For tech company founders and investors, the tax treatment of a future exit could look very different from 1 July 2027 as the tried and tested 50% CGT discount will be replaced with a cost base indexation model. Under the indexation model, founders and early-stage investors would likely have their entire gain taxed at marginal tax rates upon a successful exit.
The IBCC is designed to incentivise innovation and entrepreneurial risk-taking by preserving the 50% CGT discount for founders, investors and early-stage employees of innovative Australian businesses. When we first wrote about the IBCC a few months back, many of the details about the concession were still unclear. Treasury has now released draft legislation providing further clarification about how the IBCC is proposed to operate.
What’s changed?
The Exposure Draft contains several significant improvements compared with the original measures:
- 3 year holding period: Minimum holding period reduced from five years to three years.
- No $10 million cap: The proposed lifetime cap on qualifying gains has been removed.
- 15 year incorporation limited: Increased from ten years, so older technology companies may now qualify.
- More than shares: Concession extended to options and certain convertible instruments (e.g. SAFEs).
- No 30% minimum capital gains tax: Qualifying IBCC gains would be excluded from the minimum tax.
Which companies could qualify?
The IBCC is aimed at unlisted innovative Australian companies rather than businesses generally. An IBCC company will need to:
- be incorporated under Australian law for less than 15 years;
- have aggregated turnover of no more than $50 million;
- be unlisted and an Australian resident;
- satisfy Australian workforce and asset requirements;
- satisfy an ‘innovative company test’ and ‘predominant activity test’; and
- register annually as an IBCC company.
Founders and investors familiar with the Early Stage Innovation Company (ESIC) rules will recognise some of the concepts – the IBCC looks at factors such as high-growth potential, scalability and the ability to address markets broader than the local market.
Since these tests can be subjective, the Exposure Draft has introduced a safe harbour to provide companies with more objective ways of demonstrating their innovation credentials. The safe harbour has various conditions the company would need to satisfy, but include indicators based on matters such as claiming the R&D tax incentive, raising capital, setting up an ESOP, going through an accelerator program, scaling revenue and going global.
Transitional measures have also been introduced to allow existing equity to be qualify for the concession.
Some important issues remain
Despite the improvements made, the Exposure Draft still contains issues that could impact many typical technology company structures. In our submission to Treasury we identified several areas requiring further work:
- Holding company structures: the rules may not adequately accommodate groups where the innovation sits within an operating subsidiary rather than the holding company in which the shares are issued.
- Secondary transactions: shares acquired from another shareholder would not satisfy the ‘direct-issue’ requirement, potentially affecting founder and employee liquidity transactions.
- Corporate restructures: further certainty is needed for shares acquired via a flip-up and whether those shares retain their IBCC eligibility.
- Family trusts: the proposed ‘beneficiary continuity’ rules require further clarification for shares held via a discretionary trust.
These issues are particularly important because the structure adopted today could affect the tax outcome on an exit years in the future.
What should founders be doing now?
The IBCC is still a proposed measure, so founders and investors should not restructure simply to obtain the concession. However, the following questions should be considered now:
- Raising capital or implementing an ESOP – do the shares, options, convertible notes or SAFEs qualify?
- Flip-ups or corporate restructures – will the transaction preserve IBCC eligibility?
- Secondary market transactions – is this still attractive if the shares acquired won’t qualify for the IBCC?
- Preparing for an exit – are the company’s IBCC registrations all in order?
Given the requirement for IBCC companies to register annually, businesses should also be retaining documentation supporting their innovation activities, including R&D expenditure, capital raising documents, customer contracts, IP, export activities and commercialisation plans. These are among the matters relevant to the proposed safe harbour framework.
The bottom line
The IBCC Exposure Draft is materially more attractive than Treasury’s original proposal and the tax outcome on a future exit could depend on decisions being made today.
How you structure the group, raise capital, issue employee equity, undertake a flip-up and document the company’s innovation activities are all relevant, so speak with your William Buck advisor today about how the IBCC could apply to your business and your equity.
