BDO submission on draft Innovative Business CGT Concession legislation

BDO has made a submission to Treasury in response to the exposure draft legislation, explanatory memorandum and draft legislative instrument for the Innovative Business CGT Concession, known as the IBCC.

Our submission identifies eight areas where the proposed framework would benefit from greater clarity, more proportionate rules and stronger protections for investors. These include the interaction between the IBCC and Early Stage Innovation Company regimes, the treatment of holding company structures, the operation of workforce and predominant activity tests, and the consequences of registration or reporting failures.

Key themes in BDO's submission

Clarifying the interaction between the IBCC and ESIC regimes

The explanatory memorandum does not clearly explain how the proposed IBCC is intended to interact with the existing Early Stage Innovation Company, or ESIC, framework.

Without a clear statement of policy intent, the two regimes may overlap in unintended ways or influence investment choices between early-stage and later-stage businesses. Investors, founders and advisers may also find it difficult to understand why an investment qualifies under one regime but not the other, or how the concessions are intended to apply throughout a company’s lifecycle and fundraising journey.

BDO recommends that the explanatory memorandum:

• Clearly identify the distinct purpose and target cohorts of the ESIC and IBCC regimes
• Explain how the two regimes are intended to interact
• Include worked examples covering different stages of a company’s lifecycle and circumstances in which an investment could potentially satisfy both regimes.

Accommodating holding company and group structures

Innovative businesses may use holding company structures for legitimate commercial reasons, including intellectual property ownership, asset protection, international expansion, acquisitions and investor requirements. However, the proposed framework appears to focus principally on investment in a single operating company and provides limited certainty where innovation activities are conducted across a group.

BDO considers that investors and founders should not be disadvantaged because a start-up adopts a commercially sensible group structure. Requiring all qualifying activities and assets to be held by the entity issuing the shares could encourage tax-driven restructuring, create transaction costs and fail to reflect the way venture-backed groups operate.

Our submission recommends:

• A clear look-through rule for wholly owned groups
• Assessment of the innovation and predominant activity tests on a consolidated group basis, supported by appropriate integrity rules
• Confirmation that shares in a holding company can qualify where the innovative business operates through controlled subsidiaries
• Examples addressing common start-up, venture capital, intellectual property and international expansion structures.

Clarifying the Australian workforce test

The draft legislation requires at least 50 per cent of the people engaged by a company to perform services to perform those services primarily in Australia. However, uncertainty remains about who is included and how the threshold should be measured.

It is unclear whether the test applies only to employees or extends to contractors, consultants and other service providers. The draft materials also do not specify whether the threshold is measured using headcount, full-time equivalent employees, labour hours, remuneration costs or another metric.

Further uncertainty arises where services are provided through another entity, such as an overseas service company, related party or non-tax-consolidated subsidiary. Businesses may be required to determine where the individuals performing those services are located, potentially creating significant compliance burdens.

BDO recommends that the legislation and explanatory memorandum clarify:

• Whether the test covers employees only or a broader population, including contractors and consultants
• How the 50 per cent threshold should be calculated
• How services supplied through related entities, subsidiaries and third-party providers should be treated
• Whether companies must look through an entity to the location of the individuals performing the services.

Providing practical guidance on the 75 per cent tests

Under the proposed predominant activity test, a company must satisfy at least two of three alternative limbs. These assess whether more than 75 per cent of its assets, employees or income are attributable to activities connected with developing or commercialising a qualifying innovation.

The draft materials do not provide sufficient guidance about how these thresholds should be measured, particularly where employees, assets and income support multiple activities or broader group operations. Businesses may have shared management teams, intellectual property used across several products, or employees and assets supporting both qualifying and non-qualifying activities.

BDO recommends detailed guidance explaining:

• How the asset, employee and income thresholds should be calculated
• What evidence taxpayers may use
• When an asset is “used primarily” for qualifying activities
• When an employee is “engaged primarily” in those activities
• How mixed-use assets, shared intellectual property, management functions and corporate overheads should be treated.

Worked examples should cover groups with controlled entities, businesses commercialising multiple innovations, software companies with shared development teams, and businesses moving from development into commercialisation.

Allowing innovative businesses to evolve

The predominant activity rules could cause a company to lose its qualifying status when its innovation focus changes. BDO considers the proposed 20-year period for determining whether the relevant innovation-based activity requirements have been met to be unduly long for fast-moving innovative businesses.

Successful start-ups commonly refine products, pivot their business models, combine technologies or commercialise adjacent opportunities. These developments can represent successful innovation rather than a departure from the policy objective.

BDO recommends:

• Replacing the 20-year period with a three-year period
• Introducing a transitional rule following a genuine pivot
• Preserving access to the concession for value accrued while the company qualified, with an appropriate method for apportioning later value
• Establishing a binding prospective ruling or determination process
• Providing examples that distinguish ordinary commercial evolution from a substantive departure from innovation-based activity.

Protecting investors from retrospective cancellation

Under the draft framework, a company’s registration may be cancelled retrospectively if the administering authority later decides that the company was never eligible or that its registration was based on incorrect information. The company may then be treated as never having been registered, potentially causing investors to lose the concession years after making their investment.

Investors may have little or no visibility of a company’s registration application, evidence or annual reporting. BDO considers that investors should not bear the tax risk associated with errors, omissions or interpretive differences they could not reasonably identify or control.

Our submission recommends:

• Making a registration determination conclusive for an investor unless the registration was obtained through fraud in which that investor participated
• Introducing a grandfathering or reasonable-reliance rule for investors who acquired an interest while the company appeared on the register
• Allowing company non-compliance to be addressed prospectively without retrospectively disadvantaging arm’s-length investors.

Addressing annual reporting failures proportionately

A failure to lodge an annual report can suspend a company’s registration and may cause investors’ interests to become disqualified assets during the suspension period. Investors may not know that the company’s registration has been suspended or that their tax position is temporarily at risk.

BDO recommends that companies and affected investors be notified before a suspension takes effect. Investors should also be protected where the failure is administrative and the company continues to satisfy the substantive eligibility requirements.

Introducing service standards for registrations and rulings

Registration timing may be critical to fundraising and transaction execution. Delays could jeopardise a capital raising or transaction, particularly during implementation when existing companies may seek to access transitional arrangements while also requesting rulings or determinations.

BDO recommends:

• Statutory timeframes for registration decisions, reviews and ruling requests
• Deemed approval where a complete application is not decided within the specified period, subject to targeted integrity safeguards
• An expedited pathway for companies satisfying objective safe-harbour criteria
• Publication of service performance data
• Clear guidance about when an application is considered complete.

Download the submission

Download the full BDO Submission - Draft legislation for the Innovative Business CGT Concession (IBCC) to read BDO’s detailed concerns and recommendations.

Download Submission

How BDO can help

BDO's tax specialists work with founders, investors, venture capital funds and growing businesses across Australia's innovation ecosystem. To discuss the proposed reforms and their potential impact on your business, speak with your local adviser or learn more about our tax services.