Private ruling: ESIC Investor entitlement to tax offset and modified CGT.
Date of advice: 22 June 2018
Published: September 2018
Ruling period: Year ending xx XX 20XX
Date scheme commenced: yy YY 20XX

Ruling: Q1: Is the Investor, Trust A, and its ultimate beneficiaries, entitled to a tax offset and modified capital gains treatment for shares in Company A for the portion of its investment funded in cash, under Subdivision 360-A of the Income Tax Assessment Act 1997 (‘ ITAA 1997’)? | A1: Yes, the Trustee of Trust A can determine each beneficiary’s share of the tax offset amount.

Relevant facts and circumstances: 1. Trust A is a family trust, settled on yy YY 20XX. 2. The Investor is Trust A, and the Trust Deed specifies the designated beneficiaries to be Taxpayer A, Taxpayer B, Taxpayer C and Taxpayer D. The Trustees of the Trust are Taxpayer A and Taxpayer B. 3. Trust A is currently undertaking due diligence in its consideration of investing in Company A, a qualifying Early Stage Innovation Company (ESIC) for the 20XX financial year. 4. Trust A has advised that they will be paying $xxx for shares in the company in the 20XX financial year. Additional shares valued at $yyy will be financed by way of a company loan from Company A. Trust A intends to repay this loan over the next xx years. 5. Taxpayer A has stated that Taxpayer A makes decisions for Trust A and is not influenced by others. 6. Trust A and Taxpayer A have stated they have no influence over the business affairs of Company A. 7. The Trust Deed for Trust A provides the Trustee with discretion to distribute or accumulate the income of the Trust in the year ending xx XX 20XX. 8. The shares are not issued under an employee share scheme. 9. Taxpayer A holds a certificate issued by a qualified accountant on zz ZZ 20XX. Information provided 10. You have provided information in a number of documents and phone conversations in relation to your application, including: a. your private ruling application dated zz ZZ 20XX. b. our phone conversation with Taxpayer A on z ZZ 20XX. c. supplementary information provided on z YY 20XX. 11. We have referred to the relevant information within these documents and conversations in applying the relevant tests to your circumstances. 12. You propose to invest in new shares issued by Company A at a particular time in the year ending xx XX 20XX.

Relevant legislative provisions: ITAA 1997 Subdivision 360-A | Further issues for you to consider | The following information is general advice regarding the additional shares valued at $zzz that will be financed by way of a company loan from Company A. | Shares that are issued in an income year may qualify an investor for the Early Stage Investor Tax Incentives including a tax offset. The amount of the tax offset available to an investor for that income year is calculated by reference to the amount paid for the shares. | Where shares are issued in an income year and paid for in a later income year, the investor may not be entitled to the Early Stage Investor Tax Incentives on those shares in the later income year.

Reasons for decision: Summary: All legislative references are to the ITAA 1997 unless otherwise indicated. Trust A is seeking a ruling to determine its eligibility to the tax incentives described under subdivision 360-A of the Income Tax Assessment Act 1997 for the year ending xx XX 20XX. Company A has provided Trust A with relevant information including confirmation that it has received a Private Ruling confirming that it meets the criteria of the ESIC tests under subsection 360-40(1) for the year ending xx XX 20XX. The following reasoning applies to the investor’s circumstances for the year ending xx XX 20XX. | Detailed Reasoning - Tax incentives for early stage investors in innovation companies: 13. Division 360 outlines the criteria for an investor purchasing new shares in a qualifying ESIC to be eligible to the following tax incentives: ● non-refundable carry forward tax offset equal to 20% of the amount paid for their qualifying investments, capped at a maximum tax offset amount of $200,000 for the investor and their affiliates combined in each income year ● modified capital gains tax (CGT) treatment, under which capital gains on qualifying shares that are continuously held for at least 12 months and less than ten years may be disregarded. Capital losses on shares held less than ten years must be disregarded | Detailed Reasoning - Entitlement to the tax offset – Section 360-15: 14. Section 360-15 provides that the tax incentives are available to all types of investors, regardless of their preferred method of investment (whether an investment is made directly as a corporation or individual or indirectly through a trust or partnership) other than ‘widely held companies’ (as defined in section 995-1) and 100 per cent subsidiaries of these companies provided certain conditions are met and restrictions do not apply. | Detailed Reasoning - Limited entitlement for certain kinds of investors – Section360-20: 15. Entities that acquire newly issued shares in an Australian ESIC may receive a non- refundable carry-forward tax offset of 20 per cent of the value of their investment subject to a maximum offset cap amount of $200,000 provided they satisfy certain conditions. | Detailed Reasoning - Sophisticated Investors- sections 708(8) or (10) or (11) of the Corporations Act 2001: 16. There are no restrictions on the amount an entity may invest if the entity meets the requirements of the Sophisticated Investor Test as described 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. 