Explanatory Memorandum
(Circulated by authority of the Minister for Revenue and Financial Services, the Hon Kelly O'Dwyer MP)Chapter 1 Amendments to innovation measures
Outline of chapter
1.1 Schedule 1 to this Bill makes minor technical changes to the income tax law to ensure the National Innovation and Science Agenda measures contained in Tax Laws Amendment (Tax Incentives for Innovation) Act 2016 operate in accordance with the original policy intent.
1.2 All legislative references in this Chapter are to the Income Tax Assessment Act 1997 (ITAA 1997), unless otherwise stated.
Context of amendments
1.3 The Tax Laws Amendment (Tax Incentives for Innovation) Act 2016 amended the tax law to implement the following two National Innovation and Science Agenda measures to:
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- provide concessional tax treatment for investments in innovative, high-growth potential startups (tax incentives for early stage investors measure); and
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- reform tax arrangements for venture capital limited partnerships to improve access to capital, and make the regime more user-friendly and more internationally competitive (venture capital investment measure).
1.4 The amendments in Tax Laws Amendment (Tax Incentives for Innovation) Act 2016 generally apply for the 2016-17 income year and later years.
1.5 Currently, investors that invest through an interposed trust are not able to access the capital gain concessions provided by these two measures, as intended.
Summary of new law
1.6 These amendments make technical corrections to ensure the Tax Laws Amendment (Tax Incentives for Innovation) Act 2016 operates in accordance with the original policy intent. The amendments ensure that investors that invest through an interposed trust are able to access the capital gain concessions provided by the tax incentives for early stage investors and venture capital investment measures.
Detailed explanation of new law
Tax incentives for early stage investors measure
1.7 The tax incentives for early stage investors measure provided concessional capital gains tax (CGT) treatment for investors holding certain shares in an early stage innovation company. Specifically, an investor that has continuously held the share for at least twelve months and less than ten years may disregard a capital gain arising from the share (refer subsection 360-50(4)). See Explanatory Memorandum for the Tax Laws Amendment (Tax Incentives for Innovation) Act 2016 for further information.
1.8 This concessional CGT treatment is intended to be available to all types of investors, regardless of their preferred method of investment (whether an investment is made directly by 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 widely held companies.
1.9 However, prior to the amendments made by this Schedule, if an investor invests in an early stage innovation company indirectly through a trust, CGT event E4 would apply to claw back any disregarded capital gains that are later distributed through the trust. In particular, CGT event E4 would result in the CGT cost base of the unit or interest in the trust held by the investor being reduced by the amount of the distribution. If this would reduce the cost base of the unit or interest below zero, the cost base is reduced to zero and the investor has a capital gain equal to the balance of the amount (section 104-70).
1.10 These amendments ensure that investors that invest through an interposed trust are able to access the capital gain concessions provided by the tax incentives for early stage investors measure, as intended. This is achieved by modifying CGT event E4 by including amounts that are disregarded under subsection 360-50(4) in the list of amounts that are excluded when applying CGT event E4 under section 104-71. [Schedule 1, item 4, paragraph 104-71(3)(e)]
1.11 Accordingly, CGT consequences do not arise under CGT event E4 for a beneficiary in respect of the beneficiary's share of a capital gain that is disregarded because of these tax concessions.
1.12 This ensures that the same CGT outcome arises for the investors in an early stage innovation company, regardless of whether they invest directly or indirectly, such as through a fixed trust (including a unit trust) or a discretionary trust. That is, such investors will have access to the modified CGT treatment under subsection 360-50(4) in the same way a direct investor in an early stage innovation company would.
1.13 However, these amendments only have application in relation to payments made to an investor directly from a trust that holds the interest in an early stage innovation company. These amendments do not apply to payments made to an investor from a trust where that trust is the beneficiary of the underlying trust which holds the interest in the early stage innovation company. That is, the members of that other trust will not have access to the modified CGT treatment under subsection 360-50(4) in relation to the receipt of a distribution of capital proceeds.
