House of Representatives

Explanatory Memorandum

(Circulated by authority of the Minister for Industry, Scienceand Resources, Senator the Hon Nick Minchin)

OUTLINE

Introduction

The purpose of this Explanatory Memorandum is to provide clarifying information on the 1999 reforms to the Pooled Development Funds (PDF) Program.

Established under the Pooled Development Funds Act 1992 , the Program was previously amended in 1994. This Explanatory Memorandum should be read in conjunction with the Explanatory Memoranda which accompanied the 1992 Act and the 1994 Amendment to the Program.

What is the Pooled Development Funds (PDF) Program?

The PDF Program arose out of recognition that there were imperfections in the capital markets and that small and medium sized enterprises (SMEs) often have difficulty obtaining equity capital, especially those that are in the early stages of development. The risks associated with such investments, and the long time frame before returns on such investments can be realised, have in the past limited the availability of equity capital or venture capital for such firms.

Through the establishment of commercially operating private sector funds (the PDFs), the PDF Program aims to develop and demonstrate the potential of the market for patient equity capital to small and medium sized Australian enterprises that carry on eligible businesses.

By providing concessional tax treatment for income received from investing in eligible businesses, the Program also aims to make these investments more attractive to investors.

What are PDFs and what is their tax treatment?

PDFs are private sector investment companies, registered to operate under the PDF Program. They attract funds from investors to develop a pool of capital available for private equity investment in eligible Australian companies.

The establishment of PDFs is encouraged by giving both companies registered as PDFs, and shareholders in PDFs, concessional tax treatment.

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Companies registered as PDFs have a concessional 15 per cent tax rate for PDF income earned from eligible SME investments. Other income, such as income from unregulated investments, is taxed at a concessional rate of 25 per cent.

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For shareholders in PDFs, unfranked PDF dividends are tax exempt. Franked PDF dividends are also tax exempt in the hands of investors, unless an investor elects to be taxed. Where investors elect to be taxed they can use the imputation credits attached to the franked dividend to offset other tax obligations.

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Further, gains made by investors as a result of trading shares in PDFs are exempt from capital gains tax. To ensure symmetry of gains and losses, any losses from disposals of shares in PDFs can not be used to offset investors other taxable capital gains.

PDFs may invest in new equity in SMEs (total assets of not more than $50 million) that will either establish a new business; substantially expand production capacity or services; or expand or develop markets. PDFs are not permitted to invest in companies whose primary activities are retail sales operations or property development.

PDFs are companies that are free to operate, within the broad parameters of the Program, with minimal government involvement in their activities.

PDF Program Review

In 1998, the PDF Program was comprehensively reviewed. The review recommended the Program be modified to make it more attractive to investors.

The modifications agreed to by the Government will offer PDF Program participants more commercial flexibility and will make PDFs a more attractive proposition for Australian superannuation funds, overseas pension funds and other investors. The expected increase in capital invested in PDFs will increase the supply of patient equity and venture capital available to small and medium sized Australian enterprises.

Extension of the Program

The PDF Program has been extended until 30 June 2003. The Program will be reviewed again before that date.