The Government introduced the Treasury Laws Amendment (2018 Measures No 2) Bill 2018 into the House of Reps this Thur 8.2.2018 to implement the this previously announced measure (and one other, which I will not be covering). This Bill was referred to the Senate Economics Legislation Committee, on 15 February 2018, for report by 15 March 2018.
Venture capital and early stage investors – amendments to the venture capital and early stage investor tax concession provisions in the ITAA97 to ensure they operate as intended with respect to CGT transactions, MITs and the early stage investor tax offset. DATE OF EFFECT: 1 July 2018.
Tax Technical has reported on these various ‘Innovation’ measures this previously – see Early Stage Investors measures announced, Flow Through Law; Insolvency Reform; Similar Business Test Introduced; SBT passed; SBT Ruling; ESVCLP changes introduced;
Some background will assist in explaining this (which I’ve taken from the EM for this Bill).
2.3 Venture capital is a mechanism for financing new, innovative enterprises at the seed, start up and early-expansion stages of commercialisation. Venture capitalists invest funds in such enterprises in return for an equity share. The funds are used to develop an enterprise’s ideas to the stage where their commercial potential is sufficient for the venture capitalist to sell its equity to another party.
2.4 The Commonwealth provides various tax concessions to support Australian venture capital investments; specifically the VCLP and ESVCLP programs.
2.5 The VCLP (Venture Capital Limited Partnership) regime supports investment in venture capital entities at the high-risk, start-up and expansion stages that would otherwise have difficulty in attracting investment through normal commercial means.
2.6 A VCLP is taxed on a ‘flow-through’ basis rather than being treated as a company for tax purposes like other limited partnerships resulting in the partners rather than the ‘partnership’ being taxed [as a company] (s94D(2) ITAA36). One of the key benefits is that certain foreign partners are exempt from income tax on capital and revenue gains from disposals of eligible investments made by the VCLP, with corresponding losses also being disregarded (s118-405 ITAA97). In addition, amounts received by general partners for their successful management of the partnership’s investments (‘carried interests’) are taxed on capital account, thus potentially entitling them to the CGT discount if they have been a partner for over 12 months and meet the other eligibility requirements for the CGT discount. [If the limited partnership were taxed as a company, then the gains would be profits and the distributions would be taxed as dividends.]
2.7 The ESVCLP (Early Stage VCLP) regime provides additional tax concessions for high-risk start-up entities (with a value of no more than $50 million).
2.8 Like VCLPs, ESVLPs are taxed on a ‘flow-through’ basis (s94D(2)). However, the tax concessions are more generous than for VCLPs given the higher degree of risk involved. Both Australian and foreign investors are exempt from income tax on capital and revenue gains from disposals of investments made by ESVCLPs, with corresponding losses also being disregarded (s118-407 ITAA97). Income derived from the partnership’s investments, such as dividends, is also exempt from income tax (s51-52 ITAA97). See also Subdiv 61-P of ITAA97 for an off-set broadly equal to 10% of the amount invested, to reduce the cost of these investments.
Early stage investors
2.9 A separate incentive was also introduced for early stage investors outside of the venture capital framework. Broadly, this incentive allows eligible investors that acquire shares in an innovation company in an income year to receive a carry forward tax offset for that income year equal to 20 per cent of the amount paid for the shares (Div 360 ITAA97). However, the total amount of this offset to which an entity and its affiliates is entitled in an income year cannot exceed $200,000.
[See also: Business.gov.au – Venture Capital]
The amendments include the following:
Early Stage Venture Capital Limited Partnership (ESVCLP) – CGT exemptions on investments
- Section 118-408(2) [Item 1] – this is the provision that gives a partial exemption from capital gains if the ESVCLP exceeds the value of $250m. The Gain that is protected is the amount that would have been the gain, had the investee shares been sold 6 months after the year in which the investor entity exceeded the $250m value.
- Section 118-428(1)(c)(ii) [Item 2] – the exemption from CGT, for an ESVCLP is subject to various requirements, including the limit (in s118-428) that the value of ‘pre-owned’ investments doesn’t exceed 20% of the partnerships ‘committed capital’.
