Private ruling: Early stage investors offset
Date of advice: 28 May 2018
Published: August 2018
Ruling period: Year ending 30 June 2018
Date scheme commenced: 10 November 2017

Ruling: Q1: In respect of the shares issued by Company A on 10 November 2017 does the Taxpayer meet the eligibility criteria for Tax incentives for early stage investors in qualifying innovation company under Subdivision 360-A of the ITAA 1997? | A1: No | Q2: If the answer to question 1 is yes, is the Taxpayer able to claim an offset of $X under section 360-25 of the ITAA 1997? | A2: Not answered. | Q3: In respect of the additional shares that will be issued by Company A by 30 June 2018 does the Taxpayer meet the eligibility criteria for Tax incentives for early stage investors in a qualifying innovation company under section 360-15 of the ITAA 1997? | A3: Yes. | Q4: If the answer to Question 3 is yes, is the Taxpayer able to claim an offset of $X under section 360-25 of the ITAA 1997? | A4: Yes.

Relevant facts and circumstances: 1. The Taxpayer is an individual. 2. Company A was incorporated on 10 November 2017 with a $X investment from the Taxpayer (and three other unrelated shareholders). 3. Company A is a qualifying Early Stage Innovation Company (ESIC) for the period from 10 November 2017 to 30 June 2018 on the basis that it satisfied the principle-based test. 4. On Date X Company A received a ruling to advise that they were an ESIC. 5. The Taxpayer has advised that they will be investing an additional $X in Company A during the year ending 30 June 2018. 6. The Taxpayer has stated that they are not an affiliate of Company A or its directors. 7. Your tax agent advised us that the Taxpayer is considered a sophisticated investor for the 2017-18 financial year. 8. Company A issued no share options to the Taxpayer during the year ending 30 June 2018. Information provided 9. You have provided information in a number of documents and phone conversations in relation to the shareholding including: a. your private ruling application, and b. supplementary information. 10. We have referred to the relevant information within these documents and conversations in applying the relevant tests to your circumstances.

Relevant legislative provisions: ITAA 1997 Subdivision 360-A | Further issues for you to consider | N/A

