Private ruling: ESIC eligibility
Date of advice: 23 January 2025
Published: 17 March 2025
Ruling period: Year ending 30 June 20XX

Ruling: Q1: Are the unit holders of the Trust entitled to a tax offset pursuant to subsection 360-15(2) of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the Trust's acquisition of shares in the ESIC? | A1: Yes | Q2: Can the Trust disregard the capital gain arising on the sale of the Shares on 27 June 2024 pursuant to section 360-50 of the ITAA 1997? | A2: Yes

Relevant facts and circumstances: On XXXX, the Trust purchased newly issued shares (the Shares) in an Early Stage Innovation Company (ESIC), the ESIC, for a total of more than $XX. The Shares were not issued under an employee share plan. The ESIC is run and managed by an unaffiliated entity Immediately after this issue, the Trust held less than X% of the shares in the ESIC. The controlling individual of the trust at the time Controlling Person, was issued a certificate dated a month prior to the issue of the Shares by a qualified accountant certifying that he had at least $XX of gross income for each of the previous two financial years. In 20XY, the Shares were sold for $XX.


Reasons for decision: Summary: The unit holders of the Trust are entitled to a tax offset pursuant to subsection 360-15(2) of the ITAA 1997 in respect of the Trust's acquisition of shares in the ESIC. | Detailed Reasoning - Detailed reasoning: Background - offset for members of a trust and trustee of a trust Broadly, under the ESIC rules a trust is not directly entitled to claim an ESIC tax offset. However, under subsection 360-15(2) a member of a trust at the end of an income year is entitled to a tax offset for an income year if the trust would be entitled to a tax offset, under subsection 360-15(1), for the income year if the trust was treated as an individual. A member of a trust (except a public trading trust) is a beneficiary of a trust, unit holder or object of the trust. A trustee of a trust is also entitled to a tax offset under subsection 360-15(3) if the trustee would be entitled to a tax offset under subsection 360-15(1) if the trustee was treated as an individual. However, for subsection 360-15(3) to apply, the trustee must be liable to be assessed (or has been assessed), and is liable to pay tax, on a share of all (or a part of), the trust's net income under section 98, 99 or 99A of the Income Tax Assessment Act 1936 for the income year. Regardless of whether subsection 360-15(2) or subsection 360-15(3) applies we need to treat the trust as if it was an individual, and determine if the requirements of subsection 360-15(1) are met by the trust. Subsection 360-15(1) Relevantly, under subsection 360-15(1) an individual is entitled to the offset for an income year where each of the following conditions is satisfied: • at a particular time during the income year, a company issues them with equity interests that are shares in the company (paragraph 360-15(1)(b)) Note: An investor will be precluded from satisfying this condition where the total investment in an ESIC(s) exceeds $XX and the investor does not meet the 'sophisticated investor test' in the Corporations Act 2001 - see the following discussion titled 'Limited entitlement to ESIC tax offset - section 360-20' • the company was an ESIC immediately after that time (paragraph 360-15(1)(c)) • neither the individual investor nor the company is an affiliate of each other at that time (paragraph 360-15(1)(d)) • the issue of those shares is not an acquisition of an ESS interests under an employee share scheme (paragraph 360-15(1)(e)), and • immediately after that time the individual did not hold more than X% of the equity interests in the company or in an entity connected with the company (paragraph 360-15(1)(f)). Limited entitlement to ESIC tax offset - section 360-20 Section 360-20 limits the entitlement to an ESIC offset for certain kinds of investors. Broadly, under this provision an investor will not satisfy the first condition in paragraph 360-15(1)(b) and thus not be entitled to the ESIC offset where both of the following conditions are met: • the investor's total investment in one or more ESICs exceeds $XX, and • the investor does not meet the 'sophisticated investor test' as described in subsection 708(8), (10) or (11) of the Corporations Act 2001 (Corporations Act), in at least one of those share offerings. The Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 explains the rationale for this provision. At paragraphs 1.18 to 1.21 it states that: ...whilst the tax incentives are generally available to all types of investors, investment in innovation companies is inherently risky and some protections are necessary to ensure more vulnerable investors are not over-exposed to this risk. Many investments may lose money, while others have the potential to make large gains.... There are no restrictions on the amount an entity may invest if the entity meets the requirements of the sophisticated investor test in section 708 of the Corporations Act 2001 (Corporations Act) in relation to a relevant offer of shares ... at any time in the income year. In the Corporations Act the sophisticated investor test is used for investment opportunities that have reduced disclosure requirements, on the basis that investors that meet this criteria are more likely to be able to evaluate offers