SMSF Trustees love tax-based investing. First and foremost, it is the absolute love for franking credits.

Think of this.  An SMSF member who is pension stage investing in banks, retail and telecommunications stocks for the dividends not only does not pay tax on the cash dividends but also gets all the underlying company tax – via franking credits back as a refund.  So, for a 64 year-old SMSF retiree who lives on 4% of their account balance and who invests mainly in imputation stocks, will generally have their income covered by the cash dividend and the franking credit refund stashed away to preserve and boost capital.  What a great strategy and used for decades.

SMSF Trustees LOVE Tax-Based Investing

Look at the stink that was raised when the Labor Opposition vowed to do away, not with the franking credits but the refund.

But is tax-based investing good for Australia?  Well the tax equity proponents will say there should be a level playing field.  And funnily enough I was one of them arguing in 1988 for the Taxation Institute in the Government’s business tax review that super funds should not be treated differently from companies in terms of taxation.   I am so glad that argument did not get up.

Anyway back to the question.  Is tax-based investing good for Australia.  Well if you ask me, it kept SMSF Trustees in their dividend-paying stocks during the GFC, even when the underlying stocks went down in price.  In essence SMSF Trustees are great long-term investors and in this case tax-based investing did well for Australia.  It might skew investments into one sector but surely it is better than SMSF’s being passively invested in cash.

But not all SMSF members want stable long-term returns.  The younger brigade want something more attune with their risk profile and for many under 50, super is something they don’t mind investing in aggressively.  Sure, it is hard to in a retail or industry super fund, although these funds are now marketing aggressive portfolio options and enabling members to make a choice, should they choose to do so.  In an SMSF or my preference, a Family SMSF, where members can make their own choice, then the BIG tax-based investment is now Early Stage Innovation Companies.  It’s not for the older members but certainly a gift for contributing members under age 55.  Let’s take a closer look…..

What is ESIC?

On 1 July 2017 the Government introduced innovation guidelines for Early Stage Innovation Companies (ESIC).   It is a pure tax-based investment play and if you ask me a great one.

The tax incentives for eligible investors include:

  • A 20% non-refundable carry-forward tax offset on investment, capped at $200,000 per investor, per year. For retail investors the maximum investment is $50,000 which provides a $10,000 tax offset.
  • A 10-year capital gains tax exemption for qualifying investments held for at least twelve months.

Who is eligible?

  1. Investor criteria

To be eligible for the incentives, an investor must meet the ‘sophisticated investor’ test under the Corporations Act 2001 or, if the investor does not meet this test, their total investment in qualifying companies must be $50,000 or less for that income year.  SMSF’s may meet the sophisticated investor test depending on details.

  1. Company criteria

The incentives will be available for investments where the company is:

  • Early-stage, determined against criteria related to expenditure, assessable income, stock exchange listing and incorporation; and
  • involved in innovation, determined by allowing the company to self‑assess against either a principles-based test or a points-based gateway test, or by receiving a determination from the Australian Tax Office.

An SMSF Case Study

John Aldershot is 40 years of age and with his wife Janice they have the JJA Super Fund.  It currently has $320,000 of accumulated member benefits and is invested in a residential property in Richmond, Victoria which is now paying for itself with positive assessable income (after deductible expenses) of $5,000.

John and Janice’s employers contribute SGC on their behalf and they would like to top it up to the maximum concessional contributions limit of $25,000 each for the 2019 income year.  John has a friend who helps raise money for start-ups and has been offered the opportunity of putting money into a technology start-up – Tech Company – that has met the requirements of ESIC.

So what happens for tax purposes for the JJA Super Fund?

  1. a) The Trustee of the Fund commits to investing the $50,000 that John and Janice salary sacrifice into the Fund for the 2017 income year
  2. b) The Trustee of the Fund will include the $50,000 as part of the Fund’s assessable income pursuant to s290-160 of the ITAA 97 and pay tax of $7,500.
  3. c) As an ESIC-qualified investment, the Trustee receives a tax offset of $10,000 of which $7,500 can be applied to pay for the contributions tax on John and Janice’s salary sacrifice contributions and the remainder can also be used to reduce tax payable on their Richmond rental property of $5,000 x 15% = $650. Plus, there is some tax offset left over which if not used, is lost.

Let’s say, and there is never any guarantee with start-ups, that the JJA Super Fund’s investment in Tech Company lists on the ASX and in 2025 is worth $350,000.  If the Trustee of the JJA Fund sells at that time, then there is no capital gains tax as it is within the ten-year window.

The Final Word

SMSF’s love tax-based investing.  After all, that is why they are in SMSF’s in the first place.  Imputation credits are a huge driver in the market and refunds should be kept for the next GFC.  But the new crew in SMSF’s, ESIC is one of the best tax plays around.  Like anything, it is slow to start but will build up momentum.  Remember NRAS schemes for subsidised housing?

From a company point of view, ESIC does not apply to tech start-ups.  I Love SMSF being a business under three years old with less than $200k in revenue would meet the criteria of an ESIC for an SMSF investor.  So, for accountants or business owners, watch out for the ESIC capital raising opportunity amongst businesses.  And for SMSF Trustees keep your eyes peeled for great opportunities.  I remember seeing a start-up investment that turned a $100k investment into $1M inside of three years.  But likewise, the reverse can happen – look at Guvera!

For a great podcast on ESIC and Small and Medium Enterprise funding with SME Crowdfunders and the Marketing Director:  Nigel Abbott – go to:

Grant Abbott