Investors and fund managers both should be considering the changes affecting Early Stage Venture Capital Limited Partnerships, Venture Capital Limited Partnerships, and the Significant Investor Visa program.
The Federal Government's recent Innovation Statement announced a new tax offset and other enhancements to make Early Stage Venture Capital Limited Partnerships (ESVCLPs) and Venture Capital Limited Partnerships (VCLPs) more attractive to investors and fund managers.
This builds on the latest changes to the Significant Investor Visa (SIV) programme, which now mandates significant ESVCLP or VCLP investments for visa applicants.
We look at the changes and current considerations for investors and fund managers.
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).
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
The Fund must:
- be a limited partnership incorporated under Australian State partnership legislation or established in a country which has a double tax agreement with Australia;
- 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);
- have a term of between 5 and 15 years;
- have minimum committed capital of A$10 million. It may be conditionally registered as an ESVCLP or VCLP for up to two years pending minimum commitments.
ESVCLP has maximum fund size of A$200 million (new funds formed after 1 July 2016) or A$100m (funds existing before 1 July 2016) 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 percent of committed capital. This 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% 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, finance, insurance, construction or making investments aimed at deriving passive income;
- 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 6 or 9 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.
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; 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 6 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.
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.
Note: New features commencing 1 July 2016 are subject to Federal Parliament passing amending legislation and the legislation commencing from that date as proposed in the Government's Innovation Agenda.
SIV program investors and fund managers ‒ mandatory allocations to ESVCLP / VCLP
The latest changes to the Significant Investor Visa (SIV) 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.
- 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.
Some considerations for ESVCLP and VCLP fund managers considering investment applications from SIV applicants:
- the general partner and any appointed investment manager must be centrally managed and controlled in Australia;
- 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 provide an increased pool of investment capital to be directed into venture capital and other managed funds. This provides an opportunity for fund managers who meet the venture capital and significant investor requirements.