1.14 Extending the tax incentives for early stage investors measure to indirect investments held through another vehicle may be considered at a later date. The Government intends to review this tax incentive after a period to determine how well it is delivering on its policy outcomes.
Venture capital investment measure
1.15 The Early Stage Venture Capital Limited Partnership (ESVCLP) regime was introduced in 2007 to provide tax concessions for early stage venture capital activities. An ESVCLP is taxed on a 'flow through' basis, rather than being treated as a company for tax purposes like other limited partnerships (see subsection 94D(2) of the Income Tax Assessment Act 1936). Under the ESVCLP regime, investors are exempt from income tax on capital and revenue gains from disposals of investments made by the ESVCLP. Corresponding losses are also disregarded (sections 51-54 and 118-407). Income derived from the partnership, such as from dividends, is also exempt from income tax (section 51-52).
1.16 The venture capital investment measure included amendments modifying CGT event E4 by adding amounts that are exempt or disregarded under the ESVCLP tax concessions in sections 51-54 and 118-407 to the list of amounts that are excluded when applying CGT event E4 under section 104-71. See the Explanatory Memorandum for the Tax Laws Amendment (Tax Incentives for Innovation) Act 2016 for further information.
1.17 The amendments in this Schedule add amounts that are exempt under the ESVCLP tax concessions in section 51-52 to the list of amounts that are excluded when applying CGT event E4 under section 104-71. This ensures that CGT consequences do not arise under CGT event E4 for a partner in a limited partnership or a partner in an Australian venture capital fund of funds in relation to the partner's share of income derived from a partnership that is exempt because of the ESVCLP tax concessions in section 51-52. [Schedule 1, item 1, paragraph 104-71(3)(aa)]
1.18 The amendments also clarify the language of the provisions to ensure there is no ambiguity about the venture capital tax concessions, including the ESVCLP tax concessions being available to beneficiaries. This clarification addresses concerns that the reference to amounts exempt in the hands of the ESVCLP might make it inapplicable in most cases, as the ESVCLP is taxed on a 'flow through' basis, with the exemption applying to amounts that pass through to the partners. The amendments ensure that CGT consequences do not arise for a beneficiary in respect of the beneficiary's share of income derived from a partnership that is exempt because of the venture capital tax concessions. [Schedule 1, item 1, paragraph 104-71(3)(aa)]
Inconsistent use of term 'capital proceeds' in the CGT rules
1.19 The Schedule also amends subsection 104-71(3) (which concerns modifications to CGT event E4) to change references from 'proceeds' to 'capital proceeds' to ensure consistency throughout the CGT rules in the ITAA 1997. [Schedule 1, items 2 and 3, paragraphs 104-71(3)(b), (c) and (d)]
Application provisions
1.20 The amendments relating to the tax incentives for early stage investors measure apply to a CGT event that happens on or after 1 July 2017. [Schedule 1, subitem 5(2)]
1.21 The amendment relating to the venture capital investment measure applies in relation to payments made, in respect of a unit or an interest in a trust, in an income year starting on or after 1 July 2016. [Schedule 1, subitem 5(1)]
1.22 The retrospective application of the amendment relating to the venture capital investment measure does not adversely affect the rights of affected taxpayers. The amendment corrects an unintended consequence and applies consistent with the intended operation of the law.
STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS
Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011
Amendments to innovation measures
1.23 This Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.
Overview
1.24 This Schedule makes technical changes to the income tax law to ensure that the Tax Laws Amendment (Tax Incentives for Innovation) Act 2016 operates in accordance with the original policy intent. The amendments ensure that investors that invest through an interposed trust can access the capital gain concessions provided by the tax incentives for early stage investors and venture capital investment measures.
Human rights implications
1.25 This Schedule does not engage any of the applicable rights or freedoms.
Conclusion
1.26 This Schedule is compatible with human rights as it does not raise any human rights issues.