ATO issues draft determination on dodgy circular financing schemes

The ATO has issued a draft tax determination this week, TD 2025/D1, following the emergence of a tax avoidance scheme involving the early-stage investor tax offset.

In a taxpayer alert issued last year, the ATO explained that the scheme promoted involves an investment opportunity in a start-up company.

The scheme operators assure the interested individuals that the start-up qualifies as an early-stage innovation company (ESIC) and that they can claim the early-stage investor tax offset (tax offset), the ATO said.

The operators lend the individual the money to buy shares in the start-up, and then funds are moved around between the start-up, the individual investor and the operator to access the tax offset.

“We’re concerned that these start-ups don’t qualify as ESICs,” the ATO said in the alert.

In its draft determination, the ATO said its view is that the anti-avoidance provisions in the Income Tax Assessment Act 1936 can apply to this scheme, potentially cancelling any tax benefit obtained by participants.

“This will apply to those who are involved in the scheme before, during or after the final determination is published,” the Tax Office said.

TD 2025/D1 said that while the application of Part IVA of the ITAA 1936 to any particular arrangement depends on a careful weighing of all relevant circumstances, Part IVA is likely to apply to arrangements similar to that described in the taxpayer alert, TA 2024/1.

The ATO said there are several aspects of the arrangements described in TA 2024/1 that point to the there being a dominant purpose of obtaining a tax benefit.

For example, the manner in which the scheme was entered into or carried out.

“When considered objectively, the promotion, underlying activities (and agreements), circular funding, budget and corporate control, multi-party orchestration, and assured mechanism for investor exit makes the subscription of shares by the investor explicable only by reference to the obtaining and maximizing of the promoted tax benefits for the investor, and the indirect sharing of the economic value of those benefits between the investor and the other parties,” the draft tax determination said.

The ATO also noted that there is a significant difference in the form and substance of the scheme.

The form indicates that the investor borrows money that is invested in the start-up company and the money will be applied by the start-up company to its innovation and commercialisation activities.

In substance, however, the investor bears little, if any, financial risk for their borrowing and share investment and their subscription monies are placed under the strict control of the finance entity under a secondary deposit arrangement limiting the use of those monies by the start-up, the ATO said.

The time at which the scheme is entered into and length of the period during which the scheme is carried out also suggests the dominant purpose of obtaining a tax benefit.

Another factor is the fact that the financial position of the investor, start-up company and entities facilitating and financing the scheme is better than it would have been if the scheme had not been entered into, with this improved position depending entirely on the tax benefit.

“In these circumstances, the Commissioner is likely to exercise his powers under subsection 177F(1) to cancel the tax benefits and determine that neither the tax offset nor general deduction for interest expense are available,” the ATO said.

In its taxpayer alert issued last year, the ATO warned tax professionals to discourage any client thinking about getting into these schemes from doing so by outlining the consequences.

“If they’ve already invested, encourage them to contact us for help,” the ATO said.

“We take tax avoidance schemes very seriously. Registered tax agents found to be promoting these arrangements may be referred to the Tax Practitioners Board to assess if there’s been a breach of the Tax Agent Services Act 2009.”