12 May 2016
Enhanced Venture Capital Limited Partnerships and impact on Significant Investor Visas
by Andrew Hay, Clayton Barrett
Tax changes include making venture capital tax concessions available for FinTech, banking and insurance related activities, and who can access the 10% non-refundable tax offset.
On 4 May 2016, the Senate passed the Federal Government's proposed changes to Venture Capital Limited Partnerships (VCLP), including a number of enhancements noted in the Budget papers on 3 May 2016. The changes have now become law.
This has some implications for the Significant Investor Visa (SIV) programme, which mandates significant Early Stage Venture Capital Limited Partnerships (ESVCLP) or VCLP investments.
We look at the current state of play for investors and fund managers.
Changes in the 2016 Budget
The following amendments to the Government's Innovation Statement were included in the 2016 Budget:
- ensure the venture capital tax concessions are available for FinTech, banking and insurance-related activities
- give existing ESVCLPs the benefit of the extended $200m maximum fund size applicable to new ESVCLPs;
- relax the requirement for very small entities to provide an auditor's statement of assets; and
- add a transitional arrangement that allows conditionally registered funds that become unconditionally registered after 7 December 2015 to access the 10% non-refundable tax offset previously announced for ESVCLPs.
Benefits of ESVCLP / VCLP structure
ESVCLP investors receive a 10% non-refundable tax offset on capital invested during the year. eg. A$1m invested allows A$100,000 to be offset against other tax liabilities of the investor. (New funds formed after 1 July 2016 and conditionally registered funds whose registration becomes unconditional after 7 December 2015)
Both ESVCLP and VCLPs are flow-through vehicles for income tax purposes. ie. the fund is not a taxing point.
ESVCLP investors (limited partners) are exempt from tax on their share of returns (capital and income) from the fund's disposal of eligible venture capital investments. Both foreign and Australian domestic investors are income tax-exempt. Losses are not deductible.
VCLP investors (limited partners) that are eligible foreign investors are also exempt from CGT and income tax. Eligible foreign investors are:
- any foreign investor with less than 10% of committed capital;
- a foreign venture capital fund of funds with no more than 30% of committed capital (the Government proposes to remove the 30% requirement for foreign funds of funds widely-held by eligible foreign investors); and
- any other foreign investor that is tax-exempt in its country of residence.
Australian domestic VCLP investors are taxed on returns in their hands but may be able to claim deductions for losses.
Both ESVCLP and VCLP managers can claim their carried interest on capital account instead of revenue account, with the general partner operating as a Venture Capital Management Partnership (VCMP).
Considerations with ESVCLP / VCLP structure
- Fund to be a limited partnership incorporated under Australian State partnership legislation or established in a country which has a double tax agreement with Australia.
- Fund to obtain ESVCLP or VCLP registration under the Venture Capital Act 2002 from Innovation Australia (to be replaced by Innovation and Science Australia and also referred to as the Board).
- Fund term of between five and 15 years.
- Fund to have minimum committed capital of A$10 million. May be conditionally registered as an ESVCLP or VCLP for up to two years pending minimum commitments.
Early Stage Venture Capital Limited Partnerships
As for an ESVCLP:
- ESVCLP has maximum fund size of A$200 million in capital commitments. An ESVCLP must be a stand-alone fund and not part of a larger fund.
- ESVCLP has single investor limit of 30% of committed capital. Does not apply to investments by banks, life insurance companies and widely-held superannuation funds.
- ESVCLP may typically only invest in shares or units (typically at least 80% newly issued) or options or convertible notes of an investee that:
- is a business in its early stage of development;
- is located in Australia, typically defined as having at least 50 percent of assets and staff being located in Australia for at least the first 12 months of the investment (investments of up to 20% of committed capital may be treated as eligible even though the location test is not met);
- has total assets of no more than A$50 million;
- has a predominant activity that is not property development, land ownership, construction or making investments aimed at deriving passive income, typically requiring that eligible activities account for more than 75% in relation to two or more of the investee's assets, employees and income (The 2016 Budget papers indicated that the Government would ensure that the venture capital tax concessions are available for FinTech, banking and insurance related activities);
- is not listed on a stock exchange at the time of investment; and
- complies with the other requirements of the ESVCLP's investment plan.
From 1 July 2016, a new or existing ESVCLP need not dispose of an investment once the investee's business has grown to more than A$250 million in assets. Instead, the tax exemption is apportioned. Currently an oversize investment is required to be disposed of within six or nine months.
ESVCLP must have an investment plan with a mandate to make early stage venture capital investments approved by Innovation Australia. The plan becomes part of the partnership agreement.
