Australia: Venture Capital Investment Incentives

The Australian Government promotes investment in innovative Australian businesses by providing certain tax exemptions for Australian superannuation funds and non-resident tax exempt pension funds.

There are also specific tax-privileged investment schemes in the film production and forestry sectors.  Non-resident pension funds that are tax exempt in their home jurisdiction are exempt from income tax on the disposal of investments in new equity in eligible venture capital investments

• The investment target must not have gross assets exceeding A$50 million (at the time of writing);
  
• Investment in real estate and other passive investments is excluded;
  
• Investments must be at risk and held by the investor for at least 12 months.

The scheme exempts from income tax in Australia any profit or gain made from the disposal or realisation of the new equity. If the disposal is of a capital gains tax asset, any capital gain or loss is disregarded. If it is a disposal of a revenue asset, any revenue profit or loss is disregarded.

This scheme applies to exempt pension funds from the United States, United Kingdom, Japan, Germany, France and Canada. Non-resident pension funds have to prove that they are exempt in their home jurisdiction. Partnerships of exempt foreign pension funds from approved jurisdictions, even if all partners are not resident in the same jurisdiction, also qualify for the exemption.

Investors wishing to benefit from this exemption have traditionally needed to register with and provide information to the "Pooled Development Fund Board" at the commencement of their investment and file annual returns indicating the amount invested and distributions made. (However, see below for changes to this system.)

In 2001, the government extended the pension funds' capital gains tax to endowment funds and private investors who hold up to 10 per cent of a venture capital limited partnership. However, from July 2002, the measure excluded activities such as property development, retailing and several financial services from eligibility for venture-capital concessions.

Improvements to the tax regime for investment funds in 2002 and 2003, including a concession which cut capital gains tax for foreign investors through venture capital limited partnerships, have caused many large international investments funds to take Australia more seriously as a place to do business, according to the Australian Venture Capital Association.

AVCA suggested that investment firms such as large US and European-based pension funds could pump up to $1 billion per year into the Australian venture capital sector over the coming years as a result of the new changes.

"For the first time Australia is emerging on the international venture capital scene," explained AVCA project manager Jake Burgess. He added that: "This is massively important for the venture capital industry and for early-stage enterprises and corporate rejuvenation."

However, although the government’s move in 2003 made the country a much more attractive option for overseas investment, venture capitalists warned that the changes need “massive marketing” to ensure the country remains on the international investment map.

"It brings venture capital in Australia in line with overseas," said Malcolm Thornton, investment director for Starfish Ventures. "But a huge marketing effort is still needed to put it on the radar for overseas investors."

In February 2005, Zurich-based fund of hedge funds manager Infiniti Capital extended its reach into the relatively untapped Australasian market with its acquisition of a majority shareholding in alternative fund specialist Martini Capital Limited, a privately owned offshore and on-shore investment management group.

Anric Blatt, CEO of Infiniti, observed at the time that: “Extremely attractive and uncorrelated returns are being delivered by Asian and Australian managers and Infiniti has recently witnessed a surge in demand from Australian and New Zealand institutional investors. We already have a regional office in Hong Kong with allocations to around 20 Asian emerging managers. Our investment in Martini Capital re-affirms our commitment to this region.”

In the 2003-2004 year the Pooled Development Funds Registration Board dealt with the first group of VCLP (venture capital limited partnership) registration applications after the government permitted them to access such funds.The venture capital limited partnerships that achieved full registration in the year collectively raised over $600 million in capital, principally from domestic investors.

In May, 2005, the government announced in the budget that it would exempt all foreign investors from CGT arising on the sale of non-real property assets held in Australia for longer than 12 months. Minister for Industry, Tourism and Resources, Ian Macfarlane, also confirmed that a thorough review of the venture capital industry will be conducted.

The review was foreshadowed as a 2004 election commitment to assess the impact of recent reforms, including to Australia’s venture capital tax laws, and the contribution of the industry to the national economy.

The Government implemented changes to the Venture Capital Limited Partnerships (VCLP) legislation in June 2004. “The response to these changes has been encouraging with nine funds registered as VCLPs, eight fully registered and one conditionally registered, under the new incorporated limited partnership structures,” said Mr Macfarlane. The eight fully registered VCLP funds have capital commitments totalling around $1 billion."

“The review is to assess the impact of the Government’s support for venture capital, the contribution the industry makes to the national economy and to ensure we are keeping abreast of world’s best practice in Australia.”

“Australia is now a more attractive market for venture capital investment. The review will ensure that we remain internationally competitive in this area and attractive to investors,” said Mr Macfarlane.

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 introduced 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.

The Pooled Development Funds (PDF) program closed to new applicants on June 21, 2007. The PDF program was progressively replaced by the ESVCLP program.

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) was also to 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 at the time announced that it would 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.

Film Production and Forestry

Tax-based venture capital incentive schemes in these two sectors have seen widespread take-up, but have proved to be troublesome for the government.

In the film sector, the ATO disallowed millions of dollars in deductions, ruling that a number of film finance projects, including the Moulin Rouge production, were tax minimisation schemes, and that investor funds were used for the purchase of security bonds to ensure a return on investment, and not for film production costs as such.

Hundreds of Australian investors in theatre, film, and entertainment projects took the promoters who sold them the schemes to court as a result, alleging that prospectus documents were misleading. More than 100 investors in a film scheme called the Australian Beach Tales Project filed applications in the Federal Court against the Commissioner of Taxation appealing the decision not to allow deductions under Division 10B, covering film financing.

Despite the Government's discomfiture, Tax Commissioner Mr Michael Carmody underlined the ATO's intention to "ensure that artificial arrangements which distort intended tax concessions were not permitted".

