House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 3 - Venture capital investee companies

Outline of chapter

3.1 This chapter explains what is required for a venture capital investment to attract the tax concession (an eligible venture capital investment) and the requirements an investee company must satisfy to receive eligible venture capital investments.

Context of amendments

3.2 VCLPs make eligible venture capital investments by acquiring shares or options in unlisted Australian companies, the foreign holding company of such companies, or listed Australian companies that the VCLP delists within 12 months. Tax-exempt non-residents of certain countries, foreign venture capital funds established in those countries, and taxable non-residents of other specified countries (who hold less than 10% of the committed capital of the VCLP), who are partners in a VCLP, may qualify for an exemption from income tax on any profits or gains the VCLP makes on the realisation of shares in the Australian company or foreign holding company.

3.3 If an AFOF is a partner in a VCLP, the AFOF may acquire shares directly in these Australian companies or their foreign holding company if the VCLP in which it is a partner has made an eligible venture capital investment in the company.

3.4 Tax-exempt non-residents of certain countries who invest directly in these Australian companies or their foreign holding company may also qualify for an income tax exemption on the profits or gains on realisation.

Summary of new law

3.5 An eligible venture capital investment must satisfy a number of requirements:

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the venture capital investee company must meet the size restriction in respect of its assets and the amount of investment it is seeking (see paragraph 3.19);

•

the venture capital investee company must be an Australian resident with 50% or more of its employees and assets situated in Australia or the foreign holding company of such a company, provided the foreign parent is resident in a specified country and it does not carry on any business other than to support the primary activity of the venture capital investee company; and

•

the venture capital investee company's primary activity must not be a specified ineligible activity.

Detailed explanation of new law

Eligible venture capital investments

3.6 To qualify for the tax concession the investment must be an eligible venture capital investment.

3.7 The investment must be at risk, in that the VCLP, AFOF, or the investor in the case of direct investments, must bear the risk of owning the shares or options. [Schedule 1, item 6 of the TLA(VC) Bill; paragraph 118-425(1)(a)]

3.8 For an investment to be at risk the VCLP, AFOF, or the investor, must have no arrangement either before or after the share is acquired as to:

•

maintaining the value of the share; or

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maintaining the amount of earnings made from owning it.

For example, a put option arrangement designed to maintain the value of the shares to the owner of the shares would not be 'at risk'. [Schedule 1, item 6 of the TLA(VC) Bill; section 118-430)]

3.9 The investment must be shares or options (including warrants) in a venture capital investee company. [Schedule 1, item 6 of the TLA(VC) Bill; paragraph 118-425(1)(b)]

3.10 If the investment is made by a VCLP or an AFOF, its interest, together with any connected entities, in the venture capital investee company must not be more than 30% of the VCLP's or AFOF's committed capital. [Schedule 1, item 6 of the TLA(VC) Bill; paragraph 118-425(1)(d)]

3.11 A loan, including convertible notes, cannot be an eligible venture capital investment. There are also limitations on the amount of a loan a VCLP or an AFOF may make to a venture capital investee company in which it has made an eligible venture capital investment. This is considered in more detail in Chapter 5.

Location

3.12 At the time the investment is made the investee company must be an Australian resident. Further, if it is the first investment made in the company by the investor, the company must also:

•

have more than 50% of the persons engaged by the company at that time to perform services, actually performing those services primarily in Australia; and

•

have more than 50% of its assets (determined by value) situated in Australia,

for a period of at least 12 months from the date of the initial investment.

3.13 The value of an asset of the company is that shown on the last audited accounts prepared for the company for a period ending less than 18 months before that time. If there are no audited accounts, then an audited statement prepared in accordance with Australian Accounting Standards that shows the value of the assets at a time no longer than 12 months before that time will be required. [Schedule 1, item 6 of the TLA(VC) Bill; subsection 118-425(10)]

3.14 However, the general partner of a VCLP or an AFOF may apply to the PDF Board for a reduction in the 12 month period in appropriate circumstances. Similarly, a general partner may apply to the PDF Board to waive the requirement to comply with either or both the requirements relating to performance of services or the situating of assets in Australia. [Schedule 1, item 6 of the TLA(VC) Bill; subsection 118-425(2)]

Activities of the company

3.15 The company must not have any of the following as its primary activity:

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property development or land ownership;

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finance - to the extent that it is banking, providing capital to others, leasing, factoring, securitisation;

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insurance;

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the construction or acquisition of infrastructure activities; or

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investments that generate interest, rents, dividends, royalties or lease payments.

