CROWD-SOURCED FUNDING WAS TAX CONSIDERED · Journal of the Australasian Tax Teachers Association...

JournaloftheAustralasianTaxTeachersAssociation2018Vol.13No.1

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CROWD-SOURCEDFUNDING–WASTAXCONSIDERED?

STEPHEN GRAW*

ABSTRACT

TheCorporationsAmendment(Crowd-sourcedFunding)Act2017(Cth)allows‘eligibleCSFcompanies’to‘crowdfund’,providedtheymeettheAct’sthresholdeligibilityandotherrequirements.Unfortunately,aspassed,theActexcludesallproprietarycompanies(andmostpubliccompanies)fromitsoperation,adefectthatisbeingrectified,atleastinpart,bytheCorporationsAmendment(Crowd-sourcedFunding forProprietaryCompanies)Bill2017 (Cth).Unlikeothermeasures thathave been introduced toassist innovativestart-ups, however, neither the 2017 Act nor the present Bill provide any taxationincentivesforeitherinvestorsorthecompany.Nordotheyaddressanyofthepossibletaxproblemsthatmayarisebecauseofthereform.Thispaperconsidersboththereformsandthosepossibleissues.

* StephenGrawRFD,BCom,LLB(Qld),SJD(Syd),FAAL,CTAisEmeritusProfessorofLawintheCollegeofBusiness,LawandGovernanceatJamesCookUniversity.


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I INTRODUCTION

TheCorporationsAmendment(Crowd-sourcedFunding)Act2017(Cth)waspassedon22March2017,receivedRoyalAssenton28March2017,andcommencedoperationon29September2017(thepracticaleffectofwhichwasthatcrowd-sourcedplatformswereable to apply for a licence1 to allow them to accept ‘CSF [crowd-sourced funding]investments’fromsmallinvestorsfromthatdate2).Underthelegislation, ‘eligibleCSFcompanies’areabletoaccesscrowd-sourcedequityfunding(CSF)providedtheymeetthethresholdeligibilityrequirements,passboththe‘assetstest’andthe‘turnovertest’,theamounttheyseekfallswithinthe‘issuercap’,thefundsareraisedthroughaCSFintermediaryandtheir‘CSFofferdocument’(and,ifitisnotincludedinthe‘CSFofferdocument’,their‘CSFoffer’)meetstherequirementsoftheAct.The Act has its origins in a reference to the Corporations and Markets AdvisoryCommittee(CAMAC)inJune2013.ThatreferencerequiredCAMACtoconsiderCSFandwhether itcouldbe facilitated inAustralia.CAMACreported in June2014,notingthatwhile CSF had potentially significant benefits for both fundraising companies andinvestors,thereweremajorregulatorybarrierstosmallbusinessesusingitasaneffectivemeansoffundraising.Thesebarriersincludedthe50non-employeemember‘shareholdercaps’thatapplytoproprietarycompanies,theCorporationsAct2001s113(3)’sprohibitiononproprietarycompaniesmakingpublicoffersofequity,andthereportingandcorporategovernancerequirements thatpublic companieshave tomeet thatwould, inmanycases,make ituneconomicforsmallbusinesstoadoptapubliccompanystructurepurelytofundraise.

TheendresultwasthatCAMACrecommendedthatCSFshouldbe facilitated forsmallbusinessesinAustralia,butthatamodifiedregulatoryregimeshouldbeintroducedtoallowittooccurinacost-effectiveway.3TreasurythenissuedaDiscussionPaperinDecember2014seekingsubmissionsonthreeidentified ‘PolicyOptions’ (theCAMACModel, a ‘RegulatoryFrameworkBasedon the

1PersonsintendingtooperateaCSFplatformarerequiredtoholdanAustralianFinancialServicesLicenceandmayberequiredtoholdanAustralianMarketsLicence:ExplanatoryMemorandumtotheCorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)para3.4.2ThefirstCSFintermediaries(throughwhichallCSFinvestmentapplicationsmustbechannelled)wereonly licensed on11 January 2018- nearly three and a halfmonths after theAct came into force. SeeAustralianSecuritiesandInvestmentsCommission(ASIC),AustralianGovernment,18-004MRASICLicensesFirst Crowd-Sourced Funding Intermediaries (11 January 2018) <http://asic.gov.au/about-asic/media-centre/find-a-media-release/2018-releases/18-004mr-asic-licenses-first-crowd-sourced-funding-intermediaries>.3Reducingtheregulatoryimpedimentstocrowdfundingwasalsoaspecificrecommendationofthe‘MurrayInquiry’: Treasury, Australian Government, Financial System Inquiry: Final Report (November 2014)Recommendation 18, 177. It was also supported by the Productivity Commission: ProductivityCommission,AustralianGovernment,BusinessSet-up,TransferandClosure:DraftReport(21May2015);ProductivityCommission,AustralianGovernment,BusinessSet-up,TransferandClosure:FinalReport(7December 2015) Recommendation 6.1, 150. The government also included CSF as a FinTech priority:AustralianGovernment,FinTechStatement(21March2016)18–19.


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NewZealandModel’andthe ‘StatusQuo’). InAugust2015, followingsubmissions, thegovernment releasedanoutlineof itsproposed framework.Legislationbasedon thatframework4wasintroducedintoParliamentinDecember20155andpassedtheHouseofRepresentatives. However, as it had not passed the Senate before the 2016 FederalElectionwascalled,itlapsed.

AnewBill,largelyreplicatingthe2015Bill,thoughwithmodificationstothe‘assetsandturnover’ testsandan increase in thecooling-offperiod from48hoursto5days,wasintroduced in 20166 and passed in March 2017. It inserted a new pt 6D.3A into theCorporations Act2001 (Cth), theobjectofwhich, asdetailed in thenews738A, is ‘toprovideadisclosureregimethatcanbeusedforcertainoffersofsecuritiesforissueinsmallunlistedcompanies,insteadofcomplyingwiththerequirementsofPart6D.2’.7That is, if theiroffersqualify for themodifieddisclosureregime,smallunlistedpubliccompanies canaccess concessions in relationtonotholdingannual generalmeetings,onlyreportingtoshareholdersonline,andnotappointingauditors-concessionsthatarenotgenerallyavailabletopubliccompanies.

Theaimofthenewregime,asdetailedintheExplanatoryMemorandum,isto‘provideanadditional funding option for small businesses and start-ups in particular, that mayotherwise struggle to obtain affordable finance’.8 The ExplanatoryMemorandum alsonotedthat‘[f]acilitatingCSFwouldalsoprovideadditionalinvestmentopportunitiestoretailinvestors,whoaregenerallyunabletogaindirectaccesstoearly-stagefinancingactivities’.9

II CROWD-SOURCEDFUNDING

A Whatiscrowd-sourcedfunding?CSFtypicallyinvolvesraisingfundsfroma(normally)largenumberofsmallcontributorstofinancesomespecificobjective.10Oneof theearliestmodernexamplesofCSFwas itsuse to finance theerectionof theStatueofLibertyinNewYork.WhiletheFrenchdonatedthestatueitself,theAmericans

4CorporationsAmendment(Crowd-sourcedFunding)Bill2015(Cth).5 It was also included as one of the measures aimed at encouraging funding for start-ups that wereannounced in:DepartmentofEducationandTraining,AustralianGovernment,National InnovationandScienceAgenda(7December2015);andincludedin:AustralianGovernment,Mid-YearEconomicandFiscalOutlook2015–16(15December2015).Theothersincludedprovidingtaxbreaksforearly-stageinvestorsininnovativestart-ups(implementedin2016throughtheinsertionofsub-div360-AintotheIncomeTaxAssessmentAct1997 (Cth) (ITAA97)),andaugmentingalready-existingmeasures toencourageventurecapital investment (implemented through theTax LawsAmendment (Tax Incentives for Innovation)Act2016(Cth)andtheTreasuryLawsAmendment(2017MeasuresNo1)Act2017(Cth)).6CorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth).7CorporationsAct2001(Cth)s738A,insertedbyCorporationsAmendment(Crowd-sourcedFunding)Act2017(Cth)s14.8ExplanatoryMemorandumto theCorporationsAmendment (Crowd-sourcedFunding)Bill2016(Cth)para1.6.9Ibidpara1.8.10Ibidpara1.5.


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wererequiredtoprovidethesiteandbuildthepedestalonwhichitwouldbeerected.In1885thestatuehadbeendeliveredandwasawaitingassembly,butNewYorkCityhadnotyetraisedtheentireUS$250000thatwasneededtopayforthepedestal.ThethenGovernor,GroverCleveland,refusedtousecityfundstomeettheshortfallandtheUnitedStates Congress was unable to agree on an alternative source of funds. Other cities(notably Boston, Philadelphia, Baltimore and San Francisco) were actively circling,offeringthemselvesasalternativelocations.Topreventthathappening,JosephPulitzer,the publisher of the New York World, launched a fundraising campaign through hisnewspaper, publishing the namesof every donor and the amounts they donated as apracticalincentive.WithinfivemonthsheraisedUS$101091fromover160000donors,eachofwhomdonated,onaverage,lessthanUS$1,butcollectivelythatwasmorethanenoughtocovertheshortfall.Amore recentwell-knownexamplewas theVeronicaMarsMovieProject,whichwaslaunched inMarch 2013 through ‘Kickstarter’ (a US ‘Benefit Corporation’ that runs aglobalcrowdfundingplatform‘tohelpbringcreativeprojectstolife’).IthopedtoraiseUS$2milliontofundamovie-lengthcontinuationoftheVeronicaMarstelevisionseriesandofferedpotentialcontributorsarangeof‘rewards’varyingfromadigitalpdfcopyofthemoviescriptforaUS$10pledgetoasmallwalk-onspeakingpartinthemovieforaUS$10000pledge(anoffertakenupbyonebacker).ItwasspectacularlysuccessfulandraisedtheentireUS$2millionthatithadsoughtwithin11hoursofopening.Bythetimeitclosed,exactlyamonthlater,91585fanshadpledgedatotalofUS$5702153.

Crowd-sourcing has also recently been extensively (and successfully) used to raisesubstantial funds for (especially) blockchain start-ups,11 for companies involved inhardware,12software13andvideogame14developmentandforarangeofotherinnovationprojects.15

B TypesofCSFTherearefourmodelsforCSF:

• Donation-based(fundsareraisedfromdonorswhoreceivenothinginreturn,apartfrom,perhaps, someacknowledgementof theirdonation–aswas the casewithPulitzer’sfundraisingfortheStatueofLiberty).

