Edited version of private advice

Authorisation Number: 1052018443180

Date of advice: 16 September 2022

Ruling

Subject: Early stage innovation company

Question 1

Is the A Trust 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 members of the A Trust entitled to a tax offset under section 360-25 of the ITAA 1997 for the year ending 30 June YYYY for the shares issued to the A Trust in Company B on Date 1 and Date 2.

Answer

Yes

Question 3

Does section 360-50 of the ITAA 1997 apply to the shares issued to the A Trust by Company B on Date 1 and Date 2.

Answer

Yes

This ruling applies for the following period:

Year ending 30 June YYYY

The scheme commences on:

During the year ending 30 June YYYY

Relevant facts and circumstances

A Pty Ltd is the trustee for the A Trust.

The A Trust ('the Trust') was established by deed of trust during the year ending 30 June XXXX.

The sole director and secretary of A Pty Ltd ('the Trustee') is Individual 1, who holds the 1 ordinary share in the company that is on issue.

During the year ending 30 June ZZZZ, the Commissioner issued a private ruling to Company B, in which the Commissioner ruled that, for a 'Relevant Period', Company B met the criteria of an Early Stage Innovation Company under subsection 360-40(1) of the ITAA 1997.

On a date in the year ending 30 June XXXX a trust known as the B Capital Fund was established.

On a date in the year ending 30 June YYYY the A Trust acquired 800,000 units in the B Capital Fund at $X for each unit.

As at a date in the year ending 20XX, the A Trust owned 800,000 of a total of 4,250,100 units issued in the B Capital Fund. All units in the B Capital Fund were issued at $X for each unit.

Shortly before Date 1 the assets of the B Capital Fund were transferred to Company B and, in consideration for which, on Date 1 Company B issued ordinary shares to all of the unit holders of the B Capital Fund. Each unitholder received the same number of shares in Company B as the units that they held in the B Capital Fund. Accordingly, the number of ordinary shares issued to the A Trust in Company B was XXX ('the Exchange Transaction').

In accordance with the Exchange Transaction, on Date 1 the A Trust acquired shares in Company B when Company B issued XXX shares to A Trust.

The result of the Exchange Transaction was that, in effect, the A Trust exchanged its XXX units in the B Capital Fund, out of a total of 4,250,100 units issued in B Capital Fund, and Company B came to own all of the assets that had previously been owned by the B Capital Fund. Company B's issue of 4,250,101 ordinary shares to all the unitholders of the B Capital Fund, including the A Trust, was in exchange for the trustee of the B Capital Fund transferring the business and all of the assets of the B Capital Fund to Company B.

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

As at Date 1, immediately after the Exchange Transaction, the A Trust's shares in Company B represented X% of the ordinary shares in Company B.

On Date 2, the A Trust acquired a further XXX ordinary shares in Company B for a total of $XXX ('the Second Tranche Shares'). At the same time that Company B issued the Second Tranche Shares to the A Trust, Company B issued other ordinary shares to other investors such that at Date 2 there were XXX ordinary shares issued in Company B. Accordingly, immediately after the issue of the Second Tranche Shares, the A Trust owned XXX ordinary shares in Company B out of a total of XXX ordinary shares in Company B.

As at Date 2, immediately after the A Trust acquired the Second Tranche Shares, the A Trust's ordinary shares in Company B represented XX% of the ordinary shares in Company B.

None of the other shareholders of Company B as at Date 1 or at Date 2 were affiliates of the A Trust, or Individual 1 within the meaning of section 328-130 of the ITAA 1997 or were connected with the A Trust within the meaning of section 328-125 of the ITAA 1997.

Individual 1 did not have any active involvement in the operations of the business of Company B as at Date 1 nor afterwards. The A Trust's investment in the B Capital Fund and subsequently Company B was a passive investment.

Other than A Trust being a shareholder of Company B, there was no commercial relationship between the A Trust and Company B as at Date 1 and Date 2.

Paragraphs 708(8)(a) and 708(8)(b) of the Corporations Act removed the need for Company B to provide a disclosure statement to the A Trust in relation to the issue of the shares on Date 1 and Date 2 as the A Trust was a sophisticated investor within the meaning of subsection 708(8) of the Corporations Act for the following reasons:

1) in relation to the shares issued on Date 1, the minimum amount payable for the same shares was $XXX, above the $500,000 amount specified in paragraph 708(8)(a) of the Corporations Act: or

2) in relation to the shares issued on Date 2, the amount payable for the shares and the amount previously paid by the A Trust was above the $500,000 specified in paragraph 708(8)(b) of the Corporations Act.

