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Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016

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2013-2014-2015-2016

 

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

 

 

 

HOUSE OF REPRESENTATIVES

 

 

 

TAX LAWS AMENDMENT (TAX INCENTIVES FOR INNOVATION) BILL 2016

 

 

 

 

EXPLANATORY MEMORANDUM

 

 

 

(Circulated by authority of the

Treasurer, the Hon Scott Morrison MP)



Table of contents

Glossary.............................................................................................................. 1

General outline and financial impact............................................................ 3

Chapter 1               Tax incentives for early stage investors............................ 5

Chapter 2               Venture capital investment............................................... 37

Index................................................................................................................. 79

 



 

The following abbreviations and acronyms are used throughout this explanatory memorandum.

Abbreviation

Definition

ABR

Australian Business Register

AFOF

Australian venture capital fund of funds

ATO

Australian Taxation Office

CGT

Capital Gains Tax

Commissioner

Commissioner of Taxation

Corporations Act

Corporations Act 2001

ESIC

Early Stage Innovation Company

ESVCLP

Early Stage Venture Capital Limited Partnership

FVCFF

Foreign Venture Capital Fund Of Funds

ICCPR

International Covenant on Civil and Political Rights

ITAA 1936

Income Tax Assessment Act 1936

ITAA 1997

Income Tax Assessment Act 1997

MIT

Managed Investment Trust

NISA

National Innovation and Science Agenda

OECD

Organisation for Economic Co-operation and Development

R&D

Research and Development

TAA 1953

Taxation Administration Act 1953

TIFESI

Tax Incentive For Early Stage Investors

VCA 2002

Venture Capital Act 2002

VCLP

Venture Capital Limited Partnership



Tax incentives for early stage investors

Schedule 1 to this Bill amends the Income Tax Assessment Act 1997 to encourage new investment in Australian early stage innovation companies with high growth potential by providing investors, who invest in such companies, with a tax offset and a capital gains tax exemption for their investments.

These amendments form part of the tax incentive for early stage investors measure.

Date of effect : These amendments apply in relation to shares issued on or after the later of 1 July 2016 or Royal Assent.

Proposal announced : These amendments were announced by the Treasurer on 7 December 2015 as part of the Government’s National Innovation and Science Agenda.

Financial impact : The tax incentive for early stage investors has the following revenue implications:

2015-16

2016-17

2017-18

2018-19

2019-20

-

-

-$65m

-$65m

-$65m

Human rights implications : This Schedule raises human rights issue. See Statement of Compatibility with Human Rights - paragraphs 1.134 to 1.143.

Compliance cost impact : The tax incentive for early stage investors has an estimated compliance cost impact of $1.25 million per year. This cost has been fully offset within the portfolio.

Venture capital investment

Schedule 2 to this Bill amends the early stage venture capital limited partnership (ESVCLP) and venture capital limited partnership (VCLP) regimes within the Venture Capital Act 2002 and Income Tax Assessment Act 1997 to improve access to venture capital investment and make the regimes more attractive to investors. These changes are intended to encourage and support innovation, risk-taking, and an entrepreneurial culture in Australia.

The amendments provide an additional tax incentive for limited partners in new ESVCLPs, relax restrictions on ESVCLP investments and fund size and clarify the legal framework for venture capital investment in Australia.

Date of effect : The amendments made by Schedule 2 will broadly apply on and after 1 July 2016.

However, the ESVCLP tax offset will be available for any qualifying contributions made to ESVCLPs that become unconditionally registered on or after 7 December 2015.

Proposal announced : The measure forms part of the National Innovation and Science Agenda, announced in the Government’s Innovation Statement on 7 December 2015.

Financial impact : The measure is estimated to have the following revenue impact over the forward estimates period:

2015-16

2016-17

2017-18

2018-19

2019-20

-

-

*

*

*

- Nil

* Unquantifiable

Human rights implications : This Schedule does not raise any human rights issues. See Statement of Compatibility with Human Rights —paragraphs 2.167 to 2.172.

Compliance cost impact : This measure imposes some minor transitional and ongoing compliance costs on venture capital investors and their advisers.

 



Chapter 1          

Tax incentives for early stage investors

Outline of chapter

1.1                   Schedule 1 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to encourage new investment in Australian early stage innovation companies (ESICs) with high growth potential by providing qualifying investors, who invest in such companies, with a tax offset and a capital gains tax (CGT) exemption for their investments.

1.2                   All references to legislative provisions in this chapter are references to the ITAA 1997 unless otherwise stated.

Context of amendments

1.3                   The Australian Government currently provides tax concessions to support innovative Australian companies through the Research and Development (R&D) Tax Incentive, Early Stage Venture Capital Limited Partnership (ESVCLP) and Venture Capital Limited Partnership (VCLP) regimes.

