Thinking | 9 April 2019
Early stage innovation tax incentives for sports technology and esports
Sports technology and esports are innovative and rapidly growing industries that have spawned many new business ventures, the investors in which may be eligible for certain tax concessions under the Federal Government’s early stage innovation company (ESIC) scheme.
Hall & Wilcox has successfully helped clients obtain private rulings from the Australian Taxation Office (ATO) in relation to the ESIC status of companies that are involved in these areas.
The ESIC tax incentives
Tax incentives available to investors who invest in early-stage innovation companies (sometimes referred to as ‘angel investors’) align with the Government’s policy of encouraging innovation and assisting with the acceleration of start-ups. ESIC incentives provide a tax offset that operates as a credit against other tax payable by an investor, as well as capital gains tax concessions which, in some cases, can make capital gains tax-free.
The ESIC tax incentives are subject to strict qualification criteria. If these criteria are met, eligible investors who acquire equity interests in Australian ESICs are provided with:
- a 20% non-refundable carry-forward tax offset for qualifying investments, capped at $200,000 for each investor and their related parties (combined) per year; and
- a deemed capital account treatment, and an exemption from capital gains tax for qualifying investments held between one and ten years. Investors who hold shares for at least 10 years also receive a market value cost base on the 10th anniversary of their acquisition.
Importantly, the incentives are predominantly aimed at sophisticated investors. Retail investors can also access the ESIC tax incentives but in more limited circumstances.
Private rulings and ESICs for sports technology and esports companies
A private ruling is binding advice issued by the ATO that sets out how a tax law applies to a particular entity in relation to a specific scheme or circumstance.
A private ruling can confirm, for a particular financial year, that a company meets the ESIC requirements. However, it is for the investor to determine for themselves whether their investment in the company will entitle them to the ESIC tax incentives.
In summary, and in addition to other requirements, ESIC status may be available to companies incorporated in Australia within the three income years before ESIC status is attained. The company must have total expenses of less than $1 million and a total assessable income of less than $200,000 in the year previous to the year in which ESIC status is attained, and cannot be listed on a securities exchange.
The most important qualification requirement for a prospective ESIC is the requirement to demonstrate that it is an ‘innovative’ company. It can do so using the ‘100-points test’ or the ‘principles test’ (Innovation Tests). Sports technology and esports companies that can satisfy either of the Innovation Tests may be eligible for ESIC status.
The ‘100-points test’ is designed to be ‘self-assessed’ against specified objective criteria. Broadly, the 100-points test is a cumulative points-based innovation test, which covers indicators of innovation such as the incurring of R&D expenditure, the receipt of Commonwealth grants, and rights to certain patents and designs.
Under the ‘principles test’, a company carrying on sports technology or esports related activities may qualify as an ESIC where it can be demonstrated that:
- the company is genuinely focussed on developing for commercialisation one or more new, or significantly improved, products, processes, services or marketing or organisational methods;
- the business relating to those products, processes, services or methods has a high growth potential;
- the company can demonstrate that it has the potential to be able to successfully scale that business;
- the company can demonstrate that it has the potential to be able to address a broader than the local market, including global markets, through that business; and
- the company can demonstrate that it has the potential to be able to have competitive advantages for that business.
While the ‘principles-based’ innovation test can be self-assessed, the fact that it relies on an analysis of subjective criteria means that there is some risk in the company and/or its investors making their own assessment whether or not the test is met. Because of this risk, and the consequences that can follow if the assessment is wrong, we have assisted a number of our clients in obtaining a private ruling from the ATO to confirm the status of the company as an ESIC.
Sports technology or esports companies who wish to consider their eligibility to qualify for ESIC status and to confirm that status by applying for a private ruling from the ATO are encouraged to contact Hall & Wilcox using the details below.