Article Three: CRCs and the R&D tax incentive

Article by Ms Anne-Marie Perret, Advisor to high growth companies, Board Member & Investor

EARLY STAGE INVESTMENT TAX CREDITS & RELEVANCE TO CRCS

This article is the third of three on the factors and changes in the innovation system post the National Innovation and Science Agenda, particularly in relation to tax issues, and the impact on CRCs.  The first article focused on how to leverage the R&D tax incentive to encourage collaboration with industry.  The second article focused on the R&D tax incentive implications for CRCs spinning out IP into a corporate entity. This article focuses on the Early Stage Investor Tax Credit (ESITC), its requirements and how they may apply to encourage potential investment in early stage companies including those spun out of a CRC

Early stage investment in innovative high growth companies is by its very nature a highly risky asset class.  In order to encourage investors to take the risk of investing in early stage innovative, high growth companies, the Government has made changes to the tax system, announced in the NISA statement, to include an Early Stage Investor Tax Credit that it hopes will incentivise investment in Early Stage Innovation Companies (ESIC). By understanding the requirements of the ESTIC, CRCs may be able to leverage the incentive as a way of encouraging potential investors to invest in entities the CRC spins out it IP into.

The ESITC is available when an investor purchases new shares in a company that meets the requirements of an Early Stage Innovation Company immediately after the shares are issued.  The ESITC provides eligible investors, who satisfy the “sophisticated investor’ test, who purchase new shares in an ESIC with a:

  1. Non-refundable carry forward tax offset equal to 20% of the amount paid for the qualifying investment, capped at a maximum tax offset of $200,000 for the investor and their affiliates combined in each income year.
  2. Modified capital gains tax (CGT) treatment under which capital gains on qualifying shares that are continuously held for at least 12 month and less than 10 years may be disregarded. Note that Capital losses on shares held less than 10 years must be disregarded.

An investor that does not meet the ‘sophisticated investor’ test will only be eligible where their total investment in qualifying ESICs in an income year is $50,000 or less.

Qualifications

Like all tax incentives qualifications exist that must be considered to determine if the investment and/or the investor is eligible for the ESITC.  The CRC should not be giving tax advice to potential investors but should understand the qualifications and what the CRC must do, within its control, to facilitate an eligible investment.  The following qualifications should be considered when the CRC is framing the capital raise for the newly formed entity, if the CRC wants to ensure that the tax credit is available to eligible investors:

  • The shares purchased must be newly issued shares and must be an equity interest in the ESIC
  • The purchaser and the ESIC must not be affiliates of each other at the time the shares are issued.[1]
  • The purchaser must not hold more than 30% of the equity interests in the ESIC (including connected entities) immediately upon the issue of the new shares.
  • The share must not be acquired under an employee share scheme.

Note that the ESITC is available to both Australian resident and non-resident investors.

Early Stage Innovation Company

The incentive will be available for investments in companies that are:

  1. Early Stage, determined against criteria related to expenditure, assessable income, stock exchange listing and incorporation.
  2. Involved in innovation, determined by allowing the company to self-assess against either a principles-based test or a points-based gateway test or by receiving a determination from the Australian Tax Office.

Therefore where a CRC is spinning out IP into a corporate entity it will be useful for the CRC to assess the new entity against these rules to determine if the company can qualify as an ESIC.

How to assess:

To ensure that the new entity satisfies the test above it is important that the CRC consider the following criteria which must apply immediately after the issue of the tranche of shares to the investor:

  • Age of Entity – The entity is incorporated in Australia and registered in the Australian Business Register within the current or 2 previous income years; or has been incorporated within the current or previous 5 income years with total expenses of A$1m or less in the last 3 of those income years (including expenses of 100% subsidiaries).
  • Have incurred total expenses of A1m or less (including in 100% subsidiaries) in the income year prior to the income year in which the shares are issued.
  • Have derived a total assessable income of A$200,000 or less (including 100% subsidiaries) in the income year prior to the income year in which the shares are issued – this excludes any Accelerating Commercialisation Grants under the Entrepreneurs’ program.
  • Have no equity interests listed on any stock exchange; and
  • Pass a 100 point innovation test, or alternatively can demonstrate that the business has a high growth and scalable potential with relevant investment in the development of new or significantly improved products, processes, services or marketing or organizational methods, that would be nationally or globally marketable with competitive business advantages.

100 Point Test

Points to satisfy the 100 point test are gathered in a number of ways including:

  • Prior levels of R&D expenditure as evidenced by accessing the R&D tax incentive
  • Awarding of entrepreneur grants
  • Holding of enforceable intellectual property rights
  • Previous genuine third party investments above $50,000; and
  • Co-development agreements with research organisations or universities.

Implication for the CRC

For a CRC spinning out a new entity, as long as all the other criteria are satisfied, self-assessment against the 100 point test should be relatively straightforward given the ability of the new entity to hold the IP rights, to enter into co-development agreements with a research organisation, being the CRC and to potentially access the R&D tax incentive.

It may be desirable for the new entity to satisfy the definition of an Early Stage Investment Company as access to the tax credit may encourage a broader range of potential investment in the entity. Therefore, when spinning the new entity out of the CRC and raising capital for the new entity, the CRC should be mindful of the criteria for the ESTIC so that at least it can be considered in any structuring decisions for the new entity.

[1] An individual or company is an affiliate of another entity where, in relation to their business affairs, the individual or company acts or could reasonably be expected to act in accordance with that entity’s directions or wishes or in concert with the entity