24 June, 2016
What you need to know
- The Federal Government's "National Innovation and Science Agenda" announced in late 2015 introduced tax concessions for start-up companies and expanded venture capital tax concessions
- On 21 March 2016, the Federal Government released its Fintech Statement clarifying that fintech start-ups are eligible investments for the venture capital tax concession available under the National Innovation and Science Agenda
- The commitment of Australia's Federal Government to developing a vibrant fintech scene was given a further boost in this year's Federal Budget. Announced on 3 May, the budget calls on the Australian Securities and Investments Commission (ASIC) to begin consultation in June on a regulatory sandbox to fast-track development of new technologies
- In this Fintech Pulse, Ashurst summarises recent tax announcements related to fintech along with moves underway to establish an Australian regulatory sandbox
Venture capital tax concessions
One of a number of initiatives announced by the Federal Government last year as part of its "National Innovation and Science Agenda" was to introduce tax concessions for start-up companies and expand venture capital tax concessions. Part of that initiative is being implemented by the Tax Laws Amendment (Tax Incentives for Innovation) Act 2016, which makes some changes to the original announcement (see our alert on the original announcement here).
The expanded venture capital tax concessions include, broadly:
- Eligible investors (other than widely held companies and their subsidiaries) that acquire directly, or indirectly through a partnership or trust, equity interests (eg shares) issued on or after 1 July 2016 (other than employee share scheme interests) in an Australian early stage innovation company (ESIC) may receive a non- refundable carry-forward tax offset of 20% of the value of their investment subject to a maximum offset cap amount of $200,000. In addition, investors may disregard capital gains realised on equity interests in qualifying ESICs that have been held for between one and ten years. A total annual investment limit of $50,000 will apply to retail (non-sophisticated) investors and investors must not be affiliated with the company or, immediately after the equity interests are issued, hold more 30% of the equity interests in the company or an entity connected with the company.
- Amending the existing early stage venture capital limited partnership (ESVCLP) and venture capital limited partnership (VCLP) regimes (generally with effect from 1 July 2016) to improve access to capital and make the regimes more attractive to investors. Specifically, the amendments will:
- provide a new non-refundable carry-forward tax offset for limited partners in ESVCLPs, equal to up to 10 per cent of contributions made by the partner to the ESVCLP;
- increase the maximum committed capital for ESVCLPs from $100 million to $200 million;
- remove the requirement that an ESVCLP divest an investment in an entity once the value of the entity’s assets exceeds $250 million, subject to restricting tax concessions for such investments (effectively only an amount equal to the capital gain that would have been made had the investment been divested when the $250 million threshold is reached will be exempt); and
- allow investee entities in which a VCLP, ESVCLP or an Australian venture capital fund of funds
(AFOF) has invested to invest in other entities provided that the investee entity controls the other entity and the other entity broadly satisfies the requirements to an eligible venture capital investment.
Early stage innovation company
An ESIC must be at an early stage of its development and be developing new or significantly improved innovations for the purpose of commercialisation to generate an economic return.
Specifically, for a company to be an ESIC :
- it must at the time it issues the equity interests to the eligible investor be a company that was:
incorporated in Australia within the last 3 income years; or
incorporated in Australia within the last 6 income years and across the last 3 of those income years it and its 100% subsidiaries (if any) incurred total expenses of $1 million or less; or
registered in the Australian Business Register within the last 3 income years; and
- the company and its 100% subsidiaries (if any) incurred total expenses of $1 million or less in the previous income year; and
- the company and its 100% subsidiaries (if any) had a total assessable income of $200,000 or less in the income year before the current year; and
- none of the company’s equity interests are listed for quotation in the official list of any stock exchange in Australia or a foreign country; and
- the company satisfies a innovation test by:
- self-assessing its circumstances against a principle-based test which look at its potential to have competitive advantages, such as a cost or differential advantage over its competitors which are sustainable for the business; or
- seeking a ruling from the Australian Taxation Office that its circumstances satisfy the principle-based test; or
- determining that the company has at least 100 points for meeting certain objective innovation criteria.
- Venture capital LP regimes
The VCLP regime was introduced in 2002 to support investment in eligible venture capital investments. A VCLP is taxed on a 'flow-through' basis, rather than being treated as a company for tax purposes like other limited partnerships in Australia (ie. the partners are taxed rather than the limited partnership). Current tax concessions include that certain foreign partners are exempt from income tax on capital and revenue gains from disposals of investments made by VCLPs and amounts received by managing partners (known as 'carried interests') are taxed on capital account (which may allow them to access the capital gains tax (CGT) discount).
To gain access to tax concessions, a number of requirements must be satisfied, including that the VCLP must be registered under the Venture Capital Act 2002 with Innovation and Science Australia, the VCLP must have at least $10 million of committed capital from its partners and the total value of the assets of the entity in which the VCLP invests must not exceed $250 million at the time of the investment and more than 75% of the activities of the investee entity in which the VCLP invests must not relate to "ineligible activities".
The ESVCLP regime was introduced in 2007 to provide additional tax concessions for "early stage" venture capital activities by limited partnerships to address concerns that the VCLP program was not adequately targeting these types of entities.
Like VCLPs, an ESVCLP is taxed on a 'flow through' basis provided it is registered and meets relevant requirements, including limitation on ineligible activities. However, more generous tax concessions apply to ESCLPs, including that both Australian and foreign investors are exempt from income tax on income from the ESVCLP and capital and revenue gains from disposals of investments made by the ESVCLP.
As part of the Government’s Fintech Statement on 21 March 2016 it was announced that:
The Government will ensure that start-ups involved in fintech, including in insurance and finance related activities can be eligible investments for the purposes of the venture capital tax concession. This will allow access to the incentives for venture capital investment including those available under the National Innovation and Science Agenda, encouraging investment in fintech.
Federal Government response to Australia's fintech priorities
The Government is now calling for submissions on the scope of the 'eligible business' requirement and more specifically potential changes that need to be made to the Income Tax Assessment Act 1997 definition of 'ineligible activities' relevant to the definition of an eligible venture capital investment (see subsections 118-425(13) and 118-427(14), which currently excludes, relevantly, finance (to the extent that it is banking, providing capital to others, leasing, factoring are due on 3 June 2016 and can be made to VentureCapital@treasury.gov.au.
'Regulatory sandbox' for fintech businesses
The commitment of Australia's Federal Government to developing a vibrant fintech scene in Australia was given a further boost in this year's Federal Budget announced on 3 May.
The budget provides for the Australian Securities and Investments Commission (ASIC) to begin consultation in June on a regulatory sandbox. The sandbox aims to fast-track development of new technologies and will align Australia with other fintech hotspots such as the UK where the Financial Conduct Authority (FCA) has recently established its own regulatory sandbox. Fintech companies have until 8 July 2016 to apply to be part of the first cohort of UK sandbox participants. The sandbox will “enable entrepreneurs to test ideas for up to six months with a limited number of retail clients and up to prescribed investment thresholds. Certain consumer protections will be maintained”.
The precise limitations and pre-requisites of the ASIC sandbox are likely to be announced in June during the consultation period. Certain services will be restricted or exempt, a cap on retail investors is likely, and ASIC will seek public feedback on whether certain skills or competency standards should be required to participate.
For further information, please contact:
Vivian Chang, Partner, Ashurst
vivian.chang@ashurst.com
