Co-written by Paul Argent

The Venture Capital Problem

Venture capital tax concessions were introduced in 1999 to encourage foreign venture capital investment into Australia. The concessions were designed to stimulate investment by providing tax exemptions for certain offshore investors (being non-resident pension funds from certain specified countries) that invest in Australian venture capital enterprises. These concessions continue to be available only where the fund's income is exempt from tax and where the fund's central management, control and beneficiaries are non -residents. The investment must be made through a "resident investment vehicle'' which has assets of less than A$50 million.

The effect of these conditions has been to restrict the investment flow to just A$10 million into Australia. Compare that figure with the $US100 billion raised by venture capital funds in the US during the last year.

A Change in the Air

In October 2001, after intense lobbying by the Australian Venture Capital Association Limited ("AVCAL"), the Federal Government announced a tax reform package to address the above concerns. Now that re-election is in the bag, it is probable that the Coalition Government will honour its pre-election commitment to enact provisions that will allow foreign investors to use a venture capital limited liability partnership structure ("VC LLPs") to provide flow-through taxation to all investors. While final amendments to the Income Tax Assessment Act (1997) Cth have not yet been drafted, this article outlines the major points in the current proposal.

Why VC LLPs?

Internationally, a LLP is the most regularly used structure for venture capital investment. The structure was identified by the Federal Government and AVCAL as "world's best practice" and its familiarity to foreign investors is anticipated to help encourage foreign venture capital investment into Australia.

Under a VC LLP, each limited partner's liability is limited to their respective investment in the partnership. Like a trustee or a manager in a unit trust, a VC LLP's assets will usually be held by a manager or "General Partner" who remains subject to unlimited liability. Of course, a General Partner would generally be a corporate entity which would have the benefit of limited liability.

Not all VC LLPs are Created Equal

Not all VC LLPs will qualify for the proposed taxation benefits. While the final criteria are yet to be formulated, at this stage eligibility will depend on 3 criteria:

Investee Type: Investments must be made in businesses that are primarily based in Australia at the time of the initial investment. Eligible investments are:

  • unlisted Australian companies (or trusts);
  • listed Australian companies in the process of delisting; or
  • investments in other VC LLP's.
  • Investments cannot be made where activities of the investee include:
  • property development;
  • certain finance related activities;
  • passive investments of a type not involving regular business activities.

Investment Type:

  • ordinary shares, preference shares or convertible notes;
  • options; and
  • loans.

Investment Limits:

  • investments must be made in businesses prior to the time that the value of the assets of the business exceeds A$250 million;
  • a VC LLP must not risk more than 30 % of its capital in any one investment.

New Capital Inflows

The proposed changes to the tax regime applicable to foreign venture capital investors should be seen as a step forward in encouraging the inflow of private equity capital into Australia. By making the local venture capital industry internationally competitive, local investees and more broadly, the Australian economy, will benefit. But, like all proposed legislative amendments, the devil lies in the detail. Coudert Brothers will keep you posted on developments as they occur.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.