAA 1997 for the shares Company X acquired in Company Y on Date X and Date Y in the year ended 30 June 20xx.

Question 2

Summary

Company X is entitled to tax offset in accordance with section 360-25 of the ITAA 1997 for the year ended 30 June 20xx for the shares Company X acquired in Company Y on Date X and Date Y for an amount equal to 20% of the sum of any money and non-cash benefits received by Company Y in return for the issue of the shares to Company X. This amount will be reduced to the extent necessary to ensure it does not exceed $200,000 for the income year.

Detailed reasoning

Subsection 360-25(1) of the ITAA 1997 outlines that the amount of tax offset is 20 per cent of the sum of any money and non-cash benefits received or entitled to be received by the company in return for the issue to the shareholder of the shares. Subsection 360-25(1) states:

(1) If subsection 360-15(1) applies, the amount of your tax offset is 20% of the sum of the following:

(a)  an amount equal to any money received, or entitled to be received, by the company referred to in paragraph 360-15(1)(b) for the issue to you of the shares as described in that paragraph;

(b)  an amount equal to the market value of any non-cash benefit received, or entitled to be received, by the company referred to in paragraph 360-15(1)(b) for the issue to you of the shares as described in that paragraph, as at the time the shares were issued to you.

(2) However, reduce this amount to the extent necessary to ensure that the sum of the following does not exceed $200,000:

(a) the sum of the tax offsets under this Subdivision for the income year for which you and your affiliates (if any) are entitled;

(b) the sum of the tax offsets under this Subdivision that you and your affiliates (if any) carry forward to the income year.

Application to your circumstances

At a point in time within the 20xx income year, the assets of Trust A were transferred to Company Y and, in consideration for which, on Date X Company Y issued ordinary shares to all of the unitholders of Trust A. Each unitholder received the same number of shares in Company Y as the units they held in Trust A.

Trust A was vested and wound up shortly after all the assets of Trust A were transferred to Company Y. Upon the vesting of Trust A and the transfer of all of its assets, Trust A ceased to exist and the interest of Company X in Trust A (as represented by its units) came to an end.

On Date Y, Company X acquired further shares in Company Y for a specified amount.

As explained in question 1 of this ruling, paragraph 360-15(1)(b) applies to the Company Y shares acquired by Company X on Date X and Date Y.

For the shares acquired on Date X, paragraph 360-25(1)(b) applies. The non-cash benefit received by Company Y for the issue of the shares would be the assets of Trust A. The tax offset amount for Company X will be 20% of the sum of the amount equal to the market value of non-cash benefit received by Company Y to issue the shares.

It than becomes relevant to ask what Company Y has received for the issue of the shares. The company is part of a larger arrangement in which it has received a transfer of the capital of Trust A. After Company X's interest in the Trust A, as represented by its units, came to an end, Company Y has issued corresponding shares to you.

In this sense Company Y has received X% of the trust fund capital (your share of the trust fund capital) for the issue of the ordinary shares in Company Y to you (X% of Company Y's shares).

You should keep records of how you have calculated the market value of the shares at the time they issued. While we note that Company Y has not received the units itself for the issue of the shares; the value of the units may correspond to the value of the shares if the capital that is transferred to the company is its only capital spread in the same proportion across the same investors.

The tax offset amount for Company X will be 20% of the sum of the amount equal to the market value of non-cash benefit received by Company Y for the shares issued.

For the shares acquired on Date Y, paragraph 360-25(1)(a) applies. The tax offset amount for Company X will be 20% of the specified amount paid to acquire the shares of Company Y.

Conclusion

For the shares acquired on Date X, paragraph 360-25(1)(b) applies and the tax offset amount equals 20% of the market value of non-cash benefit received by Company Y for the issue of shares.

For the shares acquired on Date Y, paragraph 360-25(1)(a) applies and the tax offset amount equals 20% of the amount of money received by Company Y for the issue of the shares.

The total tax offset of the Date X amount and the Date Y amount is capped at $200,000 for the income year.

Question 3

Summary

As Company X is entitled to a tax offset under section 360-15 of the ITAA 1997 for the shares issued by Company Y on Date X and Date Y, modified Capital Gains Tax treatment applies to those shares under section 360-50 of the ITAA 1997.

Detailed reasoning

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 subsection 360-50(2) of the ITAA 1997.

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.

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) of the ITAA 1997

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) of the ITAA 1997.

Application to your circumstances

Investors that are entitled to the tax offset will also be entitled to modified CGT treatment under paragraph 360-50(1) ITAA 1997 and the shares are treated as being held on capital account as per paragraph 360-50(2) ITAA 1997. As Company X is entitled to the tax offset, it satisfies paragraph 360-50(1) and (2) of the ITAA 1997.

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.

Conclusion

Company X is entitled to a tax offset under section 360-15 of the ITAA 1997 for the shares issued by Company Y on Date X and Date Y and therefore, modified Capital Gains Tax treatment applies to those Company Y shares under section 360-50 of the ITAA 1997.