Edited version of private advice

Authorisation Number: 1052313426496

Date of advice: 04 October 2024

Ruling

Subject: Tax offset

Question 1

In respect of the shares issued by Company B to the Trustee of the Trust, when determining an entitlement to the tax offset under section 360-15 of the Income Tax Assessment Act 1997 (ITAA 1997) would the Trust have been entitled to the offset under subsection 360-15(1) if it was an individual?

Answer 1

No.

This ruling applies for the following period

For the income year ended 30 June 20XX

Relevant facts and circumstances

Company B is an Australian company which was incorporated in Australia. None of Company B's equity interests are listed for quotation in the official list of any stock exchange in Australia or a foreign country.

In 20XX financial year, pursuant to a share purchase agreement, Company B acquired all of the fully paid ordinary shares held by the shareholders in Company A. In consideration, the shareholders in Company A received fully paid ordinary shares in Company B.

The Trust is one of the shareholders of Company A. In exchange for Company B acquiring the Trust's shareholding in Company A, the Trust was issued with YYYY Amount ordinary shares in Company B, which was a small percentage of shares.

The share certificate confirms that the Trust was issued with YYYY Amount ordinary shares in Company B at $XX per share. The total value of its shareholding in Company B is $XXXX, being an amount in excess of $XXXX but less than $XXXX. The shares were issued to the Trust on yyyy date.

The shares issued to the Trust in Company B were not issued under an employee share scheme.

The Trust is not a 'sophisticated investor' as it does not meet the requirements in subsections 708(8), (10) or (11) of the Corporations Act 2001 to remove the need for a disclosure document.

The Trust is a discretionary trust. The business activities of the Trust are the provision of consultancy and drafting services in relation to specialised equipment.

The Trust started contracting to Company A in 20YY. The Trust supplied Company A, IP development services.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 360-15(1)

Income Tax Assessment Act 1997 subsection 360-15(2)

Income Tax Assessment Act 1997 subsection 360-15(3)

Income Tax Assessment Act 1997 section 360-20

Corporations Act 2001 subsection 708(8)

Corporations Act 2001 subsection 708(10)

Corporations Act 2001 subsection 708(11)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997, unless otherwise specified.

Summary

The Trust is not entitled to an ESIC tax offset under subsection 360-15(1) for the shares issued by Company B, an ESIC. Its investment in Company B's shares was in excess of $XXXX and it did not meet the 'sophisticated investor' test. Consequently, neither the beneficiaries of the Trust nor the trustee of the Trust (where liable to be assessed and pay income tax) is entitled to claim an ESIC tax offset.

Detailed reasoning

Background - offset for members of a trust and trustee of a trust

Broadly, under the ESIC rules a trust is not directly entitled to claim an ESIC tax offset. However, under subsection 360-15(2) a member of a trust at the end of an income year is entitled to a tax offset for an income year if the trust would be entitled to a tax offset, under subsection 360-15 (1), for the income year if the trust was treated as an individual. A member of a trust (except a public trading trust) is a beneficiary of a trust, unit holder or object of the trust.

A trustee of a trust is also entitled to a tax offset under subsection 360-15(3) if the trustee would be entitled to a tax offset under subsection 360-15 (1) if the trustee was treated as an individual. However, for subsection 360-15(3) to apply, the trustee must be liable to be assessed (or has been assessed), and is liable to pay tax, on a share of 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.

Regardless of whether subsection 360-15(2) or subsection 360-15(3) applies we need to treat the trust as if it was an individual, and determine if the requirements of subsection 360-15(1) are met by the trust.

Subsection 360-15(1)

Relevantly, under subsection 360-15(1) an individual is entitled to the offset for an income year where each of the following conditions is satisfied:

1.            at a particular time during the income year, a company issues them with equity interests that are shares in the company (paragraph 360-15(1)(b))

Note: An investor will be precluded from satisfying this condition where the total investment in an ESIC(s) exceeds $XXXX and the investor does not meet the 'sophisticated investor test' in the Corporations Act 2001 - see the following discussion titled 'Limited entitlement to ESIC tax offset - section 360-20'

2.            the company was an ESIC immediately after that time (paragraph 360-15(1)(c));

3.            neither the individual investor nor the company is an affiliate of each other at that time (paragraph 360-15(1)(d));

4.            the issue of those shares is not an acquisition of an ESS interests under an employee share scheme (paragraph 360-15(1)(e)); and

5.            immediately after that time the individual did not hold more than 30% of the equity interests in the company or in an entity connected with the company (paragraph 360-15(1)(f)).

Limited entitlement to ESIC tax offset - section 360-20

Section 360-20 limits the entitlement to an ESIC offset for certain kinds of investors. Broadly, under this provision an investor will not satisfy the first condition in paragraph 360-15(1)(b) and thus not be entitled to the ESIC offset where both of the following conditions are met:

§     the investor does not meet the 'sophisticated investor test' as described in subsection 708(8), (10) or (11) of the Corporations Act 2001 (Corporations Act), in at least one of those share offerings; and

§     the investor's total investment in one or more ESICs exceeds $XXXX.

The Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 explains the rationale for this provision. At paragraphs 1.18 to 1.21 it states that

'whilst the tax incentives are generally available to all types of investors, investment in innovation companies is inherently risky and some protections are necessary to ensure more vulnerable investors are not over-exposed to this risk. Many investments may lose money, while others have the potential to make large gains....

There are no restrictions on the amount an entity may invest if the entity meets the requirements of the sophisticated investor test 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. In the Corporations Act 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....

Other investors (non-sophisticated investors) are limited to investing amounts of $XXXX and below in an income year. These investors will not be entitled to a tax offset if their investment exceeds this maximum threshold, even in relation to any proportion of such an investment below this threshold.'

Sophisticated investor test

Under the Corporations Act 2001 (Corporations Act) an entity will qualify as a sophisticated investor if one of the requirements for the removal of the need for a disclosure document in relation to the issue of the shares as described in subsections 708(8), (10) or (11) of the Corporations Act 2001 is satisfied. These requirements for the removal of the need for a disclosure document include where the investor:

•                     has paid at least $XXXX for the qualifying shares (either as a single offer or including any amounts previously paid for shares of the same class that the investor holds in the same company) -see subsection 708(8) of the Corporations Act;

•                     holds a certificate issued by a qualified accountant no more than 24 months before the offer is made that confirms the investor meets certain asset and income requirements, or a company or trust controlled by a person holding the certificate. In this regard, as at 19 March 2020, this certificate is available only if the investor (or controller) have gross income of at least $XXXX for each of the last two financial years or net assets (assets less liabilities) of at least $XXXX - see subsection 708(8) of the Corporations Act and Regulation 6D.2.02 of the Corporations Regulations.

•                     was offered the qualifying shares through a financial services licensee who is satisfied the investor has previous investment experience that allows them to assess the offer and the person to whom the offer is made signs a written acknowledgement that the licensee has not given them a disclosure document in relation to the offer - see subsection 708(10) of the Corporations Act;

•                     meets the requirements of being a 'professional investor' under subsection 708(11) and section 9 of the Corporations Act. Investors that are considered to be 'professional investors' include the following:

o        a financial services licensee at the time the offer is made;

o        bodies regulated by APRA (except trustees of certain funds such as a superannuation fund, pooled superannuation trust),

o        bodies registered under the Financial Corporations Act 1974;

o        certain funds, trusts and schemes regulated by the Superannuation Industry (Supervision) Act 1993

•                     has or controls gross assets of at least $XXXX (including any assets held by an associate or under a trust the investor manages) at the time the offer is made - see subsection 708(11).

Application of law in your case

In this case, as a consequence of the shareholders of Company A and Company B entering into a share purchase agreement, the Trust was issued with ordinary shares in Company B on yyyy date. These shares are equity interests.

Company B was an ESIC and the shares were not issued under an employee share scheme. On the evidence provided, the equity interest held by the Trust after yyyy date was less than 30% of the equity interests of Company B.

Therefore, the only points that need further examination is first, whether the limitation in section 360-20 imposed for investments of more than $XXXX (as discussed above) will apply and preclude the Trust from satisfying the first condition in paragraph 360-15(1)(b). The application of this limitation is a substantive issue in this case as the Trust's investment in Company B is more than $XXXX.

Second, whether the Trust is an 'affiliate' of Company B for the purposes of paragraph 360-15(d) - (third condition listed above).

Sophisticated investor test

As the Trust's investment in Company B of $XXXX exceeds the $XXXX maximum threshold for investment in an ESIC, the Trust is required to meet the requirements of the sophisticated investor test under paragraph 360-20(1)(a) in order to be eligible for the ESIC tax offset.

You have stated that the Trust is not a 'sophisticated investor' as it does not meet the requirements in subsections 708(8), (10) or (11) of the Corporations Act 2001 to remove the need for a disclosure document.

In this regard, we note that the Trust's investment in Company B is below the minimum threshold of $XXXX to qualify as sophisticated investor under subsection 708(8) of the Corporations Act 2001. Further, there is no other evidence of the Trust meeting the requirements to be treated as a 'sophisticated investor' on any other grounds in subsections 708(8), (10) or (11) of the Corporations Act 2001.

As the Trust does not qualify as a 'sophisticated investor', and its investment in Company B exceeds the $XXXX maximum threshold, the Trust does not satisfy the first condition in paragraph 360-15(1)(b). As a result, the Trust would not entitled to ESIC offset under section 360-15(1) in the 2023 income year.

Consequently, neither the trustee nor the beneficiaries of the Trust, depending on whether subsection 360-15(2) or (3) applies to the Trust, are not entitled to an ESIC tax offset for the 20XX income year in relation to the shares issued to the Trust by Company B on yyyy date.

While we can appreciate your circumstances, the Commissioner does not have any discretion under the tax law to allow a taxpayer an ESIC tax offset either in full or part that has made an investment in excess of $XXXX and is not a 'sophisticated investor' as described in the Corporations Act 2001.

[Note: As the Trust does not meet the 'sophisticated investor' test, and therefore is not entitled to an ESIC tax offset, we have not discussed the application of the condition regarding the Trust's affiliate status with Company B under paragraph 360-15(1)(d).]