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What are the ESIC Incentives, and is your company eligible?

August 27th, 2020   —   Charlie Ross

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*This blog has been created in partnership with Fullstack Advisory

It's another acronym worth knowing…

Just when you thought you were on-top of every startup acronym around, another one pops up in casual conversation – “ESIC Incentives.

On hearing this pesky new acronym, you will probably take the usual approach, familiar to many founders – nod and smile.

However, if you’re a startup looking to raise money, this is probably one acronym worth learning more about.

Let’s start with the simple part. ESIC stands for ‘Early Stage Innovation Company‘.

What is the ESIC Regime?

Finding investors for your startup is no easy task. In order to foster innovative companies in Australia, the Government introduced a tax incentive scheme in order to drive more investors towards ESIC startups.

These new tax incentives are aimed at early stage investors, and provide startups with a powerful tool that can be used to attract investor attention.

The core function of the ESIC tax incentive is to provide investors with a tax offset and concessional Capital Gains Tax treatment in order to encourage investors to support innovative Australian enterprises.

It’s important to note that the investor is the recipient of the tax offset and CGT exemption — not the startup itself. However, this could be considered to be just as beneficial for you, if you think you’re ready to raise capital.

How does the ESIC Incentive work?

The tax incentive functions as a 20 percent non-refundable carry-forward tax offset on their investment, which is capped at $200,000 per investor annually. Investors that make investments in eligible ESIC businesses are provided with a tax offset that reduces their yearly tax income bill. If an investor doesn’t use all of their offset in a single financial year, they are able to carry the offset forward to future years.

The second element of the ESIC incentive is a 10-year capital gains tax exemption (CGT) on any eligible investment, provided it is held for at least 12 months.

This provides investors with the opportunity to reduce the total Capital Gains Tax they pay on capital gains generated through the sale of shares purchased as an investment in an eligible ESIC startup. It’s important to note, however, that investors can therefore not write off capital losses.

The tax incentives for early stage investors are presented in detail via the Australian Taxation Office website.

Is my startup ‘ESIC Eligible’?

There are multiple factors that must be considered for ESIC eligibility, for the company, and the investor.

The eligibility requirements most important to startup founders are the ESIC qualification requirements. Importantly, investors must also invest in a startup that qualifies for ESIC status at the time the startup issues shares. If, at a later date, the startup no longer meets ESIC requirements, these changes won’t affect the investor.

There are a series of tests that are used to determine whether a startup qualifies for ESIC status.

Eligibility Tests

A startup needs to meet the requirements outlined in two important tests:

  1. the early stage test and
  2. either the 100-point innovation test or the principles-based innovation test.

The early stage test demands that a startup meets the following four requirements:

  1. The startup must have either been incorporated within Australia, or registered on the Australian Business Register within the last three years;
  2. The equity interest of the company must not be listed on any stock exchange;
  3. The startup — and any subsidiaries — have had expenses of $1 million or below in the most recent year; and
  4. The startup — and any subsidiaries — must have an assessable income of $200,000 or below in the last year.

The 100-point innovation test uses a point system. Startups can use a variety of different activities in order to gain points, and we would always recommending getting professional advice to determine eligibility for the points. Some of the activities include:

  • The startup has completed or participated in an eligible accelerator program; or
  • The startup has been granted an innovation patent or a standard patent within the last 5 years

*A full test table is available at the ATO Website

The principles-based innovation test can be used as an alternative to the 100-point innovation test and has five requirements. The startup must:

  1. focus on commercializing an innovative, new, or improved product, method, service, or process;
  2. demonstrate high growth potential;
  3. provide evidence that it is able to successfully scale the business;
  4. provide evidence that it has the potential to scale into a broader market, such as a global market; and
  5. demonstrate a competitive advantage.

In most cases, the 100-point innovation test is a more straightforward method of satisfying the requirements for ESIC eligibility, however this will depend on your company.

Fullstack Advisory have proven processes to take you through the above step-by-step, and will save you the headache in messing things up the first time!

Eligibility for investors

In order to qualify for the ESIC tax incentive, investors must meet the following requirements:

  • The investor must purchase newly-issued shares directly from the startup;
  • The investor must hold less than 30 percent of the equity interest in the startup; and
  • The investor must not be an affiliate of the ESIC startup.
It’s important to note that investors that do not satisfy the requirements outlined in the sophisticated investor test are only able to take advantage of ESIC tax incentives if their total investment does not exceed $50,000.

Get started

Being an ESIC Incentive eligible company can clearly be a great way to attract investors if you’re done with bootstrapping, and ready to raise.

Determining whether your startup qualifies for ESIC status can be a difficult process. If you’re in the process of launching a startup and are developing a funding strategy, it’s best to reach out to a professional for advice.

Fullstack is an accounting and advisory firm that provides detailed guidance to startups & innovative SMEs, streamlining the complex process of investor funding. If you are raising capital and need guidance on ESIC eligibility, reach out to Fullstack today.

If you liked this article, check out our Capital Raising Toolkit for founders or 7 things investors look for in a startup.

This blog is designed and intended to provide general information in summary form on general topics. The material may not apply to all jurisdictions. The contents do not constitute legal, financial or tax advice. The contents is not intended to be a substitute for such advice and should not be relied upon as such. If you would like to chat with a lawyer, please get in touch and we can introduce you to one of our very friendly legal partners.

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