of securities and other financial products without needing the protection of a disclosure document.... Other investors (non-sophisticated investors) are limited to investing amounts of $50,000 and below in an income year. These investors will not be entitled to a tax offset if their investment exceeds this maximum threshold, even in relation to any proportion of such an investment below this threshold. Sophisticated investor test Under the Corporations Act 2001 ('Corporations Act') an entity will qualify as a sophisticated investor if one of the requirements for the removal of the need for a disclosure document in relation to the issue of the shares as described in subsections 708(8), (10) or (11) of the Corporations Act 2001 is satisfied. These requirements for the removal of the need for a disclosure document relevantly include where the controlling person of a trust to which an offer is made holds a certificate issued by a qualified accountant no more than X months before the offer is made that confirms the controlling person meets certain asset and income requirements. In this regard, from XX March 20XX, this certificate is available only if the investor (or controller) have gross income of at least $XX for each of the last two financial years or net assets (assets less liabilities) of at least $XX - see subsection 708(8)(c) and (d) of the Corporations Act and Regulation 6D.5.02 of the Corporations Regulations 2001. | Detailed Reasoning - Application to your circumstances: In this case, the Trust was issued with ordinary shares in an ESIC on XXXX. These shares are equity interests, thus satisfying paragraph 360-15(1)(b), subject to section 360-20. The company was an ESIC, thus satisfying paragraph 360-15(1)(c). Under subsection 360-15(2) is the trust must satisfy the entitlement to the tax offset under subsection 360-15(1) if it were treated as an individual. The shares were not issued under an employee share scheme, thus satisfying paragraph 360-15(1)(e). Sophisticated investor test As the Trust's investment in the ESIC exceeds the $XX maximum threshold for investment in an ESIC, the Trust is required to meet the requirements of the sophisticated investor test under paragraph 360-20(1)(a) to be eligible for the ESIC tax offset. Under subsection 708(8)(d) of the Corporations Act, this test is met if the controlling person of the trust was given a certificate by a qualified accountant no more than X months before the offer was made confirming that they have gross income for each of the last two financial years of at least $XX, or net assets of at least $XX million. As Controlling Person was issued such a certificate within six months before the offer of the Shares, subsection 708(8) of the Corporations Act is satisfied and there is no need for a disclosure document. As there is no need for a disclosure document for the issue of the Shares, section 360-20 will not operate to prevent the Trust from satisfying paragraph 360-15(1)(b). Thus, the Trust satisfies paragraph 360-15(1)(b). Affiliate test To satisfy this test, neither the Trust nor the ESIC can be an affiliate of each other immediately after the time the Shares were issued. Under subsection 995-1(1), affiliate has the meaning given by section 328-130. Subsection 328-130(1) states: An individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company. of the business of the individual or company. As the Trust was less than a X% shareholder in the ESIC just after the issue of the Shares, it is not reasonable to expect that the company could reasonably have acted in accordance with the Trust's direction based on their shareholdings. You have provided that the ESIC is run and managed by an unaffiliated entity. Thus, it is not considered that the Trust and the ESIC are affiliates of each other immediately after the issue of the Shares and the requirement under paragraph 360-15(1)(d) is satisfied. Limitation on equity interest held On the evidence provided, the equity interest held by the Trust immediately after the issue of Shares was less than XX% of the equity interests of the ESIC. Thus, the requirement under paragraph 360-15(1)(f) is satisfied. Conclusion The Trust is entitled to an ESIC offset under section 360-15(1) for the 20XX income year. Consequently, the trustee or the beneficiaries/unitholders of the Trust, depending on whether subsection 360-15(2) or (3) applies to the Trust, are entitled to an ESIC tax offset for the 20XX income year in relation to the issue of the Shares. | Summary: The Trust can disregard the capital gain arising on the sale of the Shares in 20XY pursuant to section 360-50 of the ITAA 1997 | Detailed Reasoning - Detailed reasoning: Subsection 360-50(1) provides that modified CGT treatment will apply where the issuing of a share gives rise to an entitlement to a tax offset under Division 360, as is the case here. Thus, modified CGT treatment under section 360-50 will apply to the Shares. Where section 360-50 applies the entity may disregard any capital gain arising within the first 10 years of ownership and must disregard any capital loss arising from any CGT event happening to the shares. In this case, The Trust disposed of the Shares within 10 years and as such can disregard the capital gain arising from their disposal. As such, no capital gain from these shares will need to be distributed to the unitholders.