Alarm raised on innovative business CGT concessions tests

William Buck partner, tax services, Jonathon Larosa shared his support in principle but also his concerns around the government’s draft legislation to implement its proposed capital gains tax (CGT) concession for innovative businesses (IBCC), which it recently released for consultation following earlier consultation on the proposals in June.

The IBCC provides a 50 per cent discount on capital gains from early-stage investments in innovative start-ups. The draft legislation broadly defines an IBCC company as one that is incorporated for less than 15 years, not controlled by another company incorporated for 15 years or more, and based in Australia.

The draft law also states that the IBCC company must not be listed or have aggregated turnover of more than $50 million and must satisfy the innovative company and predominant activity tests. This would mean it must have as its predominant activity an activity or activities relating to the development for commercialisation of a genuinely innovative product, process, service or method.

Under the predominant activity test, the company must also satisfy two of the following requirements.

First, more than 75 per cent of the assets (determined by value) that are assets of either the company or an entity controlled by the company must be used primarily in one or more eligible activities.

Secondly, more than 75 per cent of the employees of either or both of the company, or any one or more of its controlled entities, must be engaged (as such employees) primarily in one or more eligible activities.

Third, more than 75 per cent of the total assessable income, exempt income, and non-assessable non-exempt income of the company, and each of its controlled entities, must come from one or more eligible activities.

The innovative company test has several requirements including that the company must be genuinely focused on developing for commercialisation one or more new significantly improved products, processes, services, or marketing or organisational methods.

These must have a high growth potential, demonstrate that it has potential to successfully scale that business, address global markets, and have competitive advantages for that business.

Speaking to Accounting Times, Larosa said some of the tests outlined in the draft legislation are centred on the value of a company’s assets but it does not specify how a business would determine that value.

“It doesn’t say if it is an accounting value from a financial report or market value,” he said.

“If it is the market value of the assets in the business, a lot of the asset value tests revolve around making sure that more than 75 per cent of the value of your assets are used in your innovative business activity. The key assets of an innovative business are cash received from capital raising and an intangible asset. It’s not clear in the draft law if cash from capital raising qualifies. Also, are you now forced to value your intangible assets to work out if you qualify? How do you do that?

“There’s also an affiliates test related to the 15-year history requirement that appears to block founders and early investors from the IBCC when a founder shareholder controls the innovative company. This is actually how most innovative companies are established.

“I think these issues need some clarity and a safe harbour.”

Larosa also said the wording of the requirements under the predominant activity test is “clunky”.

“One of the tests is you have to have employees, and the employees need to be primarily engaged in the innovative activity,” he said.

“But a lot of early startups don't have employees. They're based around the activities of their founders and directors, and maybe some contractors.”

He continued: “When you think about the IBCC applying to founder shares and early investor shares, the employment test just may not be applicable.

“Similarly, 75 per cent of the company's revenue has to be connected to innovative business activity. But if the company's not earning any revenue, or has interest revenue connected to capital funding, the test can’t be passed. It becomes evident pretty quickly that you have two potentially non-applicable tests, and you can't qualify for the IBCC. So that needs some work.”

Larosa said many of his innovative business clients will have questions about whether they are going to qualify for the IBCC.

“There are murmurings in the industry that a lot of founders are disgruntled that their hard work is now fully taxable. They’re questioning whether or not it’s worth innovating in Australia,” he said.

He called on the government to provide more flexibility to innovative businesses and expand the eligibility for the CGT concessions in order to “bring back those innovators who feel jaded”.