1.4                   However, venture capital funds typically focus on companies that have already developed a concept that is anticipated to attract capital and the company is generally seeking higher amounts of capital to grow. Instead, Australian ESICs face difficulty trying to attract seed and pre-commercialisation equity at an earlier stage of their development.

The National Innovation and Science Agenda

1.5                   The National Innovation and Science Agenda (NISA) contains complementary measures to ensure innovative companies are supported at different stages of development, by aligning our tax system and business laws with a culture of entrepreneurship and innovation. The Australian Government seeks to encourage innovation through a tax system that encourages an entrepreneurial and risk taking culture.

1.6                   The tax incentive for early stage investors (TIFESI) is designed to promote this culture by connecting relevant start-up companies with investors that have both the requisite funds and business experience to assist entrepreneurs in developing successful innovative companies, particularly at the pre-commercialisation phase where a concept is in development, but the company requires additional investment to assist with commercialisation.

1.7                   Often it is the high risk period between initial funding to the time a start-up company begins generating revenue that makes it difficult to attract investors or obtain finance to develop a concept past initial funding. In fact, this stage is sometimes described as a ‘valley of death’ where most start-up companies fail simply because they find themselves vulnerable to cash flow requirements. Accordingly, these amendments focus on providing an attractive tax offset at the outset for investors who invest in ESICs, with an exemption for any subsequent capital gains realised on the investment, but without access to any losses realised on the investment. This treatment is consistent with the ESVCLP incentives in Subdivision 118-F.

1.8                   These amendments bridge the funding gap between pre-concept stage financing and support (typically provided through self-funding, friends and family and government offsets such as the refundable R&D tax offset) and financing through the ESVCLP and VCLP regimes for companies further along the development pathway.

1.9                   While typical start-up companies may be selective as to the type of investors they wish to bring on board, these amendments are designed to apply to a broad range of potential investors, whether they wish to invest directly or through a company, trust or partnership. However as investments in ESICs can involve high risk, the amendments limit the risk exposure of retail investors to $50,000 per year.

Developing a legislative framework for these amendments

1.10               The Government has developed the TIFESI as a high priority to alleviate industry concern about an investment drought.

1.11               Treasury, the Australian Taxation Office (ATO) and the Department of Industry, Innovation and Science undertook a targeted consultation process on the design of the TIFESI regime. Over 50 stakeholders participated in this process by either attending a targeted roundtable and/or providing a formal submission in response to the Government’s discussion paper. These stakeholders included experienced investors, start-up founders and industry bodies that are active in sectors that include the technology, financial technology, medical, corporate, financial and agricultural industries.

1.12               The Government is aware that innovation is an evolving concept which is broader than just R&D activities. As a result, these amendments adopt a principle-based definition of an innovation company that is based on industry concepts and terminology which allows the law to accommodate new innovations not yet envisioned. The legislation also includes regulation making powers to ensure the regime can easily adapt to evolving markets. In particular, these regulation making powers will allow the Government to ensure that the eligibility requirements and the incentives themselves remain up to date and fit for purpose, whilst minimising opportunities for tax avoidance.

1.13               Extending the incentive to indirect investments through an Australian Innovation Fund, as envisaged in the Government’s discussion paper, may be considered at a later date depending on stakeholder feedback on these amendments. More generally, the Government intends to review this tax incentive after a period of four years to determine how well it is delivering on these policy outcomes.

Summary of new law

1.14               These amendments create a new Subdivision 360-A ‘Tax incentives for early stage investors in innovation companies’ within Division 360 ‘Early stage investors in innovation companies’. This new Subdivision sets out the circumstances when an investor qualifies for the tax offset and the modifications to the CGT treatment of eligible investments.

1.15               These amendments also create a new requirement for ESICs to report information about their investors to the Commissioner of Taxation (Commissioner) so that the ATO can assess whether these investors may qualify for the tax offset and the modified CGT treatment. This approach minimises compliance costs for all parties involved by requiring the reporting of only the minimum amount of information necessary for the ATO to effectively administer the regime. The legislative framework supporting this reporting provides the Commissioner with administrative flexibility to further minimise the compliance burden on ESICs.

Comparison of key features of new law and current law

New law

Current law

Entities that acquire newly issued shares in an Australian ESIC may receive a non-refundable carry-forward tax offset of 20 per cent of the value of their investment subject to a maximum offset cap amount of $200,000.

In addition, a total annual investment limit of $50,000 applies to retail (non-sophisticated) investors.

Existing tax incentives are not targeted specifically to investments in ESICs.

In addition, investors may disregard capital gains realised on shares in qualifying ESICs that have been held for between one and ten years.

Investors must disregard any capital losses realised on these shares held for less than ten years.

Capital gains realised on investments in ESICs are typically taxable.