• Reward-based (funds are raised from contributors who receive some form ofrewardintheformofgoods,servicesorrights–perhapsrightstoafuturediscount–inexchangefortheircontribution.Typically,therewardsofferedaregraduated,withhigherrewardsforgreatercontributions-aswiththeVeronicaMarsMovie

11See,forexample,Filecoin(US$257million),EOS(US$185million),TheDAO(US$150million),Polkadot(US$144million),TenX(US$80million)andBANKEX(US$70.6million).12See,forexample,CoolestCooler(US$13.3million),UbuntuEdge(US$12.8million),PonoMusic(US$6.2million),MicroDrone3.0(US$3.6million)andTheDash(US$3.4million).13See,forexample,FirstbloodCrowdsale(US$6.3million),Lisk(US$5.7million),TheGrid(US$5.5million),andMastercoin(US$5million).14See,forexample,StarCitizen(US$181million),PrisonArchitect(US$19million),ShroudoftheAvatar:ForsakenVirtues(US$12.6million),Ouya(US$8.6million)andShanmueIII(US$6.3million).15See,forexample,ELIOMotors(US$102million),Glowforge(US$28million),Pebbletime(US$20million),BauBax(US$10.3million)andExplodingKittens(US$8.8million).


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Project.Therewardsmayalsobecontingentonthefundraisingreachingidentifiedminimumlevels).

• Equity-based(fundsareraisedfromcontributorsinexchangeforashare-orotherequityinterest-inthefundraisingentity.Thatgivesthosecontributorsthenormalrightsofshare-ownership,includingtherighttoparticipateinfuturedividends,therighttovoteincompanymeetingsandtherighttoparticipateinadistributionofsurpluscapitalonwinding-up).

• Debt-based(fundsareraisedfromcontributorswholendmoneytothepromotersinexchangeforagreedinterestpaymentsforthelifeoftheloanandapromiseofrepaymentonmaturity–whichcanbewithorwithoutapremiumfortherisk).

III THEAUSTRALIANPROVISIONS

A ThebackgroundCrowd-sourcedequity fundingschemescurrentlyexist inanumberofothercountriesincluding theUS, theUK,CanadaandNewZealand.16 Ingeneral, they seem tobe lessrestrictiveintheirapplicationthanthenewAustralianmodel17thoughatleastsomeofthe Australian provisions have been modelled on, in particular, the equivalent NewZealandprovisions.

Crowd-sourcedequityfundingislesspopularintheEU–thoughFrance,Germanyandthe Netherlands all have country-based regimes, none of which have yet been usedsuccessfully to raise large amounts of equity funding.18 Italy also introduced a newcrowdfundingregimein2013,whichwasinitiallyrestrictedto‘innovativestart-ups’butwasextendedto‘innovativesmalltomediumenterprises’in2015,achangethatseemstohavehadaverylimited(ifany)effectonitssuccess.Ontheevidencetodate,ithasnotbeenparticularlysuccessfulinallowingitstargetedcompaniestoraisesignificantsums.19

B CSFcoveredbythenewlegislationThe new Australian legislation only covers online equity-based CSF (though theTreasurerdidnoteinhisSecondReadingSpeechthatitwassimply‘anewfundingoptionfor small businesses’ and that it was not intended to displace ‘other forms of

16In2014–15,thefirst12monthsoftheNewZealandscheme,21innovationcompaniesraisedNZ$12.3millionusingCSF(a78percentsuccessrate),in2015–16,16companiesraisedNZ$10.8million(a57percentsuccessrate)and,in2016–17,18companiesraisedNZ$13million(a64percentsuccessrate).17IntheUS,theJumpstartOurBusinessStartupsAct2012(US)providestwoexceptionstothestandardprohibitionpreventingissuersofprivatesecuritiesfrom‘advertisingtheirofferingsorgenerallysolicitinginvestors’.Rule506(b)allowsanunlimitednumberof‘accreditedinvestors’andupto35‘non-accreditedinvestors’toinvestviaCSF,thoughtheprohibitionongeneralsolicitationstillapplies.Rule506(c)removestheprohibitionongeneralsolicitationbut,importantly,doessoinrelationto‘accreditedinvestors’only.18AngeloDelivorias,‘CrowdfundinginEurope–IntroductionandStateofPlay’(EuropeanParliamentaryResearch Service, 2017)<http://www.europarl.europa.eu/RegData/etudes/BRIE/2017/595882/EPRS_BRI(2017)595882_EN.pdf>.19MarinaNehme, ‘AustraliaNeedstoLearnfromItaly’sMistakes’,TheConversation,25February2016,<https://theconversation.com/crowd-sourced-funding-australia-needs-to-learn-from-italys-mistakes-55130>.


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crowdfundingalreadyavailable,suchasrewards-basedcrowdfundingandpeer-to-peerlending’,whichstart-upscouldalreadyusetofundandfinancetheiroperations.Itwasalso intended to ‘serve as both a complement and a source of competition to moretraditional fundingoptions forsmallbusinesses, includingbankdebtproducts.’20Eventhen,though,theentitiesthatcanaccessfundingbyusingthenewregimearerestricted.

IV HOWTHECSFREGIMEWORKS

Providedtheentityseekingtoraisefundsqualifiesasan‘eligibleCSFcompany’anditsofferisa‘CSFoffer’(ie,onethatis‘eligibletobemade’underthenewprovisionsandis‘expressedtobemade’underthem21),itcanaccesstheregime22–andCorporationsAct2001 (Cth) pt 6D.2 (which contains the general rules regarding when disclosure isrequired for offers of securities) and Part 6D.3 (which deals with the prohibitions,liabilitiesandremediesthatnormallyapplytooffersofsecuritiesthatrequiredisclosure)do not apply to its ‘CSF offers’ (unless there is a specific provision underwhich theycontinuetoapplytothem).23

A Qualifyingasan‘eligibleCSFcompany’Toqualifyasan‘eligibleCSFcompany’theentitymust:24

• beapubliccompanylimitedbyshares;25• haveitsprincipalplaceofbusinessinAustralia;• haveamajorityofitsdirectorsresidentinAustralia;• complywiththeassetsandturnovertest;

20 AustralianGovernment,ParliamentaryDebates, HouseofRepresentatives, 24November 2016, 4306(ScottMorrison,Treasurer).21CorporationsAct2001(Cth)s738B.22Ibids738G.23Ibidss703B,704and706(inrelationtopt6D.2)ands725A(inrelationtopt6D.3).Section738Edoes,however,alsoprovidethatthefactthatacompanymakesaCSFofferofsecuritiesdoesnotpreventitfromalsomakinganofferofsecuritiesofthesameclassinrelianceonaprovisionofs708.Consequently,acompanycouldmakeaCSFoffertocrowdinvestorsand,atthesametime,alsomakeanoffertoinvestorsforwhom disclosure is not required anyway – such as venture capital funds and angel investors: seeExplanatoryMemorandumtotheCorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)para2.7.24CorporationsAct2001(Cth)s738H(1).25 To beeligible for the regime’s limited governance requirements acompanymust, at present, eitherregisterasapubliccompanylimitedbysharesorconvertfromaproprietarycompanytoapubliccompanylimitedbyshares:CorporationsAct2001(Cth)s738ZI.Whileexistingpubliccompanies(whicharealreadycoveredbytheCorporationsAct’smorestringentgovernancerequirements)maybeabletomakeaCSFoffer,theyarenoteligibleforthenewconcessionsand,therefore,cannot,thereby,escapetheirexistingcorporate governance and reporting requirements: Explanatory Memorandum to the CorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)para7.20.LegislationcurrentlybeforeParliamentwillextendtheavailabilityofCSFtoproprietarycompanies:seeCorporationsAmendment(Crowd-sourcedFundingforProprietaryCompanies)Bill2017(Cth).


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• notbealistedcorporation26(arestrictionthatappliestoboththecompanyandanyrelatedpartyofthecompany27);and

• nothaveasubstantialpurposeofinvestinginsecuritiesorinterestsinotherentitiesormanagedinvestmentschemes(arestrictionthatappliesnotonlytothecompanyitselfbutalsotoanyrelatedparty).

The ‘assets and turnover test’ is satisfied if, at the ‘test time’,28 the value of theconsolidatedgrossassetsofthecompanyandallofitsrelatedentitiesislessthanAU$25million (or, if the regulations specify a different amount, that amount) - and theconsolidated annual revenue of the company and all of its related parties for the 12-month period immediately prior to the company determining its eligibility tocrowdfund,29islessthanAU$25million(or,iftheregulationsspecifyadifferentamount,thatamount).30Offerscanalsoonlybemadebyoronbehalfofalreadyexistingcompanies;theycannotbemadeiftheyrelateto‘acompanythathasnotbeenformedordoesnotexist’.31

B EligibleoffersAnofferwillbe‘eligibletobemadeunderthisPart’ifandonlyif:

• itisanofferbythecompanyfortheissueofsecuritiesofthecompany;32• thecompanyisan‘eligibleCSFcompany’whentheofferismade;• the securities are of a class specified in the regulations (under the current

provisionstheymustbefullypaidordinaryshares33-butthatrequirementonlyappears in the regulations so it can readily be changed if it is found to beunnecessarilyrestrictive34);

• theoffercomplieswiththe‘issuercap’;and

26Listedcompaniesareexcludedbecausetheyhavealready‘demonstratedanabilitytobearthecostsofcompliance requirements associatedwith listing ona publicmarket’ and because they ‘generally haveaccesstootherformsofequityraisingsbecauseoftheirlistingandcontinuouslydisclosingstatus,suchasrights issues and share purchase plans’: Explanatory Memorandum to the Corporations Amendment(Crowd-sourcedFunding)Bill2016(Cth)para2.27.27‘Relatedparty’isdefinedinCorporationsAct2001(Cth)s738G(3)as‘arelatedbodycorporateofthecompany’or‘apersonwhocontrolsthecompanyoranassociateofthatperson’.28Thetimewhenthesharesareissuedand,therefore,thetimeatwhichthecompanymustbean‘eligibleCSFcompany’:seeCorporationsAct2001(Cth)s738ZH(1).29Companiesthathavebeeninexistenceforlessthan12monthswillstillbeabletocrowdfundsolongastheir consolidatedannual revenue for the period that they have been on foot is underAU$25million:ExplanatoryMemorandumtotheCorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)para2.25.30CorporationsAct2001(Cth)s738H(2).31Ibids738ZF.32 The offer can only be for an initial issue of securities, not for a subsequent sale: see ExplanatoryMemorandumtotheCorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)para2.12.33CorporationsRegulations2001(Cth)reg6D.3A.01(1).34ExplanatoryMemorandumtotheCorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)paras2.31–2.34.


