AUSTRALIA: POOLED DEVELOPMENT FUNDS

NB The Pooled Development Fund (PDF) program will be closed to new applicants when the new Early Stage Venture Capital Limited Partnership (ESVCLP) program becomes operational. The PDF program is to be progressively replaced by the ESVCLP program announced in the Budget, which is expected to become operational around June 2007.

Existing PDFs will be unaffected. The PDF Act and relevant tax law provisions will continue to operate, and the relevant authorities will continue to support PDFs.

Pooled Development Funds ("PDF"s) are designed to promote the channelling of investment funds into small and medium sized companies (ie: total assets no greater than A$50 million) by means of concessional tax treatment.

At least 65 percent of the funds raised by PDFs must be invested in small or medium sized companies within 5 years.The PDF program was introduced in 1992 to develop the market for patient equity capital, including venture capital, for small to medium-sized enterprises (SMEs). A PDF is a private company established under the Pooled Development Funds Act 1992 that raises capital from investors and invests this capital in SMEs. Companies seeking to become PDFs are required to register with the PDF Board and provide the Board with annual returns on the status of their investments. The Board comprises five members from the private sector with experience in finance, commerce and marketing.

PDFs are taxed in the same way as other companies, but income derived from investment in small or medium companies is taxed at a concessional rate of 15 percent rather than 30 percent. Other income is taxed at a rate of 25 percent.

As an additional incentive, shareholders of a PDF are exempt from tax on unfranked dividends. PDF dividends are exempt from income tax and dividend withholding tax and any capital gains made by investors in selling their shares in the PDF are exempt from CGT. Also, any tax-preferred income received by a PDF retains its character when it is passed through to PDF shareholders.

While PDF dividends are tax exempt, the PDF shareholder may elect to have any franked dividends taxed as if they were not PDF dividends. Even though PDFs are only taxed at 15 per cent on their SME component, they are able to frank dividends at the company tax rate. Where the shareholder elects to have the PDF dividends taxed, the dividend imputation system applies and investors, such as superannuation funds, with tax rates less than the company rate are able to use the resulting excess franking credits to offset other income. Thus, with some exceptions, domestic superannuation funds are able to achieve an effective tax rate of 7.5 per cent on income from investments that is taxed at 15 per cent in the PDF.

PDFs can invest in SMEs with total assets of less than $50 million whose primary activities are not retail operations or property development. A PDF is not allowed to invest in another PDF. A PDF is able to invest in an SME for the following purposes:

• to establish an eligible business, either alone or with another party or parties;
  
• to increase substantially the production capacity or the supply capacity of an established eligible business; and
  
• to expand existing markets substantially, or develop new markets for goods and services of established eligible businesses.

Normally, investment by the PDF must be at least 10 per cent of the total capital of the investee's business although the PDF Board is able to approve investments of less than 10 per cent. The investment must be in newly issued ordinary shares or other kinds of newly issued shares approved by the Board. The PDF Board has the discretion to approve the purchase of pre-owned shares. A PDF is not permitted to invest more than 30 per cent of its capital in any one investee company without prior approval of the Board.

In the 1999-2000 Budget the Government announced changes to the PDF program to make it more attractive. These changes include allowing a complying superannuation fund, including a non-resident pension fund and limited partnerships of such funds, to own 100 per cent of a PDF and enabling a PDF to buy back shares from investors and to return capital. PDFs will also be able to merge and make loans to equity investors.

The 2003-2004 year was another eventful one for Pooled Development Funds after the government opened the way for access to the funds by VCLPs (venture capital limited partnerships). The venture capital limited partnerships that achieved full registration during the year collectively raised over $600 million in capital, principally from domestic investors.

In 2004 the Pooled Development Funds Registration Board made certain recommendations to the government designed to stimulate the venture capital sector in Australia and those recommendations are being considered. The Board believes there is a compelling case for further Government initiatives to encourage innovation, and the commercialisation of Australia’s research and development activity.

As mentioned above, in May, 2006, the Australian government announced a package of new measures aimed at increasing activity in the venture capital sector.

Under the new measures announced in the budget, the government would introduce an early stage venture capital limited partnership (ESVCLP) investment vehicle providing flow-through tax treatment and a complete tax exemption for income, both revenue and capital, received by its domestic and foreign partners.

This would progressively replace the existing pooled development fund programme which has been closed to new registrations after 31 December 2006.

To qualify, the ESVCLP will have a maximum fund size of $100 million and total assets of investee companies cannot exceed $50 million immediately prior to investment. The ESVCLP must also divest itself of any holdings once the total assets of the investee company exceed $250 million. As the income will be exempt from tax, investors will not be able to deduct investment losses.

The operation of the existing venture capital limited partnerships (VCLPs) will also be enhanced by: removing a range of restrictions including allowing investment in unit trusts and convertible notes as well as shares; relaxing the requirement that 50 per cent of assets and employees must be in Australia for 12 months after making the investment; and removing restrictions on the country of residence of investors.

The Government will also commit $200 million for a further round of funding of the Innovation Investment Fund (IIF) programme. The IIF programme provides Government funds alongside funds from private investors to encourage the development of new companies, particularly those with a technology focus.

The new round of funding will involve appointing up to two new managers each year for five consecutive years with $40 million per annum in funding available for successful fund managers. The Government funding will be matched dollar for dollar with private sector funds.

"The initiatives in this package address key findings of the Review of the Venture Capital Industry and demonstrate the Government’s ongoing support for Australia’s venture capital sector," stated Australian Treasurer Peter Costello.

Further information on the Early Stage Venture Capital Limited Partnership regime can be found on the AusIndustry government website.