4 January, 2016
What you need to know
- The Australian Government's National Innovation and Science Agenda (the Innovation Agenda) included some important tax proposals aimed at encouraging innovative activity in the Australian economy.
- Adoption of the proposals may increase access to company losses, increase the appeal of employee share schemes as a reward for effort by reducing public disclosure requirements and introduce new incentives for early and growth stage start-ups to encourage greater investment.
Increasing access to company losses
The Innovation Agenda includes changes that may make it easier for companies to utilise losses carried forward from previous tax years. This will be done by introducing a more flexible 'same business test', which will allow a company to raise equity and enter into new transactions or business activities without putting the value of prior losses at risk, provided the company continues to carry on a predominantly similar business by using similar assets and generating income from similar sources.
Background
There are two bases on which a company can utilise tax losses under the current law:
- a continuity of ownership test ('COT')
- a 'same business' test, which can be used if the company cannot satisfy the COT because it has experienced a change in its majority beneficial ownership (or continuity of its majority beneficial ownership cannot be established).
The same business test has existed in the tax law in one form or another for 50 years and was originally introduced as a concession to the COT to ensure that the COT did not prevent genuine attempts to take over, and rehabilitate, ailing businesses. However, in practice the same business test has been interpreted strictly. That is, a company needs to be carrying on exactly the same business. In addition, a company will automatically fail the same business test if it derives assessable income from a business that it did not previously carry on or from a transaction of a kind that it had not previously entered into in the course of its business operations. A company will also fail the same business test if it starts to carry on a new business or
enters into a new kind of transaction for a purpose of satisfying the same business test (even if that purpose is one of a number of
purposes).
The same business test has been subject to criticism, including by a Business Tax Working Group established by the previous Labor government in 2011 and chaired by the current Commissioner of Taxation, Chris Jordan. The Working Group noted in its Final Report that there was scope to improve the same business test by:.
- allowing differences in the business carried on by a company to be tolerated to the extent that they are 'consistent with a genuine attempt to rehabilitate an ailing business', and
- ensuring that the test has 'regard to the current dynamic business environment which requires businesses to change and adapt'.
The 'predominantly similar business test' proposed in the Innovation Agenda appears to address some of those concerns and make it easier for companies to raise additional equity and enter into new business ventures without jeopardising their ability to use their prior losses.
Application
The announcement does not provide detail about what 'predominantly similar' means. As with the current same business test, the application of the new test will depend on the specific facts and circumstances of the relevant company. The approach of the Australian Taxation Office in administering the new test is also likely to influence how it is relied upon.
Although the proposed change is aimed at 'small innovative companies', the announcement appears to apply to all companies. If enacted as announced, the 'predominantly similar' business test will apply to losses made in the current and future tax years. Any losses made in prior tax years will continue to be subject to the current 'same business' test.
Reforms to employee share scheme requirements
The Innovation Agenda includes proposals to:
- limit the requirement to make publicly available those documents that are required to be lodged with ASIC in respect of shares issued to employees in relation to an employee share scheme (ESS), and
- consult in order to make the disclosure requirements more user friendly.
This reform is intended to encourage small businesses and start-ups to utilise ESSs to reward their staff by:
- removing the risk of publicly releasing commercially sensitive information, and
- reducing the cost of preparing the disclosure documents.
This amendment builds on the tax concession introduced for start-ups implementing ESSs earlier this year. Broadly, this concession provided that employees would not be taxed on the discount attributable to the grant of ESS interests in eligible start-up companies under the ESS provisions but, rather, would be taxed on disposal under the CGT rules in respect of any gains or losses (with the 50% CGT discount potentially applying).
The release does not specify whether the amendment will be limited to certain categories of entity.
However, it does confirm that the amendment will operate in a broader range of circumstances than the current ASIC class orders that provide partial relief from disclosure requirements in certain circumstances.
Legislation introducing this change is expected in the first half of 2016.
Other tax reforms assisting start-ups
The Innovation Agenda also includes further tax incentives to encourage greater investment in early and growth stage start-ups.
Investors in certain start-up companies will be entitled to:
- a 20% non-refundable tax offset in relation to their investment, up to $200,000 per year, and
- a ten year exemption from capital gains tax for investments held for a minimum of three years.
To be eligible, the start-up must:
- undertake an 'eligible business'
- have been incorporated in the last three income years
- not be listed, and
- have expenditure of less than $1 million and income of less than $200,000 in the previous income year.
The scope of what will be an 'eligible business' will be determined following consultation.
The Early Stage Venture Capital Limited Partnerships (ESVCLPs) rules will also be amended by:
- providing a 10% non-refundable tax offset in relation to capital investments into new ESVCLPs
- increasing the maximum fund size for a new ESVCLP to $200 million (up from $100 million), and
- removing the requirement for ESVCLPs to divest their interests when the company's value exceeds $250 million.
The Government also proposes to relax the eligibility and investment requirements for ESVCLPs and venture capital limited partnerships. Details have not been provided, but the announcement states that the reforms will 'allow managers to undertake a broader range of investment activities and … enable a greater diversity of investors to participate'.
These amendments are expected to commence from 1 July 2016.
Conclusion
It is not yet clear whether the amendments to the company loss and ESS rules will apply more broadly than to the start-up sector.
However, these amendments would certainly be welcomed more broadly.
The full impact of the amendments will depend on the details that have not yet been determined and/or released. These details will need to be monitored by those hoping to rely on the amendments.
For further information, please contact:
Ian Kellock, Partner, Ashurst
ian.kellock@ashurst.com