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• thecompanydoesnotintendthatthefundsraisedwillbeused,eitherbyitselforbyarelatedparty,toinvestinsecuritiesorinterestsinotherentitiesorschemes.35

The ‘issuer cap’ is AU$5millionor, if the regulations specify a different amount, thatamount.The‘cap’isthemaximumthatthecompanycanraiseinasingleyearandincludesnotonlythemaximumamountthatitintendstoraisethroughitscurrentofferbutalsoanyamountsthatit,orarelatedparty,raisedthroughotherCSFoffers-togetherwithallotheramountstheyraisedwithintheimmediatelypreceding12monthsincircumstanceswhereCorporationsAct2001(Cth)ss708(1)or(10)didnotrequiredisclosure.36Acompany(anditsrelatedparties)canalsohaveonlyoneCSFofferopenatatime.37

IfanofferdoesnotqualifyasaCSFoffer,itthengenerallydefaultstobeinganofferthatdoesrequiredisclosureunderCorporationsAct2001(Cth)pt6D.2-sofailingtolodgethe required disclosure documents with the Australian Securities and InvestmentsCommission(ASIC)becomesanoffence.38

C TheofferdocumentA ‘CSF offer document’ must be prepared and itmust contain all of the informationrequiredbytheregulations.39Perhapssurprisingly,thatdoesnotincludefulldetailsofthe‘CSFoffer’40-though,ifitdoesnot,aseparateCSFoffermustbepublishedtogetherwiththe‘CSFofferdocument’.41Amongotherthings,the‘CSFofferdocument’mustsetoutboththe ‘maximumsubscriptionamount’andthe ‘minimumsubscriptionamount’beingsoughtthroughtheoffer.42Itmustalso‘bewordedandpresentedinaclear,conciseandeffectivemanner’43anditmustbe‘published’.Itisherethattheroleofthe‘CSFintermediary’comesintoplay.ACSFoffercanonlybemade44bypublishingacomplyingCSFofferdocument‘onaplatform

35CorporationsAct2001(Cth)s738G(1).36Ibids738(2).37Ibids738R.Acompanyhavingmorethanoneofferopenatatimecommitsanoffence:s1311(1).38 Ibid s 727(1). See also ExplanatoryMemorandum to the Corporations Amendment (Crowd-sourcedFunding)Bill2016(Cth)paras2.53–2.54.39CorporationsAct2001(Cth)ss738J(1)and(2).40The‘informationrequiredbytheregulations’includesaTableofContents,RiskWarnings,informationabout the offering company, information about the offer, and information about investor rights:CorporationsRegulations2001(Cth)regs6D.3A.02–6D.3A.06.TheCSFofferdocumentmayalsosetouttheCSFofferitself:CorporationsAct2001(Cth)s738J(2).41CorporationsAct2001(Cth)s738L(1).42 Ibids738L(7)and (8), respectively.Once theoffer is fully subscribed to themaximumsubscriptionamount, the responsible intermediary must close the offer: s 738N(4)(c). If the applications that arereceived(andnotwithdrawn)donotat leastequaltheminimumsubscriptionamount,theresponsibleintermediarymustrefundallapplicationmoneyreceived:s738ZB(3).Failuretocomplyisastrictliabilityoffence:s738ZB(5).43Ibids738K.44Ibids738L(3)providesthatcompanies‘mustnotmaketheCSFofferotherwisethaninaccordancewith[therequirementtomakeitthroughaCSFintermediary]’.Iftheydotheycommitanoffence:s1311(1).


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ofasingleCSFintermediary’45–anentitydefinedas‘afinancialserviceslicenseewhoselicenceexpresslyauthorisesthelicenseetoprovideacrowdfundingservice’.46

D Roleofthe‘CSFintermediary’TheCSFintermediaryhasanumberofdefinedrolesintheCSFprocess,allofwhichareaimedatprotectinginvestors.First, it has a defined statutory ‘gatekeeper’ role.47 It must not publish a CSF offerdocumentunless ithas firstconductedthechecksrequiredbytheregulations48and issatisfiedastotheidentityandbonafidesofboththecompanymakingtheofferanditsdirectorsandofficers.Itmustalsobesatisfiedthattheofferiseligibletobemadeunderpt6D.3Aand isnotmisleadingordeceptive.49 If it fails toconduct thosechecks(or toconductthemtoareasonablestandard)itcommitsastrictliabilityoffencewithapenaltyofupto50penaltyunits.50Second, the responsible intermediarymustensure that ‘thegeneralCSF riskwarning’appears prominently on the offer platform at all times while the offer is open orsuspended.51Thegeneralriskwarningisastatementintermsthatareprescribedbytheregulations.52Third, the responsible entity must ensure that an ‘application facility’ (a facility forinvestorstomakeanapplicationundertheoffer)isavailableatalltimeswhentheofferisopen;53thatanyapplicationmadeotherthanthroughthatfacilityisrejected;54andthata‘communicationfacility’isprovidedthroughwhichpotentialinvestorscanmakepostsrelatedtotheoffer,seepostsmadebyothersandaskquestionsabout theoffer–andthroughwhichitorthecompanycanmakepostsorrespondtoquestionsorposts.55

45Ibids738L(1).WhileadvertisingaCSFofferorintendedCSFofferisgenerallyprohibited(s738ZG(1)),that prohibition does not apply to publishing a CSF offer or a CSF offer document on a responsibleintermediary’splatform:s738ZG(2).46Ibids738C.CSFintermediariesarethereforerequiredtoholdanAustralianFinancialServicesLicence.DependingonthenatureoftheactivitiesinwhichtheCSFintermediaryengagesit‘couldalsobeconsideredto be operating a financial market and therefore be required to hold an Australian Market Licence’:ExplanatoryMemorandumtotheCorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)para3.8. TheMinister has power under ibid s 791C to exempt operators from the requirement to hold anAustralianMarketLicence.47CorporationsAct2001(Cth)s738Q.48Ibids738Q(1).49Ibids738Q(5).50Ibidss738Q(3)and1311(1).51Ibids738ZA(1).ThedetailedwordingoftheriskwarningissetoutinCorporationsRegulations2001(Cth)reg6D.3A.03.52CorporationsAct2001(Cth)s738ZA(2).SeealsoCorporationsRegulations2001(Cth)reg6D.3A.03.53CorporationsAct2001(Cth)s738ZA(3).54Ibids738ZA(4).55Ibids738ZA(5).Theintentisthatinvestorswillbeableto‘relyonthecollectivewisdomofthe“crowd”inmakingtheirinvestmentdecision’:ExplanatoryMemorandumtotheCorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)para3.64.


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Fourth, itmust ensure that statements drawing investors’ attention to their rights towithdrawtheirapplicationsduringthecoolingoffperiod56andtheprocessbywhichthatcanbedone,appearprominentlyontheplatform.57Fifth,thefeestheintermediarychargesthecompanyanddetailsofanypecuniaryinterestthattheintermediaryhasorexpectstoacquireineitherthecompanyorarelatedpartymustalsoappearprominentlyontheplatform.58Failingtocomplywithanyof thoseobligations isalsoanoffenceandrenderstheCSFintermediary liable to a penalty of up to 60 penalty units and/or one year’simprisonment.59Finally,thearrangementbetweenthecompanyandtheCSFintermediary(the‘hostingarrangement’)mustrequirethatallapplicationsmadeinresponsetotheoffer,andallapplicationmoneyinrespectofthoseapplications,besentorpaidtotheintermediaryand be then dealt with by the intermediary in accordance with the provisions ofCorporationsAct2001(Cth)pt6D.3A.60

E OpeningandclosingaCSFofferACSFofferremains‘open’untilitis‘closed’.61Itopenswhenitisfirstpublishedontheresponsible intermediary’s platform and it closeswhen the responsible intermediaryclosesit–whichmustbeassoonaspracticableafterthefirstof:aperiodofthreemonthssincetheofferopens;thespecifiedenddatefortheoffer;theintermediaryconsidersthattheoffer is fullysubscribed; thecompanynotifies theresponsible intermediarythat itwantstheofferwithdrawn;ortheActprohibitsthecontinuedpublicationoftheCSFofferdocument.62

F AcceptingaCSFofferInvestorscanonlyacceptaCSFofferbymakinganapplicationthroughtheresponsibleintermediary (using the ‘application facility’ provided). ‘Retail clients’ must also firstcompletean‘acknowledgement’thatcomplieswiththerequirementsoftheregulations.63

Theresponsibleentitymustrejectanyapplicationthatismadeotherwisethanthroughthe application facility (and, as retail clients cannot make an application withoutcompleting the required acknowledgement, that also effectively means that the

56Investorsmaywithdrawtheirapplicationwithinfivebusinessdays:CorporationsAct2001(Cth)s738ZD.57Ibids738ZA(8).58Ibids738ZA(9).59 Ibids1311(1).SeealsoExplanatoryMemorandumto theCorporationsAmendment (Crowd-sourcedFunding)Bill2016(Cth)para3.56.60CorporationsAct2001(Cth)s738L(2).Theresponsibleentities’obligationsinrelationtoapplicationmoneyaresetoutins738ZB.Itprovidesthatthegeneralobligationsinpt7.8div2sub-divAcontinuetoapply,withsomemodificationsprovidedforinthatsection.61Ibids738N(1),(2)and(3).62Ibids738N(4).Failingtoclosetheofferwhenrequiredisanoffence:s1311(1).63Ibids738ZA(3)(b).Thedetailedwordingofthe‘acknowledgement’(whichacknowledgesthattheretailclient has read the offer document, understands the riskwarning and is aware of the availability andoperationofthecommunicationfacility)issetoutinCorporationsRegulations2001(Cth)reg6D.3A.07(2).


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responsibleentitymustrejectanyapplicationthatisnotaccompaniedbyacompletedacknowledgement).64Inaddition, the legislationprovidesanumberofotherprotections for investors.First,individual‘retailclients’65arelimitedtoinvestingamaximumofAU$10000inCSFoffersbythesamecompany inany12-monthperiodandtheresponsible intermediarymustrejectapplicationsthatexceedthatamount.66Further,neitherthecompany,noranyrelatedparty,northeresponsibleintermediary,mayprovidefinancialassistancetoallowthatinvestortomaketheinvestment.67

G TheregulatoryconcessionsForcompanieswhoseoffersqualifyundertheCSFrulesthereareanumberofregulatoryconcessionsthatareintendedtoremovewhat theTreasurerreferredto inhisSecondReadingSpeechforthe2016Billas ‘unnecessaryregulatorybarriers…[to]Australia’sinnovativeearly-stagebusinessestoobtainthecapitaltheyneedtoturngoodideasintocommercialsuccesses’.68Theseinclude,foraconcessionperiodofuptoamaximumoffiveyears:

• modifieddisclosureobligationsintheCSFofferdocument;• anexemptionfromtherequirementtoholdanAGM;• an option to provide reports to shareholdersmerely by making them available

online;and• anexemptionfromtherequirementtoappointanauditoruntilthecompanyhas

raisedatleastAU$1million69fromCSFoffers.

