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Often overlooked by start-ups and entrepreneurs, an Early Stage Innovation Company (ESIC), is an ideal structure for businesses with intellectual property to attract investors.

The Tax Incentive

Upon meeting the eligibility requirements, an investor in an eligible ESIC may access a 20% non-refundable, carry-forward tax offset and ESIC shares held for more than 12 months and within 10 years is exempt from capital gains tax exemption upon its disposal.

For example:

Investor A is a sophisticated investor and made a $500,000 investment in Smart Co, which is an engineering company and has been endorsed by the Australian Taxation Office as an ESIC.  Investor A would have had a $50,000 tax bill in the 2018-19 financial year but because of his investment in Smart Co, would be entitled to a $100,000 carry-forward tax offset and reduce his tax to zero.  Investor A can then offset a further $50,000 from his tax in the 2019-20 financial year.

Five years later Investor A decides to sell his Smart Co shares to Investor B for a profit of $300,000.  If Smart Co continues to satisfy the ESIC requirements and continues to be endorsed by the ATO, then Investor A would not have to pay any capital gains tax.

The carry-forward tax offset is capped annually at $200,000 for sophisticated investors (e.g. those who have net assets of $2.5 million and/or gross income of at least $250,000) and $50,000 for retail investors (those who are not sophisticated investors).

Investments made through trusts, partnerships and companies can still qualify.  However, companies that are publicly listed or have more than 50 shareholders do not.

Investors cannot own more than 30 per cent of an ESIC and shares issued under employee-share schemes are also precluded.  Investors can be non-resident.

What are the benefits for Start-ups and Entrepreneurs?

With the tightening of bank lending policies because of the Hayne Royal Commission, it is becoming increasingly harder for start-ups and entrepreneurs to access needed capital to commercialise their intellectual property.

More importantly, satisfying the ATO requirements to be an ESIC, would give start-ups and entrepreneurs credibility to approach investors to invest in their company.

What are the ESIC requirements?

Generally, the ESIC conditions are:

1. The Australian company must be at an early stage. This means that it must be incorporated in Australia or registered in the Australian Business Register within the past three years.  The company and any subsidiaries must also have income of less than $200,000 and expenditure of less than $1 million in the previous income year and not listed on any stock exchange.
2. The ESIC needs to satisfy a 100 point innovation test. The test is determinative upon whether the company has a registered patent, completed or undertaken an eligible accelerator program or has qualified for research and development tax concession from the ATO etc.
3. The ATO would also assess whether the ESIC has the ability to commercialise its intellectual property, whether it has high growth potential and ability to successfully scale.

How can Macpherson Kelley help?

Macpherson Kelley’s IP lawyers can assist start-ups and entrepreneurs ensure that their intellectual property is correctly registered and protected.  Our experienced tax lawyers can also ensure that start-ups and entrepreneurs are correctly structured to realise their business’ full potential including, preparing the private ruling to the ATO for their company to be endorsed as an ESIC.

This article was written by Danh Nguyen, Special Counsel – Commercial.