[Schedule 1, item 6 of the TLA(VC) Bill; subsection 118-425(3)]

3.16 A company that engages in any of the above activities that is ancillary and incidental to the primary activity (which is not one of those mentioned) will not be carrying on an excluded primary activity. For example, a company may acquire land and construct a factory for the purpose of the primary activity of manufacturing semi-conductors. The company would not be regarded as being in the business of property development in this instance. [Schedule 1, item 6 of the TLA(VC) Bill; subsection 118-425(3)]

3.17 The company's primary activity should be able to be determined from its day to day activities and its business plan even if the company engages in a number of activities, some of which may be excluded primary activities. The primary activity is not necessarily determined from the value of assets or the revenue generated by an activity.

Investment in other entities

3.18 A venture capital investee company cannot invest any part of an eligible investment in any other entity unless the other entity is connected with the company and meets the residency, primary activity, size, auditor and listing requirements of a venture capital investee company. The company cannot use any part of the investment in a trustee capacity. However, any investment the investee company makes by way of a deposit with authorised deposit-taking institution such as a bank, is disregarded. [Schedule 1, item 6 of the TLA(VC) Bill; subsection 118-425(4)]

Value of the venture capital investee company

3.19 The value of the assets of the company and any connected entity must not exceed $250 million immediately before an investment is made. This amount is referred to as the permitted entity value . [Schedule 1, item 6 of the TLA(VC) Bill; subsection 118-425(6)]

3.20 The permitted entity value is the sum of:

•

the total value of the entity's assets; and

•

the total value of the assets of other connected entities to the extent they are not included in the first entity's assets.

[Schedule 1, item 6 of the TLA(VC) Bill; subsection 118-440(1)]

3.21 The value of assets (both current and non-current) is that shown on the last audited accounts prepared for the company for a period ending less than 18 months before that time. If there are no audited accounts, then an audited statement prepared in accordance with Australian Accounting Standards that shows the value of the assets at a time no longer than 12 months before that time will be required. [Schedule 1, item 6 of the TLA(VC) Bill; subsection 118-440(2)]

Listing

3.22 At the time the investment is made the company's shares should not be listed on an Australian or a foreign stock exchange. If the shares are listed, the investment can be an eligible venture capital investment if the company is delisted within 12 months of the initial investment. [Schedule 1, item 6 of the TLA(VC) Bill; subsection 118-425(7)]

Scrip for scrip investments

3.23 Where shares in another company are acquired in exchange for shares that at the time of disposal were an eligible venture capital investment (i.e. a scrip for scrip exchange), the replacement shares will be treated as an eligible venture capital investment even if the company does not satisfy the requirements. However, if the company in which the replacement shares are held does not actually satisfy the requirements for a venture capital investee company, any shares acquired from a further scrip for scrip sale will not be treated as an eligible venture capital investment. [Schedule 1, item 6 of the TLA(VC) Bill; paragraphs 118-425(8)(a) and (b)]

3.24 The replacement shares acquired under a scrip for scrip sale will only qualify as an eligible venture capital investment if the investor, that is, VCLP, AFOF or eligible venture capital investor, disposes of all of its shares in the original investee company in return for shares in one other company. [Schedule 1, item 6 of the TLA(VC) Bill; paragraph 118-425(8)(c)]

Non-resident holding companies

3.25 A non-resident company that meets the value and listing requirements (see paragraphs 3.19 and 3.22) may be treated as a venture capital investee company if the company:

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is a resident of Canada, France, Germany, Japan, the United Kingdom, the United States of America, or any other country prescribed by regulation;

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beneficially owns all the shares in an Australian resident company that satisfies the requirements for an eligible venture capital investment; and

•

does not carry on any business other than to support the primary activity of the Australian company.

[Schedule 1, item 6 of the TLA(VC) Bill; subsection 118-435(1)]

3.26 If a non-resident holding company is treated as meeting the requirements of a venture capital investee company, and the Australian subsidiary ceases to be an Australian resident within 12 months of the initial eligible venture capital investment being made in the company:

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eligible venture capital investments already made in the company cease to be eligible for the exemption; and

•

any further investments made in the company will not be eligible for the exemption.

[Schedule 1, item 6 of the TLA(VC) Bill; subsection 118-435(2)]