Yet Division 10B of the Tax Act covering film financing has given a successful stimulus to movie production in Australia by overseas studios. Schemes under the Act typically involve a 100 per cent tax write-off of investment over two years, while some deals have been structured using loan funds to achieve a larger write-off.

Despite these problems, the then Treasurer, Peter Costello stunned the country's film industry by announcing new tax incentives for investors. Late in 2001, Mr Costello announced that films with an Australian production budget of between $15 million and $50 million would qualify for a 12.5% tax break if more than 70% of the film's total budget was spent in Australia. Films where more than $50 million is spent in Australia would qualify automatically, the Treasurer said, no matter what this figure represents as a proportion of the total budget.

The new tax incentive would also apply to telemovies and mini-series which fulfil the spending criteria and are agreed upon by a panel of industry and government officials, and Mr Costello confirmed that films already in production in Australia can apply to receive the tax break. However, productions benefitting from the offset will not be eligible to receive any other tax assistance.

In May, 2006, the Australian government announced a review of its film finance tax incentives in an attempt to stimulate more private sector investment in the industry.

Minister for the Arts and Sport at the time, Senator Rod Kemp announced that this "broad-ranging" review would encompass consideration of funding for the Film Finance Corporation for 2008-09 and beyond, taking into account the outcomes from the additional funding provided as part of the Government’s 2004 election commitment, as well as the scheduled review of Film Australia.

The 2006 package of measures was worth A$88 million (US$66 million) over four years (from 2004-05). Funding for Australian Government film agencies in 2006-07 would total over A$160 million.

The review was also slated to look at the tax incentives available to the industry, and assess their effectiveness at attracting investment.

The findings of the review of the 10BA and 10B tax incentive schemes would also inform the broader review, Senator Kemp stated.

Investors in 10BA certified projects could claim an accelerated tax deduction of 100 per cent in the year the investment is made.

10B was a broader-based concession relating to the first ownership of copyright in a production. It allowed a 100 per cent tax deduction to initial investors over two financial years, starting when the film is first used to derive income (i.e. when the project is completed).

However, the 10B and 10BA concessions were superseded in 2007, and a new Producer Rebate was unveiled to take their place in the 2007/08 budget.

The 2010/11 budget changed the eligibility criteria for film tax offsets with the reduction of the expenditure thresholds for the post, digital and visual effects (PDV) from A$5m to A$500,000. The requirement for films to have at least 70% qualifying expenditure in Australia within a total budget of A$15-A$50m was also removed.

Forestry tax-incentive schemes shared the limelight with film production schemes, when the ATO attacked various categories of so-called 'abusive' schemes. Then, despite a long drawn-out and very public tussle, probably won on points by the ATO, but resulting in a serious fall-off in forestry plantings, then tax office commissioner, Michael Carmody, released a statement issuing a 'tax guarantee' on a range of agricultural investment products. Although they included timber, he was careful not to dwell on its investment appeal, but did describe timber as a safe investment.

Mr Carmody referred to a range of timber investments that allow the investor to obtain a tax deduction on the investment with the return relying on forest growth and sale of the timber.

In the statement Mr Carmody confirmed that investors would be entitled to tax benefits with a valid Tax Office Product Ruling. He said: 'Managed investments, including in the forestry industry, that have a Product Ruling are quite distinct from the mass-marketed, tax-abusive schemes that the tax office has taken action against.'

In September 2006, the Australian government said it was considering placing a limit on the tax breaks offered to investors in plantation forests amid protests, as they are distorting the market and discriminating against small landowners.

Under proposals drawn up by Assistant Treasurer at the time, Peter Dutton, a cap would be applied on the tax-deductibility of investment amounts per hectare. Currently investors in the forestry sector receive a 100% first-year tax deduction on their investment.

The schemes had come under increasing attack from farmers who argued that they drive up land and water prices, and are creating a new class of absentee landowner.

Some coalition members of parliament also called for the review to be widened to include other agribusiness schemes that offer big tax deductions to investors, including avocados, olive oil and pearls.

However, the issue split the coalition, and Forestry and Conservation Minister at the time, Eric Abetz came out in support of the tax schemes.

In December 2006, Senator Abetz and Peter Dutton announced new arrangements for the taxation of investments in forestry managed investment schemes (MIS).

The Ministers argued that the new arrangements would provide greater certainty for investors and will ensure the continued expansion of Australia's plantation forestry estate, so reducing the country's reliance on native forests and on overseas imports.

The new arrangements also recognised the critical role plantation forestry plays in sequestering greenhouse gases. Additionally, the decision addressed concerns about the level of commissions charged.

The government decided that, with effect from 1 July 2007, investors in forestry MIS would be entitled to immediate upfront deductibility for all expenditure provided that at least 70% of the expenditure is directly related to developing forestry.

Then in September 2007, the then Australian Treasurer, Peter Costello hailed the introduction of legislation providing tax concessions for carbon sink forests as an important practical measure to reduce Australia’s net carbon emissions.

The Tax Laws Amendment (2007 Measures No. 6) Bill 2007, introduced into Parliament on September 13th, was designed to allow carbon sink forest operators to claim a tax deduction for the cost of establishing trees in a qualifying carbon sink forest.

To help the carbon sink forest industry establish a strong foundation in Australia, an immediate deduction would be allowed for a five year period from 1 July 2007, it was announced. From 1 July 2012, the immediate deduction is replaced with a write-off rate of 7%. The write-off period starts on the first day of the income year in which the trees are established and ends 14 years and 105 days later.

To qualify for tax deductibility, carbon sink forest operators must comply with environmental and natural resource management guidelines.