ATO finalises tax determination on circular financing arrangements

The ATO has issued Taxation Determination TD 2025/3, which sets out its views on how Part IVA applies to certain early stage innovation company investment arrangements.

The Tax Office previously issued a draft determination back in March outlining its views on the use of certain circular financing arrangements for claiming the early stage investor offset.

The ATO said it was concerned that these arrangements appeared to be designed to artificially meet the conditions for claiming the maximum tax offset, allowing individuals to benefit with minimal (if any) risk on their investment.

It first raised concerns about these arrangements in a taxpayer alert issued in December last year.

In the alert, the ATO warned that advisers were encouraging investors and start-up owners to claim the early-stage investor tax offset using circular financing arrangements, despite the start-ups not qualifying for the scheme.

“These arrangements are being promoted by advisers as legitimate tax arrangements to both individual taxpayers and start-up companies seeking seed capital,” it said.

“Entities promote, orchestrate, and finance these schemes primarily for the individuals to obtain the tax offset, with the refunded offset shared with those entities.”

The ATO outlined in TD 2025/3, that these arrangements typically display the following features:

• The individual (investor) becomes or is made aware of an opportunity to invest in a start-up company.
• The company is held out to qualify as an early stage innovation company under section 360-40 of the Income Tax Assessment Act 1997 (ITAA 1997).
• A financing arrangement is offered to fund the individual's share subscription amount, less any nominal deposit required. This enables the individual to acquire shares, typically up to an amount that qualifies for the maximum tax offset.
• The company places the subscription amount back on deposit with the financier who controls the use of the subscription monies by the company. This includes limiting that amount which the company can directly apply to further its stated innovation and commercialisation activities.
• The individual claims the early stage tax offset under Subdivision 360-A of the ITAA 1997 (tax offset) in their tax return and receives a refund. This refund is typically available as the tax offset reduces the individual's tax liability on their salary and wage income, enabling a refund of pay as you go withholding or other credits.
• The tax offset refund is used to partially repay the finance.
• The remainder of the financing is repaid by the individual within a short period out of subscription monies returned to the individual by the company. This returned amount is typically by way of selective share buy-back (or other disposal) of some or all of the individual's shares.
• In substance:

• • The individual has paid no amount for any residual shareholding they might continue to have in the company, and
  • the refunded tax offset is shared between the individual, the company and the entities facilitating and financing the individual's share subscription.

"For sophisticated investors, the terms of the arrangement typically allow for an extended period. This extension provides a greater benefit by enabling a longer duration for the investor to claim tax deductions for interest expenses under their borrowing," the ATO said.

The tax determination said that while the description of the scheme for the purposes of Part IVA would depend on the facts of the particular case, the scheme would normally consist of some or all of the features described in the determination.

"While these arrangements may assure investors of their ability to repay their financing through returned subscription monies by way of share buy-back or otherwise, the actual return of subscription monies to the investor is not essential for Part IVA to apply," the ATO stated in the tax determination.

TD 2025/3 outlines that while the application of Part IVA to any particular arrangement depends on careful weighing of all the relevant circumstances, Part IVA is likely to apply to arrangements similar to that described in TA 2024/1.

The ATO said the determination applies both before and after the date of issue.

"However, the determination will not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the determination," it said.