Early stage investor tax offsets
- Section 61-770(3) [Item 4] – Section 61-770 of the ITAA97 is the provision under which the ESVCLP 10% tax offset is calculated for persons who have invested through partnerships and trusts. A partner/beneficiary’s share of the partnership/trust’s ‘notional offset’ will be an amount to be determined by the partnership or trustee. However, under ss(3) the amount determined must equal the fixed share of any capital gain, which the partner/beneficiary is entitled to. A new ss(3) will be inserted to tie the fixed share to the particular investment that gave rise to that tax offset. Item 10 does the same for the 20% ‘early stage’ tax offset.
- Section 360-15(1)(a)(i) [Item 5] – An investor should not qualify for both the 10% ESVCLP tax offset and the ‘early stage investor offset’ (available under Div 360). To ensure this, a new sub-para (ia) is added to make it a requirement (to get the 20% offset) that the entity not be an ESVCLP.
- Section 360-15(1)(f) [Item 6] – An investor can only get the 20% ‘early stage’ investor benefits, if it does not own more than 30% of the invested company. This provision is amended to redefine the 30%, so that it is either 30% of any distributions or 30% of voting power.
- Section 360-15(2) [Item 7] – likewise, and investor cannot get the ‘early stage’ investor benefits, if it invests through a ‘widely held company’ (as defined in s995-1 ITAA97) or their subsidiaries. This section has been amended to ensure that this remains the case, where the same investment is made indirectly through a partnership or trust. However, this provision is also amended to make it clear that the ‘early stage’ concessions are available, when the investment is made through a chain of interposed trusts and/or partnerships.
- Section 360-25(1) [Item 8] – the ‘early stage’ tax offset is 20% of any money invested in the for the issue of shares together with the value of any non-cash benefits for the issue of its shares. The the non-cash benefits is determined at the time the shares are issued.
- Section 360-30(1) [Item 9] – The early stage tax offset is limited to $200,000 pa. This limit is set out in s360-25, for direct investments, but is not set out for indirect investments in s360-30. The limit is inserted in a new ss(1A).
- Section 360-30(3) [Item 10] – Section 360-30 performs a similar function, for the 20% ‘early stage’ tax offset as s61-770 did for the 10% ESVCLP tax offset (see Item 4 above). A new ss(3) replaces the old ss(3) to make it clear that the partner/beneficiary’s share of the tax offset, is its entitlement to a share of the capital gain, on the particular investment that gave rise to that notional tax offset.
- Section 360-35(b) [Item 11] – This is a minor consequential amendment, following the Item 9 change to insert the $200k pa limit for tax offsets obtained through indirect investments.
- Section 360-40(1)(a)(ii) [Item 12] – Section 360-40 defines what an ‘early stage innovation company’ is. This includes a cascade of alternate requirements, namely: incorporated within the last three years, or only registered with an ABN for the last three years, or incorporated within the last 6 years and not spent more than $1m over the last 3 years. s360-40(1)(a)(ii) is amended to allow the expenditure to be measured in the last three completed years (prior to the ‘test time’) so that that information is locked away and is known by the entity’s accounts.
- Section 360-40(1) [Item 13] – A new requirement, to be an ‘early stage innovation company’ is added (by adding a new para (f), that states the company must not be a ‘foreign company’, within the meaning of the Corporations Act 2001, at the ‘test time’.
Study questions (answers below*)
- Does this Bill effect a variety of changes to some of the requirements, that exist, for the various types of ‘venture capital’ investment tax concessions?
- Are there three types of venture capital concessions: Venture Capital Limited Partnerships (VCLPs), Early Stage Venture Capital Limited Partnerships and ‘early stage investors’ (who are outside the venture capital ‘limited liability partnership’ framework)?
- Does an investor, in an ESVCLP, get only partial CGT exemption, under s118-408, once the ESVCLP exceeds $500m in value?
- Can a person be entitled to both the ‘early stage’ tax offsets (the 10% one for ESVCLPs and the 20% one for investments in ‘early stage innovation companies)?
- Is the ‘early stage’ (non-limited partnership) tax offset (based on 20% of the amount invested), capped at $200k pa (of carry forward, as well as freshly claimed, offsets)?
- Can a company, be an Early Stage Innovation Company, if it is incorporated within 6 years of the ‘test time’ and has an aggregate expenditure, over the previous 3 years, of no more than $10m?