New incentives for investors in early stage venture capital funds

Publication May 6, 2016

Executive Summary

The recent introduction of the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 (Bill) reflects the Federal Government’s commitment to further its National Innovation and Science Agenda.  The measures should help in boosting the use of pooled venture capital focused funds as a way of channelling investor capital into otherwise cash starved start ups in the technology and innovation sectors.  In the second reading speech, the Treasurer stated:

“The tax incentives for funding provided through venture capital limited partnerships [VCLP] including early stage venture capital limited partnerships [ESVCLP] are designed to attract investments at the growth stage of a company’s development. At this stage, entrepreneurs can face further difficulties accessing funding, despite typically receiving a few rounds of initial funding, as they are not yet able to market themselves for public or broader investor buy-in.”

A key plank is the introduction of a new 10% tax offset available to fund investors.  The tax offset will supplement the existing tax concessional status of investments into such vehicles.
The Government has also used this as an opportunity to relax some of the strict parameters for operation of complying venture capital limited partnership structures and that have to date discouraged many fund managers from using such vehicles to capture investor capital.

Coincidentally, the Bill complements the Significant Investor Visa regime, which, since July 2015, mandated that aspiring high net worth migrants invest $500,000 of their $5 million Australian investment into a complying venture capital fund for a minimum 4 year holding period.  

This article aims to provide a summary of the key measures related to investments in ESVCLPs. Some of the measures also apply to VCLPs and AFOFs registered with Innovation Australia.

New Tax Offset available for investors in ESVCLPs

The changes are expected to take effect from 1 July 2016, and complement the existing broad based investor tax exemption potentially available to complying investments in ESVCLPs.

Key Points

  • Limited partners in ESVCLPs may be eligible for a 10% non-refundable carry-forward tax offset on contributions made to the ESVCLP during an income year.
  • Tax offset applies to ESVCLPs that are unconditionally registered after 7 December 2015, and to contributions made after 1 July 2016. Some transitional rules may apply for contributions prior to this date.

Significant Investor Visa (SIV) investors as a source of funding

The high risk nature of tech start-ups and the relatively cautious Australian attitude towards venture capital (at least relative to the United States) has significantly limited the amount raised in pooled venture funds.  The new tax offset regime will complement the changes made (in July 2015) to the significant investor visa (SIV) regime, and hopefully deliver a new source of investor capital from high net worth non-resident individuals wishing to access the SIV visa.

Broadly, the SIV operates as a provisional visa that provides a pathway to permanent residency for SIV holders who meet certain requirements.  An SIV applicant must invest at least $5 million in complying investments over four years, allocated as follows:

  • Minimum of $500,000 in eligible Australian venture capital or growth private equity fund(s) investing in small start-ups and small private companies. A vehicle must be registered with Innovation Australia as an ESVCLP, VCLP or AFOF (venture capital fund of funds).
  • Minimum of $1.5 million in an eligible managed fund(s) or Listed Investment Company (LICs) that invest in ‘emerging companies’ listed on the ASX.
  • Minimum of $3 million in managed fund(s) or LICs that invest in a combination of eligible assets that include ASX listed companies, infrastructure trusts, preferred equity, eligible corporate bonds or notes, deferred annuities and commercial real property.

ESVCLP Liberalisation Measures

The existing ESVCLP regime contains a number of integrity measures that need to be met by general partners in order to access certain tax exemptions/concessions. The Bill will relax some of the measures, as summarised below.

Key Measures:

  • The maximum allowable fund size (ie committed capital) for an ESVCLP will be increased from $100 million to $200 million.  
  • The requirement that an ESVCLP divest an investment once the investee entity’s assets exceeds $250m will be removed. Instead, a partial CGT exemption will apply for disposal of a high value investee that is retained in the ESVCLP and disposed of down the track.
  • Changes to remove uncertainties arising out of an ESVCLP investing into a pure holding company.  In general, where an ESVCLP has invested in an entity (investee), that investee will be entitled to invest in an underlying entity provided the investee controls the underlying entity and the underlying entity satisfies the ‘eligible venture capital investment’ requirement.
  • Relaxing the need (and cost) for an audit of small start ups (less than $12.5 million entity value) that are not otherwise required to be audited under the Corporations Act.
  • Changes to facilitate investment by a Managed Investment Trust (MIT) into an ESVCLP.  Currently, an MIT may risk breaching the ‘public trading trust’ rules and therefore lose tax transparency if it takes a controlling stake in an ESVCLP that takes controlling positions in underlying investee companies.  The new measures will require that the MIT and its associates not represent more than 30% of the committed capital of the ESVCLP (and that the Managed Investment Trust is not the general partner of the ESVCLP).
  • Innovation Australia will now be able to issue public or private rulings in relation to whether particular investments will qualify as eligible investments.  Given the consequences to an ESVCLP of making an ineligible investment, this ruling process should provide additional certainty to general partners. Innovation Australia will be required to follow a 60 day timeframe for private ruling applications, subject to certain extension rights.

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