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Wednesday, 4 December 2002
Page: 9635

Mr COX (6:30 PM) —The purpose of these two bills, the Venture Capital Bill 2002 and the Taxation Laws Amendment (Venture Capital) Bill 2002, is to facilitate foreign investment in the Australian venture capital industry by providing certain tax concessions. Currently, there is $9.3 billion invested in the Australian venture capital sector, according to the AustralianVenture Capital Journal. Of this, $7.01 billion is invested with fund managers and listed companies and $2.34 billion is invested with firms that are private, government or local offices of offshore groups. A survey by the Australian Venture Capital Journal shows that the sector has grown 126 per cent in the 10 years since 1992-93, when investments amounted to $4.1 billion.

The Ralph review accepted the principle that Australia needed to develop its venture capital industry. The review found that funding from international investors was of paramount importance in developing a domestic venture capital industry. To facilitate this, Ralph recommended changes to Australia's CGT regime. In spite of advice from industry groups, the government introduced a limited CGT exemption. This exemption is embodied in subdivision 118G of the Income Tax Assessment Act 1997. The exemption failed to achieve its policy objective of stimulating foreign investment in the Australian venture capital industry and was widely regarded as a total failure. Since the introduction of the exemption in 1999, there has been only one reported $10 million investment.

The key problem with the exemption was that it only applied where pension funds invested directly in companies. In practice, US pension funds did not invest directly and instead invested through fund managers and through funds of funds. The bill intends to overcome this problem by extending this exemption to certain tax exempt non-residents, non-resident venture capital funds of funds and certain taxable non-residents.

The current CGT exemption to certain overseas pension funds on the profit or gain from the sale of investments in eligible venture capital investments will be extended to partners in the VCLP or AFOF which are tax exempt entities, including pension funds, endowment funds and foundations, from Canada, France, Germany, Japan, the UK, the USA or any other country prescribed in the regulations. These investors may hold up to 100 per cent of the committed capital of the VCLP or AFOF, foreign venture capital funds of funds, established in Canada, France, Germany, Japan, the UK or the USA. These funds of funds may hold up to 30 per cent of the committed capital of the VCLP or AFOF. Also included are taxable entities from Canada, France, Germany, Japan, the UK or the USA holding less than 10 per cent of the committed capital of the VCLP or the AFOF; or an entity—taxable or otherwise—from Finland, Italy, the Netherlands, New Zealand, Norway, Sweden or Taiwan which holds less than 10 per cent of the committed capital of the VCLP or AFOF.

The investment must have been held by the VCLP or AFOF for at least 12 months to qualify for the tax exemption. To qualify for the tax exemption the investment in either shares or options must be an eligible venture capital investment and the investment must be at risk—that is, investors must bear the risk of owning the shares or options themselves.

Mr Hockey —This is Mogodoning the electorate.

Mr COX —Absolutely. The Taxation Laws Amendment (Venture Capital) Bill 2002 sets out the requirements for an eligible venture capital investment and these cover listing, size, auditor, primary activity and residency requirements. Broadly, the company seeking the capital must be an unlisted Australian company or a listed Australian company that will be delisted within 12 months of the date of the investment, have assets not exceeding $250 million at the time of the investment and have a registered company auditor. It must not have any of the following as its primary activity: property development; finance, to the extent that it is banking, providing capital to others, leasing, factoring or securitisation; insurance; construction or the acquisition of infrastructure activities; or investments that generate interest, rents, dividend, royalties or lease payments. Additionally, if the investment is first made in the investee company, for 12 months following the investment that company must have more than 50 per cent of its employees in Australia and retain more than 50 per cent of its assets in Australia.

The other significant changes introduced by these bills relate to flow-through taxation treatment and the establishment of a registration process for VCLPs, AFOFs and EVCIs. In relation to flow-through taxation, the bills allow certain entities—that is, venture capital limited partnerships, Australian venture capital funds of funds and venture capital management partnerships—to have flow-through taxation treatment. The effect is that the income, profits, gains and losses of the partnership flow-through to the partners, who are then taxed on their share according to their respective tax status. These entities will be treated as though they are ordinary partnerships for Australian tax purposes even though they are in fact limited partnerships.

The other significant change relates to the venture capital manager. The changes will allow the venture capital manager's share of gains on the sale of the investments and carried interest to be taxed as a capital gain. It has been reported that Treasury had originally taken a tough line on this issue and wanted to see the manager's profits treated as income. However, the new provisions in respect of the carried interest paid to investment managers will be treated as a capital gain rather than as income. This is intended to make it easier to attract US or UK expertise in managing funds in Australia.

This is a major change in terms of taxation treatment and is likely to be a significant component of the revenue costs. Despite our request for a breakdown of the revenue implications, the government was not forthcoming. By the time the parliamentary secretary comes back, he might have extracted a few figures for us. The revenue impact of this bill is considerable. Treasury puts the revenue cost at $76 million over three years. Originally, the cost was put at $60 million over three years. It is interesting to note that the Australian Venture Capital Association Ltd disputes these figures, suggesting that the revenue implications are significantly less than estimated.

Both Labor and Liberal governments have long sought to increase the amount of venture capital available in Australia to stimulate investment and speed economic growth. Venture capital provides an important function in commercialising new technologies and research and development that may be too risky for traditional investors. Several successful Australian companies, like Cochlear Ltd, were backed by venture capital investment in their early stages. By extending the current CGT exemption, an increase in funds should flow to the venture capital sector in Australia from foreign tax exempt entities, including overseas superannuation funds, and from taxpaying entities. The Australian Venture Capital Association expects these changes to attract an additional $1 billion in foreign capital over the next five years. Labor will support the bill.