Venture Capital Limited Partnerships
- VCLP has no maximum fund size. Capital commitments are unlimited.
- VCLP may only invest in shares or units (typically at least 80% newly issued) or options or convertible notes of an investee that:
- is located in Australia, as defined above;
- has total assets of no more than A$250 million;
- has a predominant activity that is not property development, land ownership, finance, insurance, construction or making investments aimed at deriving passive income (The 2016 Budget papers indicated that the Government would ensure that the venture capital tax concessions are available for FinTech, banking and insurance related activities); and
- is not listed or is de-listed within 12 months after investment.
- Both ESVCLPs and VCLPs have a single investment limit equivalent to 30% of committed capital.
Both ESVCLP and VCLP
- Investments must be at risk and held for at least 12 months. Debt investments are only permitted to accompany eligible equity investments, or for bridging purposes for less than six months.
- The fund may hold assets using a holding company formed for that purpose. From 1 July 2016, the rules will be more flexible in relation to investee holding companies with multiple subsidiaries.
- From 1 July 2016, an investee of an ESVCLP or VCLP will be able to make "bolt-on" acquisitions of new, complementary businesses, without affecting the eligibility of the ESVCLP's or VCLP's investment for a specified period to allow time for the acquired business to comply with the eligibility criteria.
- General partner to lodge quarterly and annual returns with Innovation Australia. An ESVCLP must report annually on its success against its investment plan.
- General partner to be a resident of Australia or a country with a double tax agreement with Australia. For an ESVCLP, it must demonstrate access to appropriate venture capital management expertise.
- VCMP (as the general partner) need not register with Innovation Australia but is a special purpose entity that only carries on activities related to being a general partner.
SIV program investors and fund managers ‒ mandatory allocations to ESVCLP / VCLP
The latest changes to the Significant Investor Visa program took effect from 1 July 2015. SIVs provide a fast tracked pathway to permanent residency if significant complying investments are made in Australia.
SIV applicants must invest a minimum of A$5 million for at least four years:
- Minimum A$500,000 in ESVCLPs, VCLPs or Australian venture capital funds of funds (which only invest in or with ESVCLPs or VCLPs). Within two years the Government proposes to increase this threshold to A$1 million for new applicants;
- Minimum A$1.5 million through eligible managed investment funds investing in emerging companies with a market capitalisation less than A$500 million. To be eligible, a fund must invest in at least 20 issuers, predominantly in Australian listed securities, with up to 20% of the fund in unlisted Australian-based entities, up to 10% in foreign quoted securities and no more than 10% in a single issuer; and
- The remainder of the A$5 million through managed investment funds in what are referred to as "balancing investments", which include Australian listed companies, A-REITs and infrastructure trusts, Australian corporate bonds and notes, deferred life annuities and Australian real property (subject to a 10% residential limit).
Advantages for ESVCLP and VCLP fund managers are:
- mandatory allocations of at least A$500,000 to ESVCLP or VCLP investments for each SIV applicant;
- the full amount of the SIV applicant's commitment is safeguarded, either by direct payment to an escrow account for the general partner, or by the amount being held as security for a bank guarantee to the general partner; or
- investment proceeds during the term of the Visa must be reinvested in ESVCLP, VCLP, emerging company or balancing investments.
What should ESVCLP and VCLP fund managers think about?
The first considerations for ESVCLP and VCLP fund managers considering investment applications from SIV applicants is that the general partner and any appointed investment manager must be centrally managed and controlled in Australia.
Secondly, the recently revised foreign investment framework under the Foreign Acquisitions and Takeovers Act 1975 may need to be considered when the ESVCLP or VCLP makes investments, depending on:
- the level of foreign ownership in the fund. A fund is typically considered a "foreign person" if an individual not ordinarily resident in Australia, foreign corporation or foreign government holds a "substantial interest" of 20% or more in the fund, or if two or more foreign persons hold an aggregate substantial interest of 40% of more of the fund;
- the value of the investee. For example, approval from the Australian Treasurer is typically required to acquire a "substantial interest"of 20% of more in an Australian private business valued at A$252 million or above ($1,094 million for prescribed investors in Chile, Japan, South Korea, New Zealand or the United States); and
- whether the investee operates an agribusiness or in a "sensitive sector" such as media, telecommunications, defence, encryption and security technologies or communications, uranium or plutonium extraction or nuclear facilities.
A boost for fund managers
The mandatory allocations required by the SIV program will continue to provide an increased pool of investment capital to be directed into venture capital and other managed funds. As at 31 March 2016, a total of A$6.555 billion of complying investments had already been made under the SIV program. This provides an opportunity for fund managers who meet the venture capital and significant investor requirements.
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