V AVAILABILITYOFTHECSFREGIME

A InitiallylimitedtoaselectgroupofpubliccompaniesAs indicatedabove, as theCSF regimewasoriginally intended tooperate, itwasonlyavailabletounlistedpubliccompanieslimitedbyshares,withlessthanAU$25millioninbothgrossassetsandannual revenue.Consequently, allproprietaryandmanypublic

64CorporationsAct2001(Cth)s738ZA(4).65Definedinibids738Das‘apersonwhoisaretailclientforthepurposesofChapter7inrelationtoacrowdfundingservicethatrelatestoaparticularCSFoffer’.Chapter7providesthatfinancialservicesorproducts will be provided to a person as a retail client unless the exclusions in sub-ss 761G(5)–(7)(‘wholesaleclients’)ors761GA(‘sophisticatedinvestors’)applytothem.66Ibids738ZC(1).Anintermediarywhofailstorejectanapplicationthatexceedstheretailinvestorcapcommitsanoffence:s1311(1).Thereare,however,nopenaltiesforinvestorswhomake,orpurporttomake,applicationsthatexceedthatcap:seeExplanatoryMemorandumtotheCorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)paras6.15–6.17.67CorporationsAct2001(Cth)s738ZE.Failuretocomplywiththisprohibitionisanoffence:s1311(1).68AustralianGovernment(Morrison),aboven20.69Under the CorporationsAmendment (Crowd-sourcedFunding for Proprietary Companies)Bill 2017(Cth) the audit threshold is to be raised fromAU$1million to AU$3million to align itwith the auditthresholdbeingproposedforproprietarycompaniesoncetheyarepermittedtoraisefundsthroughCSF.


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companies were automatically excluded. Thismeant that the option of raising fundsthroughcrowd-sourcingwasdeniedtoabout99.7percentofallAustraliancompanies.70However,evenforcompaniesthatdidqualify, theavailableconcessionshada limitedlifespan(andthereforeconferredalimitedbenefit).

B Problemswitheligibilityandthelimited‘concessionperiod’While unlisted public companies can raise funds through crowd-sourcing, and aregrantedanumberofexemptionsfromtheCorporationsAct’sstandardpubliccompanyregulatoryobligationstoallowthemtodoso(reduceddisclosureobligations,exemptionsfromtherequirementtoholdanAGM,abilitytoprovidereportstoshareholderssimplybymakingthemavailableonline,andexemptions fromtherequirementtoappointanauditoruntil thecompanyhadraisedat leastAU$1million fromitsCSFoffers), thoseexemptions only apply for a maximum five-year concession period (starting once ‘asuccessfulCSFround’hasbeencompleted).71The facts that CSF is only available to that limited group of companies and that theavailableconcessionsare‘time-limited’bothhaveanumberofnegativeeffects:

1. Ifasmallbusiness(includingastart-up)wantstoraisecapitalthroughCSFithaseither to register as, or, if it was already registered as a proprietary company,convertto,apubliccompanytobeeligibletodoso.

2. As the concessions only last for a maximum of five years, the small business(especiallyifitisastart-up)needstoconsider,carefully,whereitwouldbeattheendoftheconcessionperiodbeforedecidingtoregisterorconvert.Theriskisthat,havingregisteredas(orconvertedto)apubliccompanytoattractinitialcapital,itcould be stranded with a structure that, because of the ‘standard’ complianceburdens that will apply to it once the concession period ends, is not reallyappropriateforitsbusiness(especiallyifitdoesnotachievethesortofscalethatwouldjustifysuchastructure).72

3. Because‘investors(especiallyventurecapital)generallyconsiderpubliccompaniesalessattractivetargetduetothecomplexitiesandshareholderconsentassociatedwith takeover laws’,73 the requirement to register as, or convert to, a publiccompanycouldalsoadverselyaffectcompaniesiftheyintendtoexittheirbusinessviaatradesaleafteritmatures.

4. Becausethetype(andthereforethenumber)ofcompaniesthatcanusethenewrules is limited, the number of CSF intermediaries that can expect to operate

70MarinaNehme, ‘Australia Finally Has Crowd-SourcedEquity Funding, But There’sMore toDo’,TheConversation,22March2017<https://theconversation.com/australia-finally-has-crowd-sourced-equity-funding-but-theres-more-to-do-74921>.71 SeeExplanatoryMemorandum to the CorporationsAmendment (Crowd-sourcedFunding)Bill 2016(Cth)paras7.8,7.25and7.31.72ThisproblemisexpresslyrecognisedintheExplanatoryMemorandumtotheCorporationsAmendment(Crowd-sourcedFundingforProprietaryCompanies)Bill2017(Cth)para2.41.73Ibidpara2.38.Seealsoparas2.6and2.16.


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profitablyascommerciallysuccessfulbusinessesisalsolimited.That,inturn,canleadtoreducedcompetitionandincreasedcostsforcapital-raisingcompanies.74

5. Tosomeextent,theavailableconcessionsalsolimitinvestors’abilitytocontroltheirrisk.Inparticular,theabsenceofauditandAGMrequirementsmeansthatinvestorsmayfinditdifficulttoidentifyandreacttoproblems(by,forexample,changingtheboard,changingthecompany’sdirectionoreven,inextremecases,windingitup).

6. Thefact that thecompanymustbeunlistedraisesanadditionalprobleminthat‘bailingout’canbedifficultandshareholderswantingorneedingtoextracttheirinvestmentmayfinditdifficult(orevenimpossible)toselltheirshares.75

C ProblemswithexcludingproprietarycompaniesAbout 98 per cent of all companies in Australia are proprietary companies.76 Theproprietary companystructure is also theone that ismost favouredby start-upsandearly-stage companies.77 Therefore, excluding proprietary companies from the CSFregimewasalwaysgoingtobeproblematic-andthathaslongbeenknown.

Forexample,eveninhisSecondReadingSpeechforthe2016BilltheTreasurerreferredtothepossibilityofextendingtheavailabilityofCSFtoproprietarycompanies–notingthat a consultation paper on that possibility had been released in 2015 and that thegovernmentwascontinuingtoconsultonhowitmightwork.78Theproblemwas,ofcourse,thatproprietarycompaniesaregenerallyprohibitedfromoffering shares to thepublic79- soallowing them to crowdfund immediately raisedanumberofbasicissueswiththeveryconceptsunderwhichtheyareallowedtooperate.

D Solvingthe‘proprietarycompanyproblem’Despitethat,inthe2017BudgettheTreasurerannouncedthattheavailabilityofcrowd-sourcedequityfundingwouldbeextendedtoproprietarycompanies.Thereason,hesaid,wastomakeitpossibleforagreaternumberofinnovativecompaniesandstart-upstoaccessthatoption.

74Ibidpara2.41.InItaly,wheretheavailabilityofCSFisrestricted,onlyoneCSFintermediaryequivalentcurrentlyexists.Similarly,inNewZealandanumberofintermediarieswereestablishedinitially,andsomehavealreadywithdrawnfromthefield:seeNehme,aboven70.75 The Explanatory Memorandum to the Corporations Amendment (Crowd-sourced Funding forProprietaryCompanies)Bill2017(Cth)para2.37doessuggest,though,that,‘aspubliccompaniesmaintainamoreconsistentflowofinformationtothepublic,itismorelikelythatasecondarymarketinsharesinpublicCSFcompaniescouldbedevelopedintime.’76Ibidpara2.38.77Ibidparas2.38and2.40.78AustralianGovernment(Morrison),aboven20.79CorporationsAct2001(Cth)s113(3)effectivelyprohibitsaproprietarycompanyfromofferingitssharestootherthanitsexistingshareholdersoremployeesofitselforofasubsidiary.


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DraftlegislationtogiveeffecttothatannouncementwasreleasedinMay2017andwasintroduced into Parliament on 14 September 2017.80 It passed the House ofRepresentativeson26February2018.Undertheproposedlegislation,proprietarycompaniesthatmeettheAct’srequirementswillbepermittedanunlimitednumberofCSFshareholdersbut,inexchange,willhavetomeethighergovernanceandreportingobligations.Inparticular,theywillhavetohaveaminimumoftwodirectors(atleastoneofwhommust reside in Australia), will have to prepare financial reports in accordance withaccountingstandards(whetherornottheyare‘largeproprietarycompanies’–theonlyproprietarycompaniesthatarecurrentlysubjecttothatrequirement),willberequiredtohavethosestatementsaudited(atleastaftertheyraisemorethanAU$3millionfromCSFoffers),willhaveadditionalreportingobligations(theywillhavetorecorddetailsoftheirCSFoffersandCSFshareholdersandreportanychangestothosedetailstoASIC)and,toprotectinvestors,willbesubjecttorestrictionsonrelatedpartytransactions.IfproprietarycompaniesdoqualifytoundertakeCSF,theprocessunderwhichtheycanraise capitalusingCSFoffers is very similar to thatwhichpresentlyapplies topubliccompanies.Inparticular,thelocation,assetsandturnovertests,issuercap,investorcap,offer requirements, CSF intermediary requirements (and obligations), communicationfacility requirements, cooling off rights, prohibitions on financial assistance andadvertising restrictions will all be the same for them as they are for eligible publiccompanies.

OnechangethatwillbemadetotheexistingCSFregimeisthat,oncethenewlegislationispassed,thetemporaryconcessions(thoseapplicabletoAGMs,reportingandaudit)thatcurrentlyapplywillberemoved–subjecttoagrandfatheringofthosearrangementsforcompaniesthatregisteredorconvertedtopubliccompaniesprior to theregimebeingextended to proprietary companies.81 This is a direct consequence of the proposedchangebecause those concessions ‘were initiallyonlygrantedon theassumption thatproprietary companies would not have the opportunity to access crowd-sourcedfunding’.82

E TaxationconsiderationsMaking CSF available is merely one of many measures that have been introduced,especiallyinthelast20years,toassistinnovation-basedenterprises,especiallyintheirstart-upphase.Those measures really began with the tax incentives for ‘early venture capitalinvestments’(EVCIs)thatinvestorsmadethroughVentureCapitalLimitedPartnerships(VCLPs), Early Stage Venture Capital Limited Partnerships (ESVCLPs) or AustralianVentureCapitalFundsofFunds(AFOFs).