Further shares were issued by Company B after Date 2 to entities other than the A Trust, the effect of which diluted the A Trust's shareholding proportion in Company B.

The trustee resolution for A trust and a notice of determination were provided to confirm that Individual 1 would be entitled to XX% of the notional tax offset.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 360-A

Income Tax Assessment Act 1997 section 360-15

Income Tax Assessment Act 1997 section 360-20

Income Tax Assessment Act 1997 section 360-25

Income Tax Assessment Act 1997 section 360-30

Income Tax Assessment Act 1997 section 360-50

Reasons for Decision

These reasons for decision accompany the Notice of private ruling for The A Trust.

This is to explain how we reached our decision. This is not part of the private ruling.

Division 360 - early stage investors in innovation companies

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:

•         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 - Section 360-15

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.

Limited entitlement for certain kinds of investors - Section360-20

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

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 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 a company or trust controlled by a person holding the certificate, 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

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

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

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.

Members of trusts or partnerships - Section 360-30

A member of a trust or partnership, being a beneficiary or unit holder of a trust, or a partner in a partnership (section 960-130) at the end of an income year is entitled to a carry-forward tax offset for that income year, provided that if the trust or partnership were an individual it would be entitled to a tax offset.

The amount of the offset is determined by the:

•         notional tax offset that is the member's share of the offset as determined by the trustee or partnership; and

•         notional tax offset amount that is the amount of the offset that would be available to the trust or partnership were it an individual.

Section 360-30 applies if a member of a trust or partnership is entitled to the tax offset for an income year under subsection 360-15(2).

Subsection 360-30(1) calculates the amount of tax offset that can be claimed by a member of a trust or partnership as the member's share of the tax offset multiplied by the amount referred to as the notional tax offset amount. The notional tax offset amount is defined to be the amount of the trust's or partnership's tax offset calculated under section 360-25 as if the entity had been an individual.

Subsection 360-30(2) provides that a member's share may be determined by the trustee or partnership as a percentage of the notional tax offset amount. Subsection 360-30(5) requires that the sum of all percentages determined in relation to all members does not exceed 100% of the amount that the trust or partnership would be entitled to if it was an individual investor.

Subsection 360-30(3) provides that if, under the terms of a trust or partnership, a member would be entitled to a fixed proportion of any capital gain if any asset were disposed of at the end of the income year, then the member's share of the tax offset must be equivalent to that fixed proportion. Consequently, a determination of any other percentage has no effect for calculating the member's share of the tax offset. Apart from this requirement in subsection 360-30(3), there are no other requirements about what share of the tax offset should be distributed to each member.

Subsection 360-30(4) requires that the trustee or partnership must give the member written notice of the determination made about their share of the tax offset. The notice must include enough information to enable the member to work out the member's share of the notional tax offset. The notice must be given to the member within 3 months of the end of the income year, or within a further time allowed by the Commissioner.

Trustee of a Trust - Section 360-15(3)

A trustee of a trust is entitled to a tax offset for an income year if:

(a)  the trustee would be entitled to a tax offset, under subsection (1), for the income year if the trustee were an individual; and

(b)  the trustee is liable to be assessed or has been assessed, and is liable to pay tax, on a share of, or all or a part of, the trust's net income under section 98, 99 or 99A of the Income Tax Assessment Act 1936 for the income year.

Modified CGT Treatment - section 360-50

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).

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

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

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 per subsection 360-50(5).

Application to your circumstances - year ending 30 June YYYY

Question 1

Is the A Trust 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?

Summary

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

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 section 995-1) and 100 per cent subsidiaries, the A Trust satisfies paragraphs 360-15(1) and (2) as it would be entitled to a tax offset if the trust were an individual, provided that it satisfies 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)

The A Trust was issued with equity interests that were shares in Company B on Date 1 and Date 2 (during a period when Company B met the criteria of an ESIC). Therefore, it satisfies subparagraph 360-15(1)(b).

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

Company B has met the criteria of an ESIC for the year ending 31 December XXXX, receiving a private ruling issued on during the year ending 30 June ZZZZ. Therefore, paragraph 360-15(1)(c) is satisfied.

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

The A Trust invested in Company B and has stated it has no influence over the business affairs of Company B.

Neither the company nor the individual is an affiliate

The meaning of affiliate is set out in section 328-130.Under subsection 360-130(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.

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.

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.

