New crowd-sourced funding legislation for startups is meant to provide incentives for investors - but it doesn’t quite achieve that goal. Not, that is, when compared with the tax and other concessions that apply to other schemes.
Startups are inherently risky. All previous government measures to incentivise people to invest in things like early venture capital, research and development, employee share schemes and early stage innovation companies have involved some form of tax break.
But this new way of getting investors involved through crowdfunding will be treated just like any normal share issue — without any special tax offsets, write-offs or capital gains tax relief at all.
This type of investing became available under law last year but only for eligible unlisted public companies. The aims of the legislation are two-fold: to provide small businesses an additional option for funding (startups in particular) and to provide additional opportunities for retail investors to access early-stage investments.
The change to the law made it administratively simpler for companies to raise money without being subject to the normal disclosure requirements. Affected companies are also exempt from holding an annual general meeting and can provide reports to shareholders by merely making them available online (for a maximum five years). In addition, they don’t have to appoint an auditor until they have raised at least A$1 million.
But this legislation didn’t apply to proprietary companies - small, less regulated companies - which are the preferred structure for incorporated startups. These companies may only have a maximum of 50 non-employee shareholders — not much of a crowd if you need to raise the maximum-permitted A$5 million. Particularly if “mum and dad” investors are each limited to a A$10,000 investor cap.
New laws currently before parliament will extend crowd-sourced funding to proprietary companies and allow them to have an unlimited number of crowd-sourced funding shareholders. In exchange, they will have to meet higher governance and reporting obligations. This means preparing financial reports, having them audited, recording details of their share issues — and reporting any changes to the Australian Securities and Investments Commission.
By not allowing tax concessions for crowd-sourced funding, the government is departing from their past practice with start-up assistance and it could be a disincentive. But it may not deter the small “mum and dad” investors for whom the regime exists.
They can each invest no more than A$10,000, so they are more likely to be motivated by family or other connections with the companies’ founders. They could also be motivated by the promise of potentially unlimited gains.
In fact, if “mum and dad” investors were offered the same concessions that already apply to early stage innovation companies, they could be disadvantaged.
Investors in early stage innovation companies are entitled to both tax offsets and a modified capital gains tax treatment. This is only if both the companies and their share issues meet detailed conditions. If they do not, investors lose the concessions.
They may also lose them if they exceed their A$50,000 annual investment limit. Those risks simply do not exist for crowd-sourced funding investors.
The modified capital gains tax treatment for investing in early stage innovation companies is also a double-edged sword. While investors may escape capital gains tax on their gains in the first 10 years of their investments, any capital losses they incur, and the associated tax benefits, are also disregarded. Given the distinct possibility that any investment in a start-up may fail, crowd-sourced funding investors may be happy not to have that risk
Whether crowd-sourced funding will be attractive for small “mum and dad” investors, without tax or other incentives, is yet to be seen.
The first crowd-sourced funding intermediaries (through which all crowd-sourced funding investment applications must be channelled), were only licensed on January 11, 2018. So there haven’t been any attempts yet to raise funds under the new regime.
However, the fact that the government has already been willing to be flexible, by extending the regime to proprietary companies, is a positive step.
It may see the government extend taxation concessions to crowd-sourced funding in the future if take-up of this new option proves to be limited.
Authors: Stephen Graw, Emeritus professor, James Cook University