80CorporationsAmendment(Crowd-sourcedFundingforProprietaryCompanies)Bill2017(Cth).81SeeproposedamendmentstoCorporationsAct2001(Cth)s738ZI:CorporationsAmendment(Crowd-sourcedFundingforProprietaryCompanies)Bill2017(Cth)sch1pt1items42,43and44.82ExplanatoryMemorandumtotheCorporationsAmendment(Crowd-sourcedFundingforProprietaryCompanies)Bill2017(Cth)para2.27.Seealsopara2.34


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Thoseincentives,whichwereprovidedthroughacombinationoftheVentureCapitalAct2002(Cth)andamendmentstoboththeAustralianGovernment’staxationlegislationandthe individual state and territory PartnershipActs,83 were intended to facilitate non-residentinvestmentintheAustralianventurecapitalindustry.Theydidthatbyprovidingthoseinvestorswithanexemptionfromcapitalgainstax(CGT)ontheirEVCIs(providedtheyhadheldthemforatleast12months)andanexemptionfromincometaxontheirshareoftheprofitsthatweremadebythebusinessesinwhichtheyhadinvested.84In addition, under the Income Tax Assessment Act 1997 (Cth) (ITAA97) div 355,businesses can access a research and development (R&D) tax offset, which is jointlyadministeredbyAusIndustryandtheAustralianTaxationOffice(ATO).85Itreplacedtheformerly available ‘R&D Tax Concession’ and allows eligible R&D entities that incureligible R&D expenditure on defined ‘core’ or ‘supporting’ R&D activities to a self-assessedtaxoffset,thenatureandextentofwhichdependsonthesizeoftheR&Dentity’sturnoverandtheamountofitseligibleexpenditure.R&Dentitieswithanaggregatedturnoverof less thanAU$20million,onaworldwidebasis,areentitledtoarefundabletaxoffsetequalto43.5percentoftheirtotaleligibleR&Dexpenditure for theyearof income; thosewithanaggregatedturnoverofAU$20millionormoreonthesameworldwidebasisareentitledtoanon-refundabletaxoffsetequalto38.5percentoftheirtotaleligibleR&Dexpenditureforthatyear–inbothcases,providedtheyhavenotionaldeductionsofat leastAU$20000.86Since2014,however,thoseoffsetshavebeenlimitedtothefirstAU$100millionoftheaffectedR&Dentity’seligibleR&Dexpenditureforthatyear.AseparateoffsetequaltothecompanytaxrateisavailableforexpenditureoverAU$100million.Thoseoffsetsareinlieuofataxdeduction,sotheirneteffectisthatentitiesundertheAU$20millionthresholdreceiveaminimumnetbenefitof13.5¢inthedollarandthoseoverthethresholdreceiveaminimumnetbenefitof8.5¢inthedollar–atleastuptoanotional R&D expenditure of AU$100 million. After that, the net effect of the then-availablelesseroffsetis,effectively,toprovideanimmediatewrite-offforthatadditionalexpenditure.Toassiststart-upstoattractstaff,theITAA97div83Awasalsoamendedin2015,inlinewith the government’s Industry Innovation and Competitiveness Agenda,87 to provide,inter alia, a ‘start-up’ concession for shares and options that eligible small start-up

83InWesternAustralia,therequiredpartnershiplawchangesarecontainedintheLimitedPartnershipsAct2016(WA).InNewZealandthesameconsiderationsledtoboththepassageoftheLimitedPartnershipsAct2008(NZ)andchangestotaxationlegislationtoencourageventurecapitalinvestmentintoNewZealand.84Onthedownside,lossesonbothcapitalandrevenueaccountarealsodisregarded.85AusIndustryhasresponsibilityforregistrationandadministrationofprogrammeactivitiesunderptIIIoftheIndustryResearchandDevelopmentAct1986(Cth);theATOhasresponsibilityforadministrationofexpenditureonwhatmightbeeligibleR&DactivitiesundertheITAA97div355.86Theoffsetswereoriginally45percentand40percent,respectivelybuttheywerereducedbytheBudgetSavings(Omnibus)Act2016(Cth).Thenewratesapplyforincomeyearscommencingonorafter1July2016.87AustralianGovernment,IndustryInnovationandCompetitivenessAgenda:AnActionPlanforaStrongerAustralia(2014).


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companies issue to their employees in lieu of the higher salaries that they mightotherwisehavetopaytoattractappropriatetalenttotheirbusinesses.Inaddition,since1July2015start-upcompanies,partnershipsandtrustshavebeenabletoaccessanimmediatewrite-offunderITAA97s40-880(2A)foranycapitalexpenditurethat they, as ‘small business entities’ (defined in ITAA97 s 328-110), incur either inobtainingadviceorservicesrelatingtotheproposedstructureorproposedoperationofthe business or in paying government agency fees, taxes or charges relating toestablishingeitherthebusinessitselforitsoperatingstructure.Thisdoesnotallowthemtoimmediatelywrite-offallset-upexpenditure88butmanyofthoseotherexpensesmaybedeductibleoverfiveyearsunderotherprovisionsins40-880.More recently, in 2016, the Tax Laws (Tax Incentives for Innovation) Act 2016 (Cth)introducedarangeof‘taxincentivesforearly-stageinvestors’,byinsertinganewsub-div360-A into the ITAA97 to augment the other, already existing,measures- especiallythoseapplicabletotheventurecapitalindustry.Subdivision 360-A provides tax incentives to encourage ‘angel investors’ to invest ininnovativeAustralianstart-upcompaniesatastageearlier thanthatatwhichventurecapital funds are typically willing to invest.89 In particular, the tax incentives wereintendedtomakeiteasierfor‘early-stageinnovationcompanies’(ESICs)‘toattractseedandpre-commercialisationequityatanearlierstageoftheirdevelopment’,90particularlytogettheirinnovationsfromtheconcepttothecommercialisationstage91-aninterimperiodcommonlyknownas‘thevalleyofdeath’.The tax incentives that ‘angel investors’ can access under sub-div 360-A are a non-refundablecarry-forwardtaxoffsetof20percentofthevalueoftheinvestmentuptoamaximum‘taxoffsetcap’ofAU$200000(with,toprotect‘non-sophisticated’investors,atotal annual investment limitof AU$50000 for retail investors), and a ‘modified CGTtreatment’thatallowsearly-stageinvestorstodisregardanycapitalgainstheymakeontheirsharesineligibleESICs,providedtheshareshavebeenheldforbetweenoneandtenyears92–ataxtreatmentthatissimilartothatwhichisalreadyaccordedEarlyStage

88Inparticular,thecostofacquiringassetsthatmaybeusedbythebusiness,thedirectcostsofacquiringstart-upcapitalitself(suchasinterest,dividendsorcapitalrepayments),expensesthebusinessmayincurfor the operation of a proposed business (such as travel costs to assess locations for a business), andexpenditurerelatingtotaxesofgeneralapplication(suchasincometax)arenotincluded.89 Paragraph 1.4 of the Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives forInnovation)Bill2016(Cth)noted,inparticular,that‘[venturecapitalfunds]typicallyfocusoncompaniesthathavealreadydevelopedaconceptthatisanticipatedtoattractcapitalandthecompanyisgenerallyseekinghigheramountsofcapitaltogrow’.90Ibid.91The‘taxincentivesforearly-stageinvestors’donotapplyattheconceptstagebecause,beforeacompanycanbeclassifiedasanESICunderITAA97s360-40itmust,interalia,be‘genuinelyfocusedondevelopingfor commercialisation one or more new, or significantly improved, products, processes, services ormarketingororganisationalmethods’:s360-40(1)(e)(i).92Though,toensurethat investmentsarenotmade(togaintheoffset)andthenwithdrawnbeforethecompany can benefit from them, any capital losses on shares held for less than 10 years are alsodisregarded.


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Venture Capital Limited Partnerships, Venture Capital Limited Partnerships andAustralianVentureCapitalFundsofFundsundersub-div118-F.93There are a number of problemswith the application of sub-div 360-A in a practicalsense94butsomeofthosehavealreadybeenaddressed95andothersareintheprocessofbeingaddressed.96Ingeneral,though,theSubdivisiondoesseemtobeagoodstartpointto address (and redress) the problems that ESICs have in attracting early-stageinvestment.

VI ‘RISK’ANDTAXINCENTIVES

Compensatingfor‘risk’hasbeenasignificantfactorinmakingtaxincentivesavailableforinvestmentininnovationandthatwasparticularlysowiththe2016‘taxincentivesforearly-stageinvestors’.AstheTreasurernotedinhisSecondReadingSpeech,theaimoftheTaxLawsAmendment(TaxIncentivesforInnovation)Act2016(Cth)was,specifically,to‘fosterashifttowardsacultureofinnovation,wherebyentrepreneurialrisk-takingisencouragedandrewarded’.97Thatapproachwaseminentlyjustifiedbecauseprovidingfinancetoinnovativestart-upsis inherently risky. Data shows that somewhere in excess of 50 per cent of all smallbusinesses fail in the first fouryearsof theiroperation.98 For innovative start-ups thefigures,sittingatabout60percent,99areworse.Thefiguresareworseagainforfirst-timeentrepreneurs,forwhomthereisonlyan18percentchanceofsuccess.100Potentialinvestorsarethereforeunderstandablyselective,bothintheinnovationstheyarepreparedtoback,especiallyintheveryearlystagesofthebusiness’sexistence,andintheamountofcapitaltheyarepreparedtorisk.In fact, investor reluctance to invest in innovation, and the resulting difficulty thatinnovative small businesses in particular encounter when trying to access adequatecapital, has been identified as ‘a major contributor to poor innovation outcomes inAustralia’.101ThatproblemisalsoconfirmedbytheresultsoftheAustralianBureauof

93Providedtheconditionsinsub-div360Aaremet,anycapitalgainsorlossesthatresultfromCGTeventsrelatingto‘eligibleventurecapitalinvestments’(EVCI)thatpartnersinESVCLPs,‘eligibleventurecapitalpartners’inVCLPsor‘eligibleventurecapitalpartners’inAFOFshaveownedforatleast12monthsaredisregarded:ITAA97ss118-405,118-407and118-410.Thoseinvestorsarealsoexemptfromincometaxontheirshareofanyprofits(ss51-54and51-55)andaredeniedadeductionforanylossesthatarisefromdisposalofthoseinterests:ss26-68and26-69.94 Those problems are dealtwith in detail in StephenGraw, ‘Encouraging Innovation –TheTax LawsAmendment (Tax Incentives for Innovation) Act 2016’ (Paper presented at the ATTA Conference,Masterton,NewZealand,18–20January2017).95SeeTreasuryLawsAmendment(2017MeasuresNo1)Act2017(Cth)sch1.96SeeTreasuryLawsAmendment(2018MeasuresNo2)Bill2018(Cth).97AustralianGovernment(Morrison),aboven20.98MattMansfield,SmallBusinessTrends,StartupStatistics–TheNumbersYouNeedtoKnow(1November2016)<https://smallbiztrends.com/2016/11/startup-statistics-small-business.html>.99ErinGriffith,‘ConventionalWisdomSays90%ofStartupsFail.DataSaysOtherwise’,Fortune(online),27June2017<http://fortune.com/2017/06/27/startup-advice-data-failure>.100Mansfield,aboven98.101 G Withers, N Gupta, L Curtis and N Larkins, ‘Australia’s Comparative Advantage: Final Report’(AustralianCouncilofLearnedAcademies,Melbourne,August2015)120.