Reasons for decision: Summary: 11. The Taxpayer is not entitled to the tax incentives described under subdivision 360-A of the ITAA 1997 for the shares issued by Company A on 10 November 2017. | Detailed Reasoning - Detailed reasoning: 12. In our detailed reasoning to our answer to Question 3 we listed the criteria that need to be met by an individual under subsection 360-15(1) in order to be eligible for the offset for early stage investors. 13. One of the requirements is that the company issuing the shares must be an ESIC immediately after the relevant shares were issued. 14. Company A received a ruling that they were an ESIC on the basis that they passed the principles-based test in subsection 360-40(e). To pass this test the company must be genuinely focused of the development of their innovation for commercialisation. 15. The initial $X investment was made by the Taxpayer to become a founding shareholder and establish Company A. Therefore at the time of the founding investment Company A was not in existence and could not have been genuinely focused on developing the innovation for commercialisation. It was only after Company A became a legal entity that it could start to focus on developing the innovation even though another person may have developed the initial idea. Therefore at the time of initial $X investment Company A was not an ESIC and the Taxpayer is not entitled to claim the tax offset for the founding shares. | Detailed Reasoning - Question 2: If the answer to question 1 is yes, is the Taxpayer able to claim an offset of $X under section 360-25 of the ITAA 1997? | Detailed Reasoning - Answer: The answer to question 1 is no, therefore question 2 is not answered. | Detailed Reasoning - Question 3: In respect of the additional shares that will be issued by Company A by 30 June 2018 does the Taxpayer meet the eligibility criteria for Tax incentives for early stage investors in a qualifying innovation company under section 360-15 of the ITAA 1997? | Detailed Reasoning - Answer: Yes. | Summary: 16. The Taxpayer is entitled to the tax incentives described under subdivision 360-A of the ITAA 1997 for the additional shares that will be issued by Company A by 30 June 2018. | Detailed Reasoning - Subsection 360-15(1): 17. Under subsection 360-15(1) an individual is entitled to the offset if: ● at a particular time during the income year, a company issues them with equity interests that are shares in the company; ● the company was an ESIC immediately after that time; ● neither the individual nor the company is an *affiliate of each other at that time; ● the issue of those shares is not an acquisition of an ESS interests under an employee share scheme; and ● immediately after that time the individual did not hold more than 30% of the equity interests in the company or in an entity *connected with the company. 18. The investor must also satisfy section 360-20 to satisfy subsection 360-15(1). 19. In this case: a. the Taxpayer was issued ordinary shares which would be an equity interest. b. Company A issued no share options to the Taxpayer during the year ending c. 30 June 2018. d. Company A was an ESIC from 10 November 2017. e. The shares were not issued under an employee share scheme. f. The equity interest held after 10 November 2017 was 25%. 20. Therefore the only point that needs further examination is whether the Taxpayer and Company A were affiliates when the shares were issued and whether the Taxpayer also satisfies section 360-20. | Detailed Reasoning - Affiliates: 21. 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. 22. 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. 23. 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 24. In this case, the relationship between the Taxpayer and Company A is summarised as: a. The Taxpayer is not a Director (or office holder) of Company A. b. Company A has four unrelated shareholders; and one is the Taxpayer. Each shareholder holds an equal proportion of ordinary shares in Company A. c. The Taxpayer is a founding member of Company A with an initial investment of $X (25% of the total). d. All shareholder and board resolutions are passed by simple majority unless a separate shareholder resolution (of 75% of shareholder votes) is required by law, under the Corporations Act 2001. e. Company A has four directors; and one is the Taxpayer’s spouse. f. The Taxpayer and Company A make business and investment decisions independently of one another. g. The Taxpayer nominated their spouse to the board. The constitution of Company A indicates that: i. The directors must elect one of their number as chairman of their meetings. ii. Questions arising at a meeting of directors are determined by a majority of votes of the members present and voting. iii. The chairman of a meeting of directors has the casting vote (in addition to their own vote). iv. A director may, with the approval of the other directors, appoint a person (whether a member of the company or not) to be an alternate director in his or her place during such a period as they think is suitable. The alternate director is entitled to attend meetings and vote. h. Although the Directors of Company A consult with the shareholders, the Directors are ultimately responsible for making the final decisions. i. Although the Taxpayer could discuss shareholder issues with their spouse, their spouse does not have more than 25% control of Company A. The Taxpayer could potentially influence their spouse’s decisions within the business; however this would not influence the remaining Directors or shareholders. 25. In examining the above factors there is no indication that Company A would act, or reasonably be expected to act, in accordance with the Taxpayer’s directions or wishes in relation to the affairs of the business of Company A and vice versa. 26. In this case, prior to the additional shares being issued Company A is being effectively controlled evenly by the four shareholders. 27. Therefore the Taxpayer and Company A are not affiliates of each other. | Detailed Reasoning - Section 360-20: 28. Section 360-20 placed restrictions to the amount certain kinds of investors can invest in ESICs and still be entitled to the offset. 29. In effect an investor, who is not a 'sophisticated investor' under the Corporations Act 2001 , will not be entitled to the offset if their total investment across all ESIC’s is more than $50,000 in the income year. 30. In this case you have advised that the Taxpayer is a sophisticated investor so section 360-20 will not apply. However you also advised that their investment will be at least $X and no more than $X in this income year. So had the Taxpayer not been a sophisticated investor section 360-20 would not have applied as their investment has not exceeded $50,000. | Detailed Reasoning - Question 4: If the answer to Question 3 is yes, is the Taxpayer able to claim an offset of $X under section 360-25 of the ITAA 1997? | Detailed Reasoning - Answer: Yes. | Summary: The Taxpayer is seeking a ruling to determine her eligibility to claim an offset under section 360-25 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: 31. Section 360-25 of the Income Tax Assessment Act 1997 (ITAA 1997) 32. If subsection 360-15(1) applies, the amount of the *tax offset is 20% of the total amount paid for the *shares to which paragraph 360-15(1)(b) applies. 33. Note: If subsection 360-15(1) applies for shares issued to you at several times during the income year, then this subsection uses the total amount paid for all of those shares. | Detailed Reasoning - Subsection 360-25(2): 33. However, reduce this amount to the extent necessary to ensure that the sum of the following does not exceed $200,000: a) the sum of the *tax offsets under this Subdivision for the income year for which you and your *affiliates (if any) are entitled; b) the sum of the tax offsets under this Subdivision that you and your affiliates (if any) carry forward to the income year. 34. If Subsection 360-25(2) applies to the Taxpayer’s circumstances it is up to the Taxpayer and their affiliate investors to determine who gets the offset.

Reasons for decision: All legislative references are to the ITAA 1997 unless otherwise indicated.