New test for innovation investment

It’s difficult to manage outcomes when tax and incentives are mixed.

Many investors will be considering the tax changes that have come into force encouraging investment in innovation via startups.

The new rules are aimed at bringing ‘angel’ investors and startup companies together at a critical juncture – the period between initial funding and the time a company begins generating revenue.

That is a period when it is difficult to attract investors or obtain finance, a time so risky that the federal Treasury has accepted the widely used term ‘valley of death’ as a valid description.

The government has consulted widely with industry to come up with a formula that is very complicated, but can earn investors an instant tax offset of 20 per cent, or up to $40,000 depending to their level of sophistication.

A company will be a qualifying ESIC (early stage innovation company) at the time of investment, if: spending is below $1 million a year (or below $1 million over three years in the case of companies between three and six years old) and assessable income less than $200,000; is Australian but isn’t listed; and, importantly, passes one of three innovation tests.

1) Principles – focused on developing for commercialisation one or more new, or significantly improved, products, processes, services or marketing or organisational methods with potential to scale globally and has a competitive advantage.

2) Gateway – a points-based system that includes R&D spending, commercialisation grants, accelerator program participation, third-party financial investment, has enforceable intellectual property rights or a deal with a university.

3) Tax ruling – an Australian Taxation Office determination.

I think there are a lot of hoops to jump through here, and many of them are controlled by government entities, but I guess everyone involved has to be cautious there isn’t a rush of investment into questionable or bogus business plans.

Nothing sinks an investment strategy like a free-for-all where the only winners seem to be those who can dream up schemes and those who link them to investors.

We saw a lot of that in the wine and blue gum industries about 20 years ago, when the more hint of a tax deduction paid up front made a lot of money for a lot of people – very few of them being the actual investors.

With those tax-driven schemes, the federal government had a similarly strategic approach to encouraging investment in sectors that were seen as important to the Australian economy.

It’s hard to suggest that hardwood has really been the boon hoped for, and wine has suffered from a glut in production for a decade and half. Clearly the artificial use of tax incentives failed.

Let’s hope this one, as complicated as it seems, does what it is intended to.

Wine tax

SPEAKING of wine, the tax-effective investment rules that became managed investment schemes might have spoiled the wine sector by encouraging too much production of very average wine, but the current tax law governing the sector is another poor policy response.

For some unfathomable reason, wine is taxed by price rather than by alcohol volume – even though the excise is designed to curb consumption for health reasons.

That has created the ridiculous proposition whereby the tax on a four-litre cask of wine is a fraction of that levied on a carton of full-strength beer with less alcohol content. That is obviously contrary to the intended reasons for the tax by skewing consumption towards a more alcoholic beverage.

It also hurts producers that are focused on premium wine. They pay way more tax on an expensive bottle of wine, which may have taken much more effort to produce and potentially years to store, than some rubbish pumped out to fill a cardboard box.

To assist smaller producers to overcome this crazy situation, the government gives them a rebate of $500,000. That covers a lot of makes but there are still many who wind up paying a lot more tax than the total alcohol volume they produce would warrant if it was say, beer.

Now that rebate is set to drop and more and more winemakers will be caught in the net. Many will go broke.

It’s a shame. Winemaking is the poster child of agribusiness: it involves high-tech processes in viticulture and manufacture; it is capital and labour intensive; it has global reach with well-marketed brands; and it has small, medium and large businesses, all operating successfully.

The industry and consuming public would be better served by a tax based on alcohol volumes. I’d drink to that.

Editor's note

The original article used the word 'deduction' instead of 'tax offset'. The latter is far more generous. Helpful reader EY senior manager, BTA R&D and technology, Kate Griffiths provided the following:

"The new incentive provides a 'tax offset' so it reduces the tax payable, rather than a 'deduction' which reduces your taxable income," Ms Griffiths said.

"For sophisticated investors, it provides a 20 per cent offset on up to $1 million in qualifying investments – tax offset is capped at $200,000. So by way of example, if you had $200,000 tax payable, it would reduce your tax liability to zero."