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StatisticsBusinessCharacteristicsSurveys,whichhaveconsistentlyrated‘lackofaccesstoadditionalfunds’asthegreatestbarriertoinnovationinAustralianbusinesses.102The seriousnessof the problem is also clearly reflected in data in theStartupMusterAnnual Reports. The 2017 report, for example, noted that, while success rates forfundraisingbystart-upshadimprovedovertime,inthepreviousyearonly34.2percentofstart-upshadequityinvestors.103Thedifficultiesthatstart-upsencounterwhentryingtoraisefundswasalsoillustratedbythefactthat,inthatyear,only27.5percentofstart-ups had tried to fundraise and had either raised as much as they wanted or beenoversubscribed.Tenpercenthadtriedbuthadnotraisedasmuchastheyhadsoughtand5.8percenthadtriedbuthadnotbeenabletoraiseanyfundingatall.Moresignificantly,ofallstart-ups,42.8percenthadnevertriedtofundraiseatall.104Therefore,anythingthatencouragesinvestorstosupportinnovationistobewelcomed–particularly in the period between the initial stage of the business’s lifecycle (wherefinanceisnormallyprovidedthroughself-funding,family,friendsand,perhaps,throughgovernment supportand/or tax incentives- suchas thoseoutlinedabove)105 and thecommercialisation stage where funding is more likely to be available through theestablished ESVCLP and VCLP regimes, as well as from banks and other sources ofcommercialfinance.

VII WHERECROWD-SOURCEDFUNDINGFITSIN

A RecognitionofriskThegovernment’sdeclared intentinlegislatingtomakeCSFavailablewasto facilitatefundraisingintheinitialstagesofacompany’sexistence.106Thatiswellevidencedbythefactthat,toqualifyforthegovernanceandreportingconcessions,acompanyregisteringas,orconvertingto,apubliccompanyinordertousetheCSFregimehastostateinitsapplicationthatitintendstomakeaCSFofferafterregistrationorconversionanditmustthenalsocompleteaCSFofferwithin12months.107

102 See, for example, AustralianBureau of Statistics, AustralianGovernment,Selected Characteristics ofAustralian Business, 2015–16 (17 August 2017) para 8167.0<http://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/8167.02015-16?OpenDocument>. Itreportedthatfor2015/16,asforpreviousyears,bothinnovative-activebusinessesandbusinessesoverallidentifiedlackofaccesstoadditionalfundsasthemostcommonbarriertoinnovation:21.3percentofallinnovation-active businesses rating it as their greatest barrier to innovation (with an even higherpercentageamongSMEs).Forthepurposesofthosesurveys,‘barrierstoinnovation’aredefinedas‘thosebarriersthatsignificantlyhamperedthedevelopmentorintroductionofanyneworsignificantlyimprovedgoods,services,processesand/ormethods’.103 Startup Muster, 2017 Annual Report (2017) <https://www.startupmuster.com/reports/Startup-Muster-2017-Report.pdf>.Thesefigureswereanimprovementonresultsfromearlieryearswherestart-upshadreportedmuchworseoutcomes.104Ibid.105See,ibid,forfiguresontheavailabilityandsourcesoffundingforstart-upsin2016/17.106ExplanatoryMemorandumtoCorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)paras1.4–1.6.107CorporationsAct2001(Cth)s738ZI.


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It isalsoclear that thegovernmentrecognisedandtookstepstobringthesubstantialrisksthatcanbeinvolvedwithsuchinvestmentstotheattentionofpotentialinvestors.TheExplanatoryMemorandumtoCorporationsAmendment(Crowd-sourcedFunding)Bill2016,forexample,specificallynotesthat‘start-upsgenerallypresenthigherrisksforinvestorscomparedtolarger,moreestablishedcompanies[and]CSFinvestmentsmaybelargelyilliquid,reducingtheabilityofinvestorstoexittheirinvestment’.108Thelegislationitselfalsoexpresslyprovidesfora‘riskstatement’,109whichmustbemadeavailabletopotentialinvestors-andwhichCSFintermediariesmustpublishprominentlyontheirofferplatformforeachofferwithwhichtheyareinvolved.110‘Retailclients’mustalsocompleteanacknowledgementthat,interalia,theyhavereadandunderstoodthatriskstatement111-andresponsibleentitiesarerequiredtorejectanyapplicationfromaretailclientthatisnotaccompaniedbyacompletedacknowledgement.112

ASIC also specificallywarns on itswebsite that, because businesses that raisemoneythroughCSF‘areneworintheearlystagesofdevelopment…there’smoreriskthatthebusinesswillbeunsuccessful andyoumay loseall themoneyyou invested’.113 It alsospecificallynotesthatbecauseofthenatureofthecompanystructuresthatareinvolved‘[y]our investment is alsounlikely tobe ‘liquid’, so if youdecideyouneed themoneyyou’veinvested,youmaynotbeabletosellyoursharesquickly,oratall’.114Therefore,aswiththeventurecapitalincentivesand,inparticular,themorerecentESICtaxregimes,itmighthavebeenexpectedthatsignificanttaxincentiveswouldhavebeenattachedtoCSFofferstocompensatefortherisksassociatedwiththemandtoenhancetheirattractivenesstoinvestors.

B TaxationandtheCSFregimeSurprisingly, there are no taxation incentivesattached to the CSF regime. Investmenttransactionsunderitwillbetaxedexactlyasifthefundswereraisedbyanormalissueof

108ExplanatoryMemorandumtoCorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)para1.8.109 The detailed wording of the risk statement is set out in Corporations Regulations 2001 (Cth) reg6D.3A.03.Itreadsinpart:Crowd-sourcedfundingisrisky.Issuersusingthisfacilityincludeneworrapidlygrowingventures.Investmentinthesetypesofventuresisspeculativeandcarrieshighrisks;Youmayloseyourentireinvestment,andyoushouldbeinapositiontobearthisriskwithoutunduehardship;Evenifthecompanyissuccessful,thevalueofyourinvestmentandanyreturnontheinvestmentcouldbereducedifthecompanyissuesmoreshares;Yourinvestmentisunlikelytobeliquid.Thismeansyouareunlikelytobeabletosellyoursharesquicklyoratallifyouneedthemoneyordecidethatthisinvestmentisnotrightforyou;Eventhoughyouhaveremediesformisleadingstatementsintheofferdocumentormisconductbythecompany,youmayhavedifficultyrecoveringyourmoney.110CorporationsAct2001(Cth)s738ZA(1).Failuretocomplywiththatsubsectionisanoffence:s1311(1).111Ibids738ZA(3)(b).ThedetailedwordingoftheacknowledgementissetoutinCorporationsRegulations2001(Cth)reg6D.3A.07(2).112CorporationsAct2001(Cth)sub-ss738ZA(3)(b)and(4).Notdoingsoisalsoanoffence:s1311(1).113 ASIC, Australian Government, Moneysmart: Crowd-Sourced Funding (10 November 2017)<https://www.moneysmart.gov.au/investing/crowd-sourced-funding>.114Ibid.


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shares.115Thathasanumberofconsequences.ForcompaniesraisingfundsthroughCSFoffers,themoneytheyraisewillnotbeincomebutsimplypartofthecompany’ssharecapital.Therearethereforeno incometaxconsequences for thereceivingcompanyatthatstage.Subsequentuseofthosefundsfornon-capitalbusinesspurposeswillgiverisetodeductionsthattheycanthenoffsetagainstcurrentorfutureincomeand,ifthefundsareusedforcapitalexpenditure,animmediateoracceleratedwrite-offunderITAA97s40-880maybeavailable.IfthefundsareusedforeligibleR&Dexpenditurethenaself-assessedtaxoffsetmaybeavailableunderITAA97div355,inlieuofadeduction.

For CSF intermediaries, the fees that they receivewill be income from carrying on abusiness and will therefore be taxable in full. The fees that they pay to acquire andmaintain their Australian Financial Services Licence and, if required, their AustralianMarketsLicence,sotheycanprovideCSFservices,willofcoursebedeductible,aswillallothernon-capital expenses they incur in carryingon theirCSF intermediarybusiness.Capital expenses may give rise to depreciation deductions under ITAA97 div 40(including,iftheyare‘smallbusinessentities’,theimmediateoracceleratedwrite-offsthatareavailableunderITAA97s40-880).For investors, their investmentswill not be deductible expenses (being outgoings ofcapitalorofacapitalnature),but,ifthesharestheyreceivearesubsequentlydisposedof,anyprofitwillbetaxable(aseitheracapitalgain,asagainondisposalofarevenueassetorasordinaryincome,dependingonhowtheshareswereacquiredandheld).AnylosswillalsobetreatedaseitheracapitallosstobedealtwithunderITAA97s102-10orasalossonrevenueaccounttobedeductedunderITAA97s8-1(againdependingonhowtheshareswereacquiredandheld).Anyreturnthattheygetontheirinvestmentinthewayofdividendswill,ofcourse,betaxableasordinaryincomeunderITAA36s44.Theremay also beGST consequences.116 The supply of shares itself is an input-taxedfinancialsupplyand is thereforenotsubject toGST(sothe investorreceivesno inputcredits).TheservicesthattheCSFintermediarysuppliestothecompanyare,however,ataxablesupplyand,providedtheintermediaryiscarryingonanenterprise,isregisteredor required to be registered for GST, provides the services for consideration, and theservicesareconnectedtoAustralia(astheywillbebecauseoftheeligibilityrequirementsforCSFoffers),theywillbesubjecttoGST.

Inputtaxcreditsarenotnormallyavailableforacquisitionsthatrelatetothemakingofinput taxed supplies unless certain prescribed circumstances exist, so whether thecompanywillbeentitled to input credits for theGSTon the fees that itpays theCSFintermediary will therefore depend on whether the provision of the intermediary’sservicesfallwithinthosecircumstances(mainlythedeminimisexceptionunderANewTaxSystem (GoodsandServicesTax)Act1999 (Cth) s11-15(4)or the ‘reducedcredit

115 For the ATO view, see Australian Taxation Office, Australian Government, Crowdfunding (2017)<https://www.ato.gov.au/individuals/income-and-deductions/income-you-must-declare/crowdfunding>.116FortheATOview,seeAustralianTaxationOffice,AustralianGovernment,GSTandCrowdfunding(2017)<https://www.ato.gov.au/Business/GST/In-detail/Rules-for-specific-transactions/GST-and-crowdfunding>.


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acquisitions’detailedintheANewTaxSystem(GoodsandServicesTax)Regulations1999(Cth)reg70-5.02).

