Tax Risks and Anti-Avoidance Rules for Early-Stage Innovation Company Investments: What Investors Need to Know

On 18 June 2025, the Australian Taxation Office (ATO) issued Taxation Determination TD 2025/3, setting out its approach to applying Part IVA of the Income Tax Assessment Act 1936 (Cth) to schemes involving early-stage innovation company (ESIC) tax incentives. The determination sets out the ATO's views on the potential application of the general anti-avoidance provisions to certain schemes designed to artificially meet conditions for claiming the early-stage investor tax offset, resulting in the cancellation of any tax benefits arising from such schemes.

 

Overview of ESIC Tax Incentives 

Eligible investors who purchase new shares in qualifying ESICs may be eligible for tax incentives which include:

• a non-refundable carry forward tax offset equal to 20% of the amount paid for their investment in the ESIC, capped at a maximum amount of $200,000 for the investor and their affiliates combined in each income year (ESIC tax offset); and 
• modified capital gains tax treatment, under which any capital gains from the disposal of qualifying shares that have been continuously held for at least 12 months and less than 10 years may be disregarded. 

 

ATO concerns over Artificial ESIC Investment Schemes 

On 10 December 2024, the ATO issued Taxpayer Alert TA 2024/1 (TA 2024/1), highlighting concerns in relation to schemes designed to artificially meet conditions for claiming tax offsets under the ESIC tax rules. These schemes allowed investors to claim ESIC tax offsets effectively with minimal risk on their investment via a round-robin of their funds. Entities promoting, orchestrating, and financing these arrangements would share in the benefit of tax refunds obtained via the ESIC tax offset. 

The ATO identified that these schemes or arrangements typically involved several key features: 

• the investor is made aware of an opportunity to invest in a start-up company presented as a qualifying ESIC;
• the investor's share subscription amount is funded by way of a loan or other financing arrangement, less any nominal deposit required. This enables the investor to acquire shares that qualify up to the maximum amount of tax offset available (i.e. AUD200,000);
• the company places the subscription amount back on deposit with the financier, who controls the use of the funds. The use of funds by the ESIC company itself is limited;
• the investor claims the ESIC tax offset in their tax return and receives a tax refund. Additionally, as the investor acquires shares via a loan (and the company states that it has a reasonable expectation to pay dividends), the investor claims a tax deduction for any interest on that loan; and 
• the tax refund is used to partially repay the loan, and the remainder of the loan is repaid by the investor within a short period from subscription monies returned by the company, typically through selective share buy-back or other disposal of the shares. 

Essentially, under such schemes, investors do not pay for any residual shareholding they might continue to have in the company, and the refunded tax offset is shared among the investor and the entities facilitating and financing the share subscription.

 

How Part IVA General Anti-Avoidance Rules Apply 

Further to the concerns it identified above, the ATO issued Tax Determination TD 2025/3 on 18 June 2025, which provides additional details on when it will apply the Part IVA general anti-avoidance provisions to such schemes or arrangements as described in Taxpayer Alert TA 2024/1. 

The Part IVA general anti-avoidance rules empower the Commissioner of Taxation to cancel all, or part of a tax benefit obtained through certain schemes or arrangements. In this case, the relevant tax benefits are the amount of the ESIC tax offsets claimed by the investor and the tax deductions claimed for the interest expense on the investor loan. 

In order for Part IVA to apply, the scheme must be entered into for the sole or dominant purpose of enabling the investor to obtain the tax benefit. This is determined by objectively considering 8 factors prescribed in the tax legislation. The application of these 8 factors will depend on the relevant circumstances of the scheme and some factors may have greater weight in certain circumstances. 

In applying Part IVA, the ATO considered the below 4 factors to objectively point to a conclusion of there being a dominant purpose of obtaining a tax benefit under the scheme as described in TA 2024/1:

• Manner of the scheme: The way the scheme is carried out, including promotion, circular funding, and assured investor exit, suggests the dominant purpose is to obtain tax benefits rather than some other commercial outcome.
• Form vs. substance: Although the scheme appears to involve genuine investment in a start-up, in substance, the investor bears little financial risk, and the funds are tightly controlled by a finance entity. Therefore, there is a significant difference in the form and substance of the scheme.
• Timing: The timing and duration of the scheme also point to a tax benefit motive. The investment in the start-up is very short term and the scheme is concluded as soon as the tax refund is obtained. 
• Financial position: The financial positions of the investor, start-up, and facilitating entities are better than it would have been if the scheme had not been entered into due to the availability of the tax offsets, with the investor receiving a further potential financial benefit in the form of retaining residual shares that were funded by the tax offset.

 

What investors and ESICs should do next

Investors and ESICs should be aware of the anti-avoidance risks with such schemes being marketed. They should review their investment arrangements and confirm that investments genuinely support innovation and commercialisation activities. 

For advice on ESIC tax incentive compliance, Part IVA implications, or structuring genuine early-stage innovation investments, please contact our DLA Piper tax team.