Looking for capital? You should become an early stage innovation company (ESIC). Here’s how…

One of the foundational elements to tick off when looking for seed capital for your business is to become an early stage innovation company (ESIC).

Qualifying as an ESIC will make your startup more attractive to potential investors as it entitles your investors to tax incentives for their investment in your business.

If your startup is considered an ESIC, capital gains for the first 10 years of your investors’ shares are completely tax free to eligible shareholders.

Investors are also entitled to a non-refundable carry forward tax offset equal to 20% of the amount paid for their investment, which is capped at a maximum tax offset of $200,000 in each income year.

Because tax is applied as a percentage of the gain made, it can add up to a significant amount for investors, which makes it very attractive for an investor if your startup is ESIC registered, as it will save them a huge amount when it comes to tax time.

For the investor to be entitled to the tax incentives, your startup must qualify as an ESIC immediately after new shares are issued to the investor.

But in order to qualify as an ESIC, your startup needs to meet both the early stage test requirements and either the 100-point innovation test or the principles-based innovation test.

The simplest route is to meet first the early stage test and then the 100-point innovation test, as opposed to the principles-based innovation test.

Sound complicated? Well, it’s not once you know what you’re doing. Here’s how… ‍

Meeting the early stage test requirements

Immediately after your startup issues shares to an investor, your startup needs to meet the four requirements of the early stage test.

Note, it’s important to know that your company can meet these requirements before issuing the shares.

The four requirements include:  

• Your startup must be incorporated or registered in the Australian Business Register.
• The company’s expenses must be $1 million or less in the previous income year.
• The company’s assessable income for the previous income year must be $200,000 or less.
• Your startup must not be listed on Australia’s or any foreign country’s stock exchange.

After you have me the obligations above, you must then either meet the requirements of the 100-point innovation test (the simplest route) or the principles-based innovation test.

Obligations to meet for the 100-point innovation test

This test measures your startup’s innovation by assessing it against particular criteria.

Your company must meet at least 100 points of the designated criteria to qualify, and this test is performed immediately after the shares are issued to the investor.

If your startup doesn’t meet the requirements of this test(or the principles-based innovation test) your investor will not be able to qualify for the tax incentives related to your shares.

The full criteria for the 100-point innovation test can be found on the Australian Tax Office website here.

Your accountant or R&D consultant can assist you with the 100-point test to ensure you meet all the requirements.

Alternative: meeting the principles-based innovation test

If the principles-based innovation test is the preferred method for meeting the requirements of an ESIC, the five requirements to satisfy this test can be found on the Australian Tax Office website here.

You will need to use existing documentation to demonstrate how your startup fulfils the requirements of the principles-based innovation test.

For example: your business plan, commercial strategy and competitor analysis to demonstrate how your company has taken steps to meet the innovation requirements.

Reporting on each investor related to the ESIC status

Once you are satisfied you have met the obligations of the early stage test and the 100-point innovation test or the principles-based innovation test, you will need to complete an early stage innovation company report when you issue new shares to an investor.

Your report should include the following information on each investor:

• Name, ABN, address and birth date (if an individual) of the investor
• Number of shares issued
• Amount paid for shares
• Date shares were issued
• Percentage of shares in the company held immediately after issue

You will then need to lodge this report 31 days after the start of the new financial year (i.e. 31July) either by ‘online services for business’or ‘online services for agents’.

By lodging a report you are declaring that your startup meets the requirements to be an ESIC for the reported investors and this information will be used to qualify your investors for the tax incentive.

These tax incentives were created to encourage investment inAustralia’s tech sector and are a vital step in the process for looking for seed capital to grow and develop your business.

Please note: the information above does not constitute as tax advice and savvy founders will engage their accountant or R&D consultant to help guide them through the ESIC process.