C Willtheabsenceoftaxconcessionsbea‘dealbreaker’?Clearly,providingtaxincentivesforearly-stageinvestinghasbeenanintegralpartofhowgovernmentshaveapproachedtheissueinthepast,sowhatisdifferentthistime?Themostobviousdifferenceisinrelationtothetypesofinvestorsandtheamountsthattheyarelikelytoinvest.ThereisnolegislatedminimuminvestmentforCSFoffersbutthereisan‘issuercap’thatlimitsthetotalamountthatindividualcompanies(andanyrelatedparties)canraiseundertheCSFregimeinany12-monthperiodtoamaximumofAU$5million.117ThereisalsoaAU$10000‘investorcap’ontheamountthatanindividualretail client can invest in all CSF offersmadeby the same company in any 12-monthperiod(and,underCorporationsAct2001(Cth)s738ZC(1),aresponsibleintermediarymustrejectanapplicationmadebyaretailclientifitwouldbreachthatcap).The AU$10 000 ‘investor cap’ does not apply to sophisticated and/or professionalinvestors-thoughofferstothemarealreadyexemptfromdisclosureunderCorporationsAct2001(Cth)ss708(8)and708(11)anditismorelikelythatcompanieswouldseekinvestmentsfromthoseinvestorsunderthegeneralfundraisingprovisionsratherthantheCSFregime,especiallyas thoseother investmentsdonotcount towardstheAU$5millionissuercap,118whichcanthenremainintactforbonafidesmallretail ‘mumanddad’investors.119Individualinvestmentsarethereforelikelytobesmallandthepeoplewhomakethemare less likely to be greatly concerned about possible tax incentives than with thepotential for significant possible gainson the occurrence of an expected exit event120(suchasatradesale,initialpublicofferingorotherdisposaloftheirshares).Alternatively,theymaybemainlymotivatedbyadesiretoassistfamilyorfriendswhoarebehindthecompanyseeking the funds–albeit alsowanting toprotect their investment, tosomeextent,byacquiringequityratherthansimplyproviding‘loan’funds.121

117CorporationsAct2001(Cth)s738G(2).118TheoffersthatareexemptfromdisclosureunderCorporationsAct2001(Cth)s708,andwhichthereforedocounttowardstheAU$5millionissuercap,are‘smallscalepersonaloffers’unders708(1)andoffersmade under s 708(10) via an Australian Financial Services licenseewhere the licensee is satisfied onreasonablegroundsthatthepersontowhomtheofferismadehaspreviousexperienceininvestingthatallowsthemtoassessthemeritsandrisksofthecurrentoffer.119Asmallnumberofsmall‘mumanddad’investorscanalsobecateredforunderthe‘smallscaleoffering’provisionsinCorporationsAct2001(Cth)s708(1).Itexemptscompaniesfromthedisclosurerequirementsfor‘personaloffers’(definedins708(2))whereboththenumberofpeopletowhomsecuritiesareissueddoes not exceed 20 and the amount raised does not exceed AU$2 million in any 12-month period.Companiesmightthereforealsoelecttouses708(1)toraisefundsfromsuch‘known’investors(iftheyexist)toavoidtheeffectoftheAU$10000CSF‘investorcap’.120 See Explanatory Memorandum to the Corporations Amendment (Crowd-sourced Funding forProprietaryCompanies)Bill2017(Cth)para1.61.121Byexercisingtheirrightsasshareholders.Forstart-upcompaniesequitymayalsobepreferabletodebtgiven that equity ‘does not require immediate repayments and equity investors generally accept thatreturnsarecontingentonprofits’:ibidpara2.11.


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Becauseoftheprobablesmallscale(and,concomitantlylargenumber)ofindividualCSFinvestmentsthatarelikelytoresultfromtheAU$5million‘issuercap’,providing(andadministering)taxincentivesforCSFinvestors(whichcouldbesimilartotheincentivesthatareavailable for investments inESICs) isalsolikely to involveadisproportionateadministrativeburdenforboththefundraisingcompanyand,possibly,theATO.

However, whatever the reason for the absence of tax ‘incentives’, that may, in fact,operateintheCSFinvestors’favour.OneoftheproblemswiththeESICincentivesisthat,insomeinstances,theydonotapplyor,iftheydo,theycanoperateagainsttheinterestsoftheinvestorstheywereintendedtobenefit.First, there is therequirementthat thecompanymustqualifyasanESIC immediatelyafter the shares are issued. A particular problem with this requirement is that thecompanyhastobegenuinelyinvolvedininnovation–somethingthatithastoself-assessusing either a highly subjective ‘principles-based test’ or amore objective ‘100-pointinnovationtest’.IfthecompanyerrsforsomereasontheinvestorslosetheiranticipatedentitlementtoboththetaxoffsetandthemodifiedCGTtreatment.122ThereisnosuchriskforeitherinvestorsortheissuingcompanyundertheCSFregime.Therequirementsforacompanytobeeligibleforthelimitedgovernancerequirements,as they are stated in Corporations Act 2001 (Cth) s 738ZI, are straightforward, andcompliance (ornon-compliance) canbe simplydetermined. If the companymakesanerror,theonlyriskforinvestorsistheindirectriskthatthecompanymaythenhavetoexpendpartofthefundsitraisedonthecomplianceactivitiesfromwhichithadthoughtitwasexempt-andthatmayaffectthefinancialviabilityofitsongoingoperations(andperhapsnecessitatefurtherfundraising).

Second,sharesissuedbythecompanymustbeeligibleforthetaxincentives.Technicallythough,itisnotthesharesthatqualifyforthetaxincentives,itistheinvestor;andtheinvestoronlyqualifiesiftherelevantissuemeetseachofthecriteriainITAA97s360-15(1)(b)–(f).However, theonusofensuringthat thecompanyqualifiesrestswiththeinvestor, who, if the company does not qualify as an ESIC, is not entitled to the taxincentives.Theproblemisthateachofthes360-15(1)mattersrelatetothingsthatarenotwithin the shareholders’ control- and they thereforehave torelyentirelyon theissuingcompany‘gettingthemright’.Third,‘non-sophisticated’investorsarelimitedintheamountstheycaninvestinESICs.123Iftheyexceedthatlimit,theylosenotonlythetaxoffsettheymighthavereceivedfortheamountthatexceedsthelimit,theylosetheentireoffset-includingforthatpartoftheirinvestmentthatdidnotexceedthelimit.124Worse,becausetheylosetheentitlementtothetaxoffset,theyalsolosetheirentitlementtothe‘modifiedCGTtreatment’-again,fortheir entire investment.125 Given that they are ‘non-sophisticated’ investors (a grouplikelytobelargelyco-extensivewiththe‘retailclients’inCSFissues)itispossiblethat

122ITTA97ss360-15(1)(c)and360-50(1).123Ibids360-20(1)(b).ThelimitisAU$50000,whichincludesallinvestmentsinallESICsinanyyear.124ByinvestingmorethanAU$50000inanyincomeyear,theyaredeemednottosatisfytheITAA97s360-15(1)(b)requirementthattheyhavebeenissuedwith‘equityintereststhataresharesinthecompany’.125ThemodifiedCGTtreatmentonlyappliesiftheissuingoftheshare‘givesrisetoanentitlementtoataxoffsetunderthisSubdivision’:seeibids360-50(1).


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they might not fully appreciate the consequences of exceeding the cap, and might,therefore,inadvertentlybreachit.Finally,themodifiedCGTtreatmenttowhichESICinvestorsareentitleddependsentirelyonhowlongtheshareshavebeenheld:

• iftheshareshavebeen‘continuouslyheld’forlessthan12monthsfromthedateofissue,anycapitalgainontheoccurrenceofaCGTeventisassessedundernormalprinciples126butanycapitallossmustbedisregarded;127

• iftheshareshavebeen‘continuouslyheld’foratleast12monthsandlessthan10years from the date of issue, any capital gain arising on the occurrence of therelevantCGTeventisdisregarded128–asisanycapitalloss;129or

• ifthesharesare‘continuouslyheld’for10yearsofmorefromthedateofissue,thenormal CGT rules apply, so any gains or losses that are realised on any after-occurringCGTeventwillbedetermined,anddealtwith,unders102-5(forgains)ors102-10 (for losses)–butwith themodification that the first elementof theshares’costbase,orreducedcost,becomesthemarketvalueofthesharesonthe10thanniversaryoftheirissueinsteadoftheiractualcostatissue.130

Themajorproblemwiththe‘concessional’modifiedCGTtreatment,especiallygiventhestatisticsonthelikelihoodofstart-upsfailing,isthefactthatinvestorslosethepotentialbenefitofanycapitallossifthecompanyfails(oriftheysellouttolimittheirpossiblelosses)withinthefirst10yearsofthecompany’slife.Thiscanhavepotentiallydraconianconsequences, especiallywhere thedisposal is involuntary–aswouldbe the caseondeath.Crowd-sourcedfundinginvestorsdo,therefore,havesomeadvantagesoverinvestorsinESICsinthat,whiletheymaybesubjecttoCGTontheirpotentialgains,theircapitallossesarenotmandatorilydisregarded.

D InvestingunderbothESICandCSFregimesconcurrentlyFromthe legislation, itappearsthat there isnothingtostop investors investing inthesamecompanyunderboththeESICrules(togetthetaxconcessions)andtheCSFrules.131It also seems that they could do so in respect of the same investment, provided thecompanymeets both the requirements to qualify as an ESIC,132 immediately after therelevantshareissue,andtherequirementstobean‘eligibleCSFcompany’(which,atthe

126Thisisbecausetheinvestoristakentoholdtheshareoncapitalaccountunderibids360-50(2)butthemodifiedtaxtreatmentofanycapitalgaindoesnotcomeintoeffectunders360-50(4)unlesstherelevantCGTeventoccurs‘onorafterthefirstanniversary…oftheissue’:s360-50(4)(b).127Ibids360-50(3).128Ibids360-50(4).129Ibids360-50(3).130Ibids360-50(5).131 That possibility also seems to be indirectly suggested by the Explanatory Memorandum to theCorporationsAmendment(Crowd-sourcedFundingforProprietaryCompanies)Bill2017(Cth)para2.42.132Whichitwouldbesolongasitwas‘early-stage’(ie,ifitsatisfiedtherequirementsinITAA97sub-ss360-40(1)(a)–(d))andwasgenuinelyinvolvedininnovation(somethingthatitself-assessesundereitheraprinciples-basedtestunders360-40(1)(e)orthe‘100pointinnovationtest’ins360-45).


