Private ruling: Indirect investment in an ESIC
Date of advice: 17 April 2019
Published: June 2019
Ruling period: Income year ended 30 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Are the investors of Holding Co entitled to tax incentives for early stage investors under Division 360 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No

Relevant facts and circumstances: The group consists of the following entities: ● Holding Co ● Innovation Co ● IP Co ● Trading Co The group will carry on significant business functions and therefore believe that separate entities are required to maximise corporate efficiencies and asset protection. The role of each entity is as follows:- Holding Co Holding Co is the holding entity for the group. It is the 100% shareholder of IP Co, Innovation Co and Trading Co. All external shareholders will directly invest through Holding Co, which subsequently invests in its subsidiaries. Holding Co is not an early stage innovation company as it does not pass any of the relevant tests. It is solely a holding company that attracts external investment for the entire group. Innovation Co Innovation Co produces the innovation and requires significant investment. It bears all the costs of research & development (R&D), production, testing and implementation. Innovation Co is registered for the Research & Development Tax Incentive. All investment that has been received by Holding Co is being used in the R&D stage of the innovation. The applicant believes that Innovation Co passes both the 100 point innovation test and the principles bases innovation test and is eligible to be an early stage innovation company (ESIC). Trading Co Trading Co will sell the innovation and will be the only entity that makes sales to the public. It will also be responsible for costs associated with sales such as support, marketing and travel. It will pay a licence or royalty fee to Innovation Co for the right to sell the innovation. IP Co IP Co owns the intellectual property of the group. It will licence the IP/trademarks to Innovation Co. An arms-length licence fee will be charged between the two entities. Additional equity funding will be raised when required. It is expected that minimal capital will be required by Trading Co and the majority of the capital will be required by Innovation Co. The group was incorporated to provide a practical solution for the requirements of the business and allow external investment with ease. The business plan is to launch the innovation interstate and then eventually internationally. There are also plans to release different products and service lines, all which will be in new entities. As all shareholders are going to have an interest in the entire project it is more effective for their interest to be in one entity which then invests as required into the business entities. This structure also assists in simplifying the tax affairs and investments of the investors. The structure will be eligible to form a tax consolidated group which the applicant states will simplify the tax affairs of the group as each entity will interact with each other. Assumptions Innovation Co meets the requirements to qualify as an early stage innovation company pursuant to Division 360 of the ITAA 1997.

Relevant legislative provisions: Division 360 of the ITAA 1997 | Section 360-15 of the ITAA 1997 | Section 360-40 of the ITAA 1997 | Section 360-45 of the ITAA 1997

Reasons for decision: Summary: The investors of Holding Co are not eligible for tax incentives for early stage investors as they are not investing directly into the early stage innovation company (ESIC) as required by Division 360 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: If you invest in a qualifying ESIC, you may be eligible for tax incentives. The tax incentives for early stage investors are contained in Division 360 of the ITAA 1997. The objective of this policy is to encourage new investment in small Australian innovation companies with high growth potential by providing qualifying investors with a tax offset and modified capital gains tax treatment. For an investor to be entitled to the tax incentives, the company must qualify as an ESIC immediately after the new shares are issued by the company to the investor. If the company no longer meets the ESIC requirements after this test time, this won't affect the investor's entitlement to the early stage investor tax incentives. The early stage investor tax incentives aren't available under section 360-15 if: ● you didn't purchase the shares in the ESIC directly from the company as newly issued shares; ● the shares are not equity interests in the ESIC; ● you are a widely held company or a wholly-owned subsidiary of a widely held company; ● your total investment in one or more ESICs for the income year is more than $50,000 and you didn't meet the sophisticated investor test in relation to at least one of those share offerings; ● you or the ESIC are affiliates of each other at the time the shares are issued; ● you hold more than 30% of the equity interests in the ESIC (including any entities connected with the ESIC) immediately after you are issued with the new shares; or ● you acquired the shares under an employee share scheme. In this case, the investors are purchasing shares in Holding Co. Holding Co holds 100% of the shares in Innovation Co, as well as the shares of IP Co and Trading Co. Holding Co is not an ESIC, and is not eligible to access the early stage innovation concessions as it holds more than 30% of Innovation Co and has not purchased newly issued shares. The investors of Holding Co are ineligible for the early stage investor tax incentives as they have not purchased shares directly in Innovation Co.