Budget 2013 proposes to phase out the federal tax credit currently available on the purchase of newly issued shares of a Labour-Sponsored Venture Capital Corporation ("LSVCC"). The tax credit is equal to 15% of the cost of the shares up to a maximum credit of $750 per year (based on an investment of $5,000). The credit is proposed to be phased out as follows:

Click here to view table.

The LSVVC tax credit was introduced in the 1980s to increase the funding for small and medium sized businesses. In order to issue the tax credit, a corporation must be registered as a LSVVC (or be a prescribed LSVCC by virtue of being registered provincially under a similar program). Under the federal and provincial programs, the LSVCC is required to comply with investment restrictions to ensure that the funds raised on the issuance of the shares (for which a tax credit is provided) are used by the LSVCC in accordance with the aims of the program.

A front-end tax incentive such as the LSVCC tax credit has been criticized by some commentators for distorting investment decisions. While such commentators generally consider a back-end tax incentive, such as a lower tax rate on gains realized on a disposition of the investment, to be a preferred fiscal instrument to promote targeted investment, the Government has chosen to eliminate the incentive all together. Had it wished to have done so, the Government could have used many aspects of the existing framework, such as registration requirements and investment restrictions, to shift the program to provide for back-end tax incentives.

Consistent with the phase out of the LSVCC tax credit, Budget 2013 also proposes to end new LSVCC registrations and the prescription of new provincially registered LSVCCs for any application submitted on or after March 21, 2013. However, given the proposed phase out of the tax credit, and the prior elimination of a similar Ontario tax credit, which was phased out as of March 1, 2012, it is unclear whether any corporation would have chosen to register under the LSVCC or similar provincial program in any event.

In order to assist with an orderly phase-out of the LSVCC tax credit, the Government is seeking stakeholder input on potential changes to the tax rules governing LSVCCs, including rules related to investment requirements, wind-ups and redemptions. In this connection, hopefully the Government can learn from the Ontario government's experience with the phase out of the Ontario credit. For example, one deficiency with the Ontario phase out was that upon an early redemption (for which the legislation effectively requires a repayment of some or all of the tax credit), the investor could have been required to repay an amount that was more than the tax credit (where the share was acquired in the first 60 days of a taxation year and the tax credit was claimed for the year of acquisition as opposed to the prior year). Stakeholders should consider submitting comments on the federal legislation by May 31, 2013. The Budget Papers indicate that draft legislation will be released for further public comment.