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. 17. An entity maybe a sophisticated investor they meet one of the following requirements: i. you have paid at least $500,000 for the qualifying shares (either as a single offer or including any amounts you previously have paid for shares of the same class that you hold in the same company), or ii. hold a certificate issued by a qualified accountant that confirms you meet certain asset and income requirements, or a company or trust controlled by a person holding the certificate, or iii. you are offered the qualifying shares through a financial services licensee who is satisfied that you have previous investment experience that allows you to assess the offer and you sign a written acknowledgement that the licensee hasn't given you a disclosure document in relation to the offer, or iv. you meet the requirements of being a 'professional investor' under the Corporations Act 2001 (such as a financial services licensee), or v. you have or control gross assets of at least $10 million (including any assets held by an associate or a that you manage). | Detailed Reasoning - Other Investors: 18. For other (non-sophisticated) investors a total annual investment limit of $50,000 applies. These investors will not be entitled to a tax offset if their investment exceeds this maximum threshold. | Detailed Reasoning - The investor and the ESIC must not be affiliates of each other – Section 328-130: 19. To qualify for the tax offset, the ESIC must not be an affiliate of the investor entity nor can the investor entity be an affiliate of the ESIC at the time the relevant shares are issued. That is, the ESIC must not act, or reasonably be expected to act, in accordance with the investor’s directions or wishes, or in concert with the investor, in relation to the affairs of the business of the ESIC and vice versa. | Detailed Reasoning - 30 per cent equity interest restriction – Section 328-125: 20. To qualify for the tax offset, the investor entity must not hold more than 30 per cent of the equity interests of an ESIC, including any entities ‘connected with’ the ESIC, tested immediately after the time relevant equity interests are issued. | Detailed Reasoning - Members of trusts or partnerships – Section 360-30: 21. A member of a trust or partnership, being a beneficiary or unit holder of a or a partner in a partnership (section 960-130) at the end of an income year is entitled to a carry-forward tax offset for that income year, if the trust or partnership were an individual and would be entitled to a tax offset. 22. The amount of the offset is determined by the: ● notional tax offset that is the member’s share of the offset as determined by the trustee or partnership; and ● notional tax offset amount that is the amount of the offset that would be available to the trust or partnership were it an individual. 23. Section 360-30 applies if a member of a trust or partnership is entitled to the tax offset for an income year under subsection 360-15(2). 24. Subsection 360-30(1) calculates the amount of tax offset that can be claimed by a member of a trust or partnership as the member’s share of the tax offset multiplied by the amount referred to as the notional tax offset amount. The notional tax offset amount is defined to be the amount of the trust’s or partnership’s tax offset calculated under section 360-25 as if the entity had been an individual. 25. Subsection 360-30(2) provides that a member’s share may be determined by the trustee or partnership as a percentage of the notional tax offset amount. Subsection 360-30(5) requires that the sum of all percentages determined in relation to all members does not exceed 100% of the amount that the trust or partnership would be entitled to if it was an individual investor. 26. Subsection 360-30(3) provides that if, under the terms of a trust or partnership, a member would be entitled to a fixed proportion of any capital gain if any asset were disposed of at the end of the income year, then the member's share of the tax offset must be equivalent to that fixed proportion. Consequently a determination of any other percentage has no effect for calculating the member’s share of the tax offset. Apart from this requirement in subsection 360-30(3), there are no other requirements about what share of the tax offset should be distributed to each member. 