In examining the above factors, there is no evidence to suggest that Company B would act, or reasonably be expected to act, in accordance with the A Trust's directions or wishes, or in concert with the investor, in relation to the affairs of the business of Company B.

Therefore, the A Trust satisfies subsections 328-130(1) and 328-130(2), and paragraph 360-15(1)(d),

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

The shares issued to the A Trust 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)

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.

The A Trust has stated that it did not hold more than 30% of the equity interests in Company B ('the ESIC') immediately after the issue of its shares in the Company B on Date 1 and Date 2, that carried any of the rights under subparagraphs 360-15(1)(f)(i), (ii) or (iii).

Therefore, the A Trust satisfies paragraph 360-15(f).

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

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.

•         Under the Corporations Act 2001, '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) 'have paid at least $500,000 for the qualifying shares (either as a single offer or including any amounts you have previously have paid for the same class that you hold in the same company)'.

The A Trust paid $XXX (by exchanging 800,000 units, issued at $X per unit, that it held in the B Capital Fund), for 800,000 shares in Company B shortly before Date 1, and was issues with the shares on Date 1. On Date 2 the A Trust acquired a further 25,773 shares in Company B for an amount of $XXX. Consequently, the A Trust is considered to be a 'sophisticated investor' for the purposes of the Corporations Act 2001, and therefore paragraph 360-20(1)(a) does not apply.

Notwithstanding the A Trust has advised that their investment was greater than $50,000 in the year ending 30 June YYYY, they qualify as a sophisticated investor and therefore paragraph 360(20((1)(b) does not preclude them from satisfying paragraph 360-15(1)(b) due to the operation of subsection 360-20(1).

Therefore, the limitations under section 360-20 on the amount paid for shares will not apply in relation to the A Trust's issue of shares in Company B for the year ending 30 June YYYY.

Conclusion on subsections 360-15(1) and 360-15(2)

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

Question 2

Are the members of the A Trust entitled to a tax offset under section 360-25(2) of the ITAA 1997 for the year ending 30 June YYYY for the shares issued to the A Trust in Company B on Date 1 and Date 2.

Summary

The members of the A Trust are entitled to a tax offset under section 360-15(2) of the ITAA 1997 for the year ending 30 June YYYY for the shares issued to the A Trust in Company B on Date 1 and Date 2.

Members of trusts or partnerships - section 360-15-(2) and section 360-30

A member of a trust, being a beneficiary of the trust (section 960-130(3)(3)) at the end of an income year is entitled to a carry-forward tax offset for that income year, if the trust were an individual and would be entitled to a tax offset.

Subsection 360-30(1) calculates the amount of tax offset that can be claimed by a member of a trust as the member's share of the tax offset multiplied by the amount referred to as the notional tax offset amount. The notional tax offset amount is defined to be the amount of the trust's tax offset calculated under section 360-25 as if the entity had been an individual, i.e., 20% of the amount paid for the shares issued to the A Trust.

The trustee of the A Trust can determine each member's percentage of the notional tax offset amount. Subsection 360-30(5) requires that the sum of all percentages determined in relation to all members does not exceed 100% of the amount that the A Trust would be entitled to.

Subsection 360-30(3) provides that if, under the terms of a trust, a member would be entitled to a fixed proportion of any capital gain if any asset were disposed of at the end of the income year, then the member's share of the tax offset must be equivalent to that fixed proportion.

The trustee resolution for A trust and a notice of determination were provided to confirm that Individual 1 would be entitled to 100% of the notional tax offset.

Therefore, the requirements under section 360-30 in relation to the Trust have been satisfied.

Conclusion

The members of the A Trust are entitled to a tax offset under section 360-15(2) of the ITAA 1997 for the year ending 30 June YYYY for the shares issued to the A Trust in Company B on Date 1 and Date 2.

Question 3

Does section 360-50 of the ITAA 197 apply to the shares issued to the A Trust by Company B on Date 1 and Date 2.

Summary

Section 360-50 of the ITAA 1997 applies to the shares issued to A Trust by Company B on Date 1 and Date 2.

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

Investors that are entitled to the tax offset under Subdivision 360-A will also be entitled to modified CGT treatment under subsection 360-50(1) and the shares are treated as being held on capital account under paragraph 360-50(2). Therefore, as the A Trust is entitled to the tax offset under Subdivision 360-A, paragraphs 360-50(1) and (2) apply to it.

The specific CGT consequence arising for these shares will depend on when the Trust as 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

Section 360-50 of the ITAA 197 applies to the shares issued to A Trust by Company B on Date 1 and Date 2.