Detailed explanation of new law

What investors qualify for the tax incentives?

1.16               The tax incentives introduced by these amendments are available to all types of investors, regardless of their preferred method of investment (whether an investment is made directly as a corporation or individual or indirectly through a trust or partnership) other than ‘widely held companies’ (as defined in section 995 1) and 100 per cent subsidiaries of these companies. An investor can be any entity within the meaning of section 960-100. A trust or partnership will not directly be entitled to the tax offset, however, specific rules apply to ensure the value of these tax incentives flow through to beneficiaries and partners, where such an investment method is chosen. These rules are explained in paragraphs 1.48 to 1.56. [Schedule 1, item 1, paragraph 360-15(1)(a) and subsections 360-15(2) and 360-15(3)]

1.17               To ensure the tax offset is broadly available for all prospective investors, there are also no restrictions on an investor entity’s residency. That said, the tax offset may be less attractive to foreign residents that do not have an Australian income tax liability.

Limited entitlement for certain kinds of investors

1.18               Whilst the tax incentives are generally available to all types of investors, investment in innovation companies is inherently risky and some protections are necessary to ensure more vulnerable investors are not over-exposed to this risk. Many investments may lose money, while others have the potential to make large gains.

1.19               There are no restrictions on the amount an entity may invest if the entity meets the requirements of the sophisticated investor test in section 708 of the Corporations Act 2001 (Corporations Act) in relation to a relevant offer of shares (refer paragraph 1.25) at any time in the income year. In the Corporations Act the sophisticated investor test is used for investment opportunities that have reduced disclosure requirements, on the basis that investors that meet this criteria are more likely to be able to evaluate offers of securities and other financial products without needing the protection of a disclosure document.

1.20               This means that as long as the investor meets the requirements of the sophisticated investor test in relation to at least one offering of relevant equity interests in the income year, then there are no restrictions on the amount the entity may invest (subject to the $200,000 cap on the value of the tax offset, as described in paragraphs 1.40 to 1.45).

1.21               Other investors (non-sophisticated investors) are limited to investing amounts of $50,000 and below in an income year. These investors will not be entitled to a tax offset if their investment exceeds this maximum threshold, even in relation to any proportion of such an investment below this threshold. [Schedule 1, item 1, section 360-20]

Tax offset for shares in a qualifying ESIC

1.22               These amendments introduce a non-refundable carry-forward tax offset for qualifying investor entities equal to 20 per cent of the amount they paid for qualifying shares.

1.23               The general case set out below describes the rules relating to direct investment, where the investor entity is an individual or corporation. Special rules for members of trusts or partnerships and trustees that are liable for tax are explained in paragraphs 1.48 to 1.60.

Example 1.1  

Alex, a sophisticated investor, earns assessable income of $600,000 and has normal deductions of $100,000 in the 2016-17 income year. On the basis that Alex does not qualify for the tax offset, Alex’s tax liability on a taxable income of $500,000 would be $214,947.

However, if Alex invested $100,000 in qualifying shares then he would receive a $20,000 tax offset and reduce his tax liability to $194,947.

General case

Entitlement to the tax offset

1.24               Subject to the limitation described in paragraph 1.16 above, an entity (other than a trust or partnership) is entitled to a tax offset for an income year if during that year the entity was issued with shares by a qualifying ESIC, provided the entity was not in a restricted relationship at the relevant time, nor precluded from accessing the offset because in the income year it is the kind of investor described in paragraphs 1.18 to 1.21. The relevant relationship restrictions are explained in paragraphs 1.33 to 1.39. [Schedule 1, item 1, subsection 360-15(1) and section 360-20]

1.25               Qualifying shares are newly issued equity interests that are shares in a qualifying ESIC, where the issue of the shares does not constitute an acquisition of ESS interests under an employee share scheme (refer definition of ESS interest in section 83A-10). [Schedule 1, item 1, paragraphs 360-15(1)(b) and (c) and (e)]

1.26               The basic test for an equity interest is provided in sections 974-70 and 974-75. In addition to this, the equity interest must constitute a share within the meaning of section 995-1.

1.27               These rules ensure that the tax incentives are targeted at new investors in a qualifying ESIC rather than shares issued under an employee share arrangement or in relation to interests with a debt character, such as preference shares.

1.28               The equity interests must be issued by the ESIC, which confines these interests to those that are newly issued. This prevents entities that trade shares in an ESIC from receiving an offset for an investment that does not directly raise any additional funds for the ESIC.

1.29               The time for testing whether an entity is a qualifying ESIC is the time immediately after the relevant equity interests are issued. This ‘point in time test’ means, for example, investors that acquire equity interests from the conversion of convertible notes are not precluded from qualifying for the tax offset, where the company issuing those equity interests is a qualifying ESIC at the time of the conversion into shares. The requirements for a qualifying ESIC are explained in paragraphs 1.61 to 1.109.