27. Subsection 360-30(4) requires that the trustee or partnership must give the member written notice of the determination made about their share of the tax offset. The notice must include enough information to enable the member to work out the member’s share of the notional tax offset. The notice must be given to the member within 3 months of the end of the income year, or within a further time allowed by the Commissioner. | Detailed Reasoning - Trustee of a Trust – Section 360-15(3): 28. A trustee of a trust is entitled to a *tax offset for an income year if: a. the trustee would be entitled to a tax offset, under subsection (1), for the income year if the trustee were an individual; and b. the trustee is liable to be assessed or has been assessed, and is liable to pay *tax, on a share of, or 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. | Detailed Reasoning - Modified CGT Treatment – section 360-50: 29. An investor that acquires shares in a qualifying ESIC will be taken to hold these shares on capital account and the disposal of these shares would give rise to a capital gain or a capital loss as per paragraph 360-50(2). 30. The specific CGT consequence arising for these shares depends on: ● when the investor entity deals with the shares (and the relevant CGT event happens); and ● whether the investor entity realises a capital gain or a capital loss from that event. | Detailed Reasoning - Shares held for more than 12 months and less than ten years: 31. An investor that has continuously held a qualifying share for between 12 months and less than ten years may disregard a capital gain arising from the share however it must disregard any capital loss as per subsections 360-50(3) and (4) | Detailed Reasoning - Shares held for 10 years or more: 32. An investor that has continuously held a qualifying share for at least ten years will receive a market value, as determined on the ten year anniversary date, as the first element of the cost base and reduced cost base of the share. This ensures that any incremental gains (or losses) in value after 10 years will be taxable as per subsection 360-50(5). | Detailed Reasoning - Entitlement to the tax offset – subsections 360-15(1) and (2), 960-130(1)(3): 33. As the tax incentives are available to all types of investors other than ‘widely held companies’ (as defined in section 995-1) and 100 per cent subsidiaries, Trust A satisfies paragraphs 360-15(1) and (2) along with the meaning of member as defined in paragraph 960-130(1)(3). | Detailed Reasoning - Trust A and Company A must not be affiliates of each other – Sections 328-130(1), and 328-130(2), 360-15(1) and {(2) / (3)}.: 34. Company A has met the criteria of an ESIC for the year ending xx XX 20XX, receiving a private ruling issued zz ZZ 20YY and is seeking outside investment to help grow the business. 35. Trust A is seeking to invest in Company A and has stated it has no influence over the business affairs of Company A. | Detailed Reasoning - Neither the company nor the individual is an affiliate: 36. The meaning of affiliate is set out in section 328-130. An individual or company is an affiliate of an entity where that individual or company acts, or could reasonably be expected to act: a. in accordance with the entity’s directions or wishes in relation to the affairs of that individual or company’s business; or b. in concert with the entity in relation to the affairs of the individual or company’s business. 37. Subsection 328-130(2) states that an individual or company is not your affiliate merely because of the nature of the business relationship you and the individual or company share. 38. The following factors may have a bearing on whether an individual or company is an affiliate of an entity to the extent that they show that two or more entities acting in concert: a. family or close personal relationships; b. financial relationships or dependencies; c. relationships created through links such as common directors, partners, or shareholders; d. the degree to which the entities consult with each other on business matters; or e. whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity. 39. In examining the above factors, there is no evidence to suggest that Company A would act, or reasonably be expected to act, in accordance with Trust A’s directions or wishes, or in concert with the investor, in relation to the affairs of the business of the ESIC. Therefore, Trust A satisfies paragraphs 328-130(1), 328-130(2) and 360-15(1), (2) and (3). | Detailed Reasoning - Employee Share Scheme - 360-15(1)(e): 40. The share issue is not issued under an employee share scheme and therefore the paragraph 360-15(1)(e) is satisfied. | Detailed Reasoning - 30 per cent equity interest restriction – Section 360-15(1)(f) and (2) and 328-125: 41. To qualify for the tax offset, the investor entity must not hold more than 30 per cent of the equity interests of an ESIC, including any entities ‘connected with’ (paragraph 328-125) the ESIC, tested immediately after the time relevant equity interests are issued. 42. The ESIC has provided potential investors with an Investment Overview, with details of the capital structure; Trust A will not hold more than 30% of the equity interests in the ESIC immediately after the share issue. 