The three things the government needs to do to fix the innovation statement tax incentives

By Alexis Kokkinos

As we move into budget season and the federal government continues to carry out the implementation process for its National Innovation and Science Agenda, getting the tax arrangements right for startup investors is critical.

In the lead up to this federal budget we’re hearing a lot about changes to superannuation and negative gearing, addressing tax minimisation and the potential for income tax cuts. While this provides a lot of speculative fodder for journalists, there are more prosaic elements of the government’s tax plan that have the potential to impact significantly on economic growth outcomes in the long run.

To a large extent the government missed the mark on its crowd-sourced equity funding legislation, requiring that startups are structured as public companies, capping crowdfunding limits at a paltry $5 million a year and not allowing for crowdfunding platforms to aggregate equity funding through a vehicle like a managed investment trust.

While that was disappointing, on the positive side we’re starting to see how other elements of the government’s innovation agenda will fit together. And when we’re dealing with innovative startups, it’s critical that we get innovation right – these are the businesses that will drive economic growth and make sure that Australian industry remains internationally competitive into the future.

The government released a consultation paper in February on tax incentives for early stage investors, examining the implications of measures outlined in its December National Innovation and Science Agenda and assisting with developing the relevant draft legislation.

The proposed tax incentives are specifically targeted at encouraging equity investment into so-called “innovation companies” – giving investors a 20% non‑refundable tax offset based on the amount invested either directly or indirectly in certain cases in the qualifying startup provided the underlying investment was held for at least three years.

What needs to be fixed

These are positive developments. Encouraging targeted investments into smart Australian startups that have great ideas but limited access to equity funding and commercialisation opportunities is exactly what the government should be doing to drive innovative growth.

But the proposals in their current form may still be beset by the issues of high compliance costs and definitional ambiguity unless worked through appropriately.

Without getting into arcane tax details, we can highlight three key considerations for the government to be aware of in order to reduce red tape.

1. The definition of “innovation companies”

Firstly, we have recommended that it would make more sense to latch onto existing R&D legislation and requirements instead of setting up a separate definition and qualification scheme for identifying “innovation companies”.

This would reduce compliance costs for startups that hope to attract investment from early stage investors.

Startups should already be seeking to qualify for existing R&D concessions so they will already have to demonstrate evidence of innovation. The legislation could mandate that a certain amount of money must be spent on R&D activities for a startup to qualify as an innovation company. This removes the need for additional registration processes and red tape.

2. The sectors that are eligible

Secondly, the discussion paper includes a list of activities that are excluded from being eligible under the similar UK Seed Enterprise Investment Scheme.

Our strong recommendation is that government reviews this list to ensure that fintech operators, robo-advice platforms, peer to peer lending platforms, digital currency operators and the like are not inadvertently excluded from accessing investment tax incentives.

3. The investor protections

Finally, the government has sought input into protections that should be in place for investors. We recognise that protection of investors should be a paramount consideration for government but we highlight that significant investor protection is already afforded under the Corporations Act 2001.

Adding further requirements would be unnecessary and would complicate this proposed legislation, as well as limiting the available pool of early stage equity funding.

It’s great that the government is actively considering ways to make early stage startups a more attractive investment destination. The productivity gains from investing in innovation have the potential to transform our economy as it transitions out of mining-fuelled growth and into knowledge and services-based growth.

And it’s positive to see that the disparate elements of the government’s innovation reforms and equity funding reforms are coming together into a series of coherent and interlinked vehicles for promoting growth. Ultimately, it’s exciting to see an entire ecosystem aimed at encouraging innovative business activity taking shape.

But it’s important to ensure that potential legislation is forward looking and that unintended consequences are thoroughly accounted for.

We’re already seeing business operators that are considering delaying their projects until the legislation has passed. As a result, we urge the government to move through with introducing these provisions sooner rather than later to give certainty and stability to the tech community.

Alexis Kokkinos is a partner at Pitcher Partners.

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