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latest,mustbe‘atthetimewhentheofferismade’133).Theofferwouldalsohavetobeboth ‘eligible to bemade’ and ‘expressed to bemade’ under the CSF rules,134 and thesharesissuedunderthatofferwouldhavetobeeligibleforthetaxincentivesundertheESICrules.Noneofthatwouldseemtoinvolveinsurmountablehurdles.Inbroadterms,tobe‘early-stage’,thepotentialESICmusteitherhavebeenincorporatedinAustraliaorregisteredintheAustralianBusinessRegisterwithinthelastthreeincomeyears(thelatestbeingthecurrentyear)or,ifnot,itmusthavebeenincorporatedinAustraliawithinthelastsixyears. In addition, it and its subsidiariesmust have incurred total expenses of AU$1millionorlessacrossthelastthreeyearsand itandits100percentsubsidiariesmusthavehadatotalincomeofAU$200000orless–excludinganyamountofAcceleratingCommercialisationGrantitmayhavereceived- intheincomeyearbeforethecurrentyear; and none of the company’s equity interestsmust be listed for quotation in theofficiallistofanystockexchange,inAustraliaoroverseas.Theserequirementsallalignneatlywiththerequirementsthat‘eligibleCSFcompanies’notbeforeigncompaniesandmustsatisfytheirown,somewhatmoreliberal,grossassetsandrevenuetests.The major differences between the two sets of requirements are that there is norequirementforanESICtobeapubliccompany(arequirementthatisintheprocessofbeing removed forCSFcompaniesanyway135), ithasnoprincipalplaceofbusinessorresidentdirectorrequirementtosatisfy,ithasalessliberal‘assetsandturnover’testtomeetand,unlike‘eligibleCSFcompanies’,itisnotsubjecttoanyspecificrequirementthatitnothaveasubstantialpurposeofinvestinginsecuritiesandinterestsinotherentities(thoughthesamepracticaleffectislikelytobeachievedthroughtherequirementthatESICsbe‘genuinelyinvolvedininnovation’).Similarly,therewouldappeartobenoinsurmountablehurdlestoasingleofferbeingabletomeetboththerequirementsforittobe‘eligibletobemade’undertheCSFrulesandeligible for the ESIC tax incentives. In both cases the offermust be for ‘shares in thecompany’ (though the ESIC requirements do allow for the concessions to apply ifconvertiblenotesare laterconvertedtoshares)–and,withESICs, there isnoexpressrequirementthattheybefullypaidonissue(asisthecasewithCSFoffers).OnemajordifferenceisthatESICoffersarenotsubjecttoan‘issuercap’(asopposedtoCSF offers, underwhich companies, including related parties, are limited to raising amaximumofAU$5millioninasingleyearfromCSFandotherofferswheredisclosureisnotrequired).Anotherdifference is the ‘investor’capthat applies ineachcase136–andthedifferentconsequencesofbreachingthosecaps.CompaniesthatwanttheirofferstomeetbothCSFandESICrequirementswouldhavetostructurethoseofferssothattheymetbothsetsofrequirements (including limited maximum acceptance to AU$10 000 for each ‘retail

133CorporationsAct2001(Cth)s738G(1)(b).134Ibids738B.135SeeCorporationsAmendment(Crowd-SourcedFundingforProprietaryCompanies)Bill2017(Cth).136AmaximumAU$50000for‘non-sophisticated’investorsinESICs(intotalinanyoneyear)asopposedtoaAU$10000capforretailclientsapplyingforsharesunderaCSFofferinanyonecompanyinanyyear.


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client’/’non-sophisticated’ investor) - but that would not seem to be too onerous(dependingontheleveloffundsthatthecompanywantedtoraise).

1 Wasthepossibilityofmeetingbothregimesintended?TheproblemseemstobethatneithertheCSFnortheESIClegislationappearstohaveidentifiedthepotentialforthetworegimestooperateintandem–ortomakeprovisionforthattooccur.

Intheory,thereisnoreasonwhythetworegimesshouldnotcoexist.Infact,aswasnotedearlier,theExplanatoryMemorandumtotheCorporationsAmendment(Crowd-sourcedFunding)Bill2016specificallystatedthattheaimofthenewregimewasto‘provideanadditional funding option for small businesses and start-ups in particular, that mayotherwisestruggletoobtainaffordablefinance’137(emphasisadded).

TheTreasureralsoexpresslystatedinhisSecondReadingSpeechforthatBillthattheCSF option was simply ‘a new funding option for small businesses’, that it was notintendedtodisplace ‘other formsofcrowdfundingalreadyavailable,suchasrewards-basedcrowdfundingandpeer-to-peerlending’andthatitwasalsointendedto‘serveasbothacomplementandasourceofcompetitiontomoretraditionalfundingoptionsforsmallbusinesses,includingbankdebtproducts’.138However,theCSFlegislationdoesspecificallymakeitclearthateligibleCSFcompaniescan also onlyhave one CSF offer open at a time139- so allowing them to raise fundsthrough a concurrent capital raising under the ESIC rules could be regarded as bothinappropriateand,atleast,atoddswiththespiritofthenewlaw.

2 Potentially‘unintended’taxconsequencesThere are a number of potentially unintended tax consequences flowing from thepossibilitythatasingleoffermightqualifyunderboththeESICandCSFrules.TheyarisemainlybecauseofuncertaintyabouthowtheESICtaxincentivesareactivated.

AnissuingcompanyisrequiredtoreportanyissuesofnewsharesthatcouldgiverisetoanentitlementtotheESICtaxincentivestotheATOwithin31daysaftertheendofthefinancialyear inwhichtheshareswere issued(ie,normallyby31Julyof that incomeyear).ThestatedreasonistoallowtheATOtoassesswhetherinvestorsareentitledtothosetaxincentives.140

However,iftheissueofsharesdoescreateanentitlementtothetaxoffset(andthroughit,tothemodifiedCGTtreatment),doesthatmeanthatinvestorsarethen,immediately,

137ExplanatoryMemorandumtotheCorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)para1.6.138AustralianGovernment(Morrison),aboven20.139CorporationsAct2001(Cth)s738R.140ExplanatoryMemorandumtotheTaxLawsAmendment(TaxIncentivesforInnovation)Bill2016(Cth)para1.15.TaxationAdministrationAct1953(Cth)sch1s396-55Item10intheTableandsch1s396-60(1)(a)notethat,ifacompanyisawarethataparticularinvestorisnotentitledtothoseincentives(forexample,becausetheinvestorisanaffiliateorbecausetheirinterestinthecompanythenexceeds30percentorbecausetheshareswereacquiredthroughanemployeesharescheme-allexpressprohibitionsundertheESIClegislation),thatissueofsharesneednotbereported.


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andsimplybyvirtueoftheissueofsharestothem,automaticallycoveredbytheESICrules,ordoesitmeanthattheissueofsharestothemsimplyraisesapossibleentitlementthattheshareholdermustchoosetoactivate(byclaimingthetaxoffset)beforetheESICrulescanapply.Thatisnotclearfromthelegislationandthatlackofclaritygivesrisetoatleasttwoproblems.

First, if accepting a ‘CSF offer’ does also qualify as an ESIC investment (because thecompany has aligned the terms of its offer to achieve that effect), ‘retail clients’whoaccepttheCSFoffercouldinadvertentlylosetheirentitlementtoclaimacapitallossiftheirinvestmentlaterfails(oriftheydisposeofthosesharesatalossforanyotherreason– includingthroughan involuntarydisposal,suchasmightoccurondeath)withinthefirst10yearsof their investment.This isbecause,undertheESICrules,capital losseswithin that periodmust be disregarded.141 Thatoutcome is technically possible, eventhoughthoseinvestorsmaynothaveinvestedwiththeESICincentivesinmind–andmaynotevenhavebeenawareofthem,orofthepotentialproblem.Second(andperhapsmoreworryingfromtheATO’spointofview),theuncertaintycouldgive rise to a situation where knowledgeable investors (including ‘sophisticatedinvestors’whocaninvestsignificantsumsunderbothregimes)mightnotimmediatelyclaimthetaxoffsettowhichtheESICruleswouldentitlethem(therebypreservingtheoptionofclaimingacapitallossifthecompanyfailsoriftheyotherwisedisposeoftheirshares at a loss shortly after investment), but then seek to amend their returnssubsequently (after it appears that the company might succeed) to gain both a(backdated)taxoffsetand,consequently,thebenefitsofthemodifiedCGTtreatmentaswell.Asaminimum,ifasingleissueofshareswastoqualifyunderboththeCSFandtheESICrules,therewouldappeartobesomejustificationforamendingthelegislationtorequireinvestors to elect to claim (or not to claim) the ESIC tax incentives, and to do so(preferably)inthefirsttaxreturnthattheylodgeaftertheissuingcompanyreportsthatissuetotheATO.

VIII CONCLUSION

TheintroductionoftheCSFregimeisalaudableadditiontothealreadyexistingchannelsoffundingthatareavailabletosmallstart-upinnovationcompanies.However,whetherthetemporarycorporategovernance,reportingandcomplianceconcessions(whicharereally to assist the company rather than the investors)will be enough tomake suchinvestmentsattractivetothesmall‘mumanddad’investorsatwhomthenewprovisionsarenotionallyaimed,orwhetherfurthertaxorotherincentiveswillbeneeded,isyettobe seen. Other refinements, especially to eliminate possible taxation complicationsresultingfromthenewrules,wouldalsoseemtobedesirable.However, the fact that thegovernmenthasalreadydemonstrated itswillingnesstobeflexible,byintroducinglegislationtoextendtheCSFregimetoproprietarycompanies,is

141ITAA97s360-50(3).


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a positive sign that may also see the introduction of appropriate taxation or otherincentivesifthetake-upofCSFinvestmentprovestobelimitedwithoutthem.

REFERENCES

A Articles/Books/ReportsAustralianSecuritiesandInvestmentsCommission,AustralianGovernment,Moneysmart:

Crowd-Sourced Funding (10 November 2017)<https://www.moneysmart.gov.au/investing/crowd-sourced-funding>

AustralianSecuritiesandInvestmentsCommission,AustralianGovernment,18-004MRASIC Licenses First Crowd-Sourced Funding Intermediaries (11 January 2018)<http://asic.gov.au/about-asic/media-centre/find-a-media-release/2018-releases/18-004mr-asic-licenses-first-crowd-sourced-funding-intermediaries>

Australian Bureau of Statistics, Australian Government, Selected Characteristics ofAustralian Business, 2015–16 (17 August 2017) para 8167.0<http://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/8167.02015-16?OpenDocument>

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Graw,Stephen,‘EncouragingInnovation–TheTaxLawsAmendment(TaxIncentivesforInnovation)Act2016’(PaperpresentedattheATTAConference,Masterton,NewZealand,18–20January2017)

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Nehme,Marina,‘AustraliaFinallyHasCrowd-SourcedEquityFunding,ButThere’sMoreto Do’, The Conversation, 22 March 2017<https://theconversation.com/australia-finally-has-crowd-sourced-equity-funding-but-theres-more-to-do-74921>

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CorporationsAct2001(Cth)CorporationsAmendment(Crowd-sourcedFunding)Act2017(Cth)

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CorporationsAmendment(Crowd-sourcedFunding)Bill2016(Cth)Corporations Amendment (Crowd-Sourced Funding for Proprietary Companies) Bill

2017(Cth)CorporationsRegulations2001(Cth)

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LimitedPartnershipsAct2008(NZ)LimitedPartnershipsAct2016(WA)

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TreasuryLawsAmendment(2017MeasuresNo1)Act2017(Cth)

TreasuryLawsAmendment(2018MeasuresNo2)Bill2018(Cth)

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