43. Trust A has stated that they will not hold greater than 30% of the ordinary equity in the ESIC and there is no evidence to indicate they hold or will hold more than 30% of the equity interests in Company A (or with another entity if the ESIC controls the other entity (or vice versa) or both are controlled by the same third entity). Therefore Trust A will satisfy paragraph 360-15(1)(f) and subsection 360-15(2). | Detailed Reasoning - Limited entitlement for certain kinds of investors – Section 360-20(1)(a) and (b): 44. Restrictions apply to the amount and entitlement of the offset as provided in paragraphs 360(20)(1) and (b) which relate to a type of investor. ● Under the Corporations Act 2001, 'sophisticated investors' who meet certain requirements don't have to be provided with a disclosure document, such as a prospectus or product disclosure statement, when being offered shares in a company. Our document entitled Tax incentives for early stage investors, available on our website ato.gov.au using quick code QC 48899 includes examples of when an entity may be a sophisticated investor. This includes an example where: ● A person holds a certificate issued by a qualified accountant that confirms they meet certain asset and income requirements. Note: the offer of shares can be made to a trust controlled by the person holding the certificate. 45. Taxpayer A holds a certificate issued by a qualified accountant on zz ZZ 20XX and the evidence provided suggests that he makes decisions to control Trust A as required by subsection 328-125(3). Consequently Trust A is considered to be a sophisticated investor for the purposes of the Corporations Act 2001. 46. Trust A has advised that their investment will be at least $xxx in this financial year. Following the example on our website this indicates that they satisfy the requirements of paragraph 360-20(1)(b) and the restrictions on the amount paid for shares will not apply for this share issue. | Detailed Reasoning - Members of trusts or partnerships – Section 360-30: 47. A member of a trust, being a beneficiary (section 960-130) at the end of an income year is entitled to a carry-forward tax offset for that income year, if the trust were an individual and would be entitled to a tax offset. 48. Subsection 360-30(1) calculates the amount of tax offset that can be claimed by a member of a trust as the member’s share of the tax offset multiplied by the amount referred to as the notional tax offset amount. The notional tax offset amount is defined to be the amount of the trust’s tax offset calculated under section 360-25 as if the entity had been an individual i.e. 20% of the amount paid for the shares issued to Trust A. 49. The trustee of Trust A can determine each member’s percentage of the notional tax offset amount. Subsection 360-30(5) requires that the sum of all percentages determined in relation to all members does not exceed 100% of the amount that Trust A would be entitled to. 50. Subsection 360-30(3) provides that if, under the terms of a trust, a member would be entitled to a fixed proportion of any capital gain if any asset were disposed of at the end of the income year, then the member's share of the tax offset must be equivalent to that fixed proportion. The Trust Deed for Trust A provides the trustee with discretion to distribute or accumulate the income of the trust in the year ending xx XX 20XX. Consequently there is no requirement about any share of the tax offset that can be determined by the trustee for each member. 51. The trustee of Trust A must give the member written notice of the determination made about their share of the tax offset. The notice must include enough information to enable the member to work out the member’s share of the notional tax offset. The notice must be given to the member within 3 months of the end of the 20XX income year, or within a further time allowed by the Commissioner. | Detailed Reasoning - Trustee of a Trust – Section 360-15(3): 52. A trustee of a trust is entitled to a tax offset for an income year if the trustee is liable to be assessed or has been assessed, and is liable to pay tax, on a share of, or 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. If any amount of the tax offset is used by the trustee for tax payable on a trustee assessment, the members of the trust can be entitled to the remaining proportion of the tax offset as determined by the trustee. | Detailed Reasoning - Entitlement to modified CGT Treatment – section 360-50(1) and (2): 53. Investors that are entitled to the tax offset will also be entitled to modified CGT treatment under paragraph 360-50(1) and the shares are treated as being held on capital account as per paragraph 360-50(2). As the Trust is entitled to the tax offset, it satisfies paragraph 360-50(1) and (2). 54. The specific CGT consequence arising for these shares will depend on when the investor entity deals with the shares (and the relevant CGT event happens); and whether the investor entity realises a capital gain or a capital loss from that event as described in paragraphs 360-50(3)(a) and (b),360-50(4)(a) and(b) and 360-50(5). | Detailed Reasoning - Conclusion: The Investor, Trust A, and its ultimate beneficiaries, have demonstrated that they satisfy the requirements under Subdivision 360-A of the ITAA 1997 and are entitled to the tax offset, as determined by the Trustee, and the trust is entitled to the modified capital gains treatment for shares issued by a qualifying ESIC for the year ending xx XX 20XX.