The federal government is considering preventing small investors from accessing tax incentives for early-stage startup investment, a move which has been widely criticised by the startup community.
In a policy discussion paper released earlier this week, further details of the concessional tax treatment for investors were released, including a proposal to limit the incentives to ‘sophisticated’ investors with net assets of at least $2.5 million and annual incomes of more than $250,000.
Announced as part of the government’s $1 billion innovation statement, investors will receive a 20% tax offset for investments in early-stage startups.
But according to the policy paper, retail investors may not be able to access these concessions due to concerns about risk.
“Investment in innovation companies is inherently risky,” the paper says.
“There is an argument that the class of eligible investors should be limited to sophisticated investors as a proxy to unlocking commercial expertise and as a way to reduce administrative costs by limiting the disclosure requirements during fund raising.”
Locking out retail investors
The proposal has been slammed by prominent investor and entrepreneur Steve Baxter, who says it goes against one of the core aims of the government’s innovation agenda.
“If the aim is to encourage more investment into ‘innovation companies’ then why do we care where the funds come from?” Baxter tells StartupSmart.
“Why is a dollar from a sophisticated investor worth more than a non-sophisticated investor? How has a tax measure to encourage investment in startup companies turned into being a benefit only for a certain class of investor?
“Why are we making this harder than it needs to be?”
While retail investors will need to be educated on the risks associated with startup investment, they shouldn’t be locked out completely from receiving the tax breaks, Pollenizer acting general manager Clare Hallam says.
“Restricting the incentives to sophisticated investors only removes mum and dad investors from taking advantage of the incentives,” Hallam says.
“Not all mum and dad investors meet the sophisticated investor requirement yet many are very intelligence and capable of understanding the risks.
“For Australia to become a truly innovative nation we need to commence this education and not exclude mum and dad investors.”
According to Connexion Media’s George Pathimos, the government needs to show more respect to these retail investors.
‘Mum and dad investors get treated almost like five year olds a lot of the time,” Pathimos says.
“The government says they’re not sophisticated, they’re not professional – it’s like a nanny state. Mum and dad investors are actually quite sophisticated even though they don’t meet the right criteria the government sets.
“They have an appetite to participate in the innovation economy but they’re being blocked because of this old-fashioned idea that they don’t know what they’re doing.”
The tax incentive details are “ridiculous” and should be more geared towards success stories, Ward says.
“They should be the other way around,” Ward says.
“Investors should not be given tax incentives at the start of their investment; instead they should have the incentives at the other end when the startup is a success.”
Defining an innovation company
The discussion paper also outlines how the tax incentives will be restricted to startups that are defined as an ‘innovation company’ – the “cornerstone” of the current debate.
These companies have to have been incorporated in Australia during the last three years, have assessable income of less than $200,000 in the last year and expenditure of $1 million or less in the last year.
A set of principles may also be applied to determine what exactly an ‘innovation company’ is.
“A principles-based definition is intended to be intuitive and draw upon established industry terminology which will allow the law to accommodate new innovative entities not yet envisioned at this point in time,” the paper says.
Brosa founder Ivan Lim says this is a necessary distinction to make.
“There is plenty more work to do but starting with creating a different classification for startups and innovation companies is important because the needs, risks and returns that come with a tech startup company are unique to other companies,” Lim says.
“Legislation to support funding of innovative companies is a positive step for building a new breed of companies that will power the Australian economy.”
But Hallam says the three years or younger clause is too restrictive.
“It could see several otherwise totally eligible companies miss out on the tax benefits in this policy,” she says.
“I suspect that many companies may be held in a dormant state while founders work out what’s next and it would be a shame to exclude companies such as this.”
SelfWealth founder Andrew Ward agrees, saying his own startup wouldn’t fit the government’s definition of an ‘innovation company’.
“I believe the definition which allows access to this tax incentive is too restrictive and should be open to a broader range of startups,” Ward says.
“It shouldn’t be limited to a particular time period or revenue generation. A startup can be 10 years old.
“SelfWealth is four years old and only now starting to boom. If a business has kept itself alive through bootstrapped and family and friends, to a point where it can get funding, then it shouldn’t be penalised for surviving so long.”
Baxter also raises a concern with the paper outlining how sophisticated investors should also be contributing “commercial or technical expertise” to their investments.
“We do not need a two-tier investment system that conflicts with that goal nor do we need investors burdened with non-monetary requirements that would discourage them – just start something,” he says.
“We need more capable founders trying more and different things.”
Submissions on the consultation paper close next Wednesday.