1.30               An investor entity that acquires shares in a company that is a qualifying ESIC at the time of issue, will not be disqualified from accessing a tax offset in relation to those shares if the company subsequently ceases to be a qualifying ESIC (nor will the investor be disqualified from accessing the modified CGT treatment in relation to those shares (refer also to paragraph 1.112)).

Example 1.2  

Simon, a sophisticated investor, acquires $50,000 worth of shares in a qualifying ESIC on 1 October 2016. Assuming Simon has a sufficient tax liability at the end of the 2016-17 income year and meets the other requirements in relation to the tax offset, he would receive a tax offset of $10,000.

Should Simon acquire an additional $500,000 worth of shares in the same qualifying ESIC on 1 December 2016 (and assuming he has a sufficient tax liability and still meets the other requirements of the tax offset) he would receive a tax offset of $110,000 in the income year ending 30 June 2017.

Should the company, for whatever reason, no longer be a qualifying ESIC by 1 June 2017, then this will not affect Simon’s entitlement to the tax offset in relation to both parcels of shares and the subsequent modified CGT treatment of those shares.

1.31               This approach recognises that a legislative regime that requires ongoing activity checks for a qualifying ESIC, with an associated clawback mechanism for the offset should circumstances change, would impose a regulatory burden on ESICs and create additional risk and uncertainty for investors.

1.32               That said, it is likely that an entity that has met the requirements to be a qualifying ESIC will remain a qualifying ESIC. To the extent that it stops being a qualifying ESIC, the goal of improving access to capital for that company has been met.

Restrictions on the relationships of the investor and the ESIC
The investor and the ESIC must not be affiliates of each other

1.33                     In order to qualify for the tax offset, the ESIC must not be an affiliate (refer section 328-130) of the investor entity nor can the investor entity be an affiliate of the ESIC at the time the relevant shares are issued. That is, the ESIC must not act, or reasonably be expected to act, in accordance with the investor’s directions or wishes, or in concert with the investor, in relation to the affairs of the business of the ESIC and vice  versa. The entities will not be considered affiliates merely because of the nature of the business relationship shared between them. [Schedule 1, item 1, paragraph 360-15(1)(d)]

1.34               The affiliate test is used in this context in order to target the tax incentives to new investors in an ESIC. The tax offset is designed to encourage new investment in ESICs rather than merely subsidise the existing investment. If an investor exerts a degree of influence over an ESIC or vice versa, as per an affiliate relationship, it might be expected that the offset is not attracting this type of new investment.

1.35               For example, a director-owner of an ESIC would be precluded from qualifying for a tax offset, as the ESIC would be an affiliate of the director-owner.

1.36               The affiliate test is also an integrity rule to prevent entities acting in concert to obtain the benefit of the tax offset, where the investment is not for an innovation purpose or does not represent new capital for the ESIC that meets the policy objectives of this measure. For example, where the investor entity is a wholly-owned subsidiary company of the ESIC, the investor entity would be precluded from qualifying for a tax offset, as the investor entity would be an affiliate of the ESIC. An investment in these circumstances would essentially represent shifting capital between two separate legal entities that does not represent new investment.

30 per cent equity interest restriction

1.37               In order to qualify for the tax offset, the investor entity must not hold more than 30 per cent of the equity interests of an ESIC, including any entities ‘connected with’ (refer section 328-125) the ESIC, tested immediately after the time relevant equity interests are issued. [Schedule 1, item 1, paragraph 360-15(1)(f)]

1.38               This restriction encourages investors to spread their investments across more than one ESIC.

1.39               An ESIC is connected with another entity if the ESIC controls the other entity (or vice versa) or both are controlled by the same third entity. The connected with test is used in this context to ensure that the policy intention behind the 30 per cent cap is not circumvented by an investor that invests in multiple related ESICs, holding less than 30 per cent of the issued capital in each, but has not, in reality, spread their investments, as there is a control relationship between the ESICs.

Amount of the offset

1.40               In the general case (described in paragraph 1.24), the amount of the offset for a qualifying investor in an income year will be equal to 20 per cent of the amount paid for the qualifying shares (refer to paragraph 1.25). However, the maximum offset for an investor entity and its affiliates in any income year is $200,000 less the sum of any previously claimed TIFESI tax offsets carried forward into the income year (refer paragraphs 1.46 to 1.47 about the carry-forward nature of the tax offset). [Schedule 1, item 1, section 360-25]

1.41               This means that for investments up to $1 million, qualifying investors receive the full 20 per cent non-refundable tax offset. Investment amounts greater than $1 million in an income year do not increase the amount of the offset available.

1.42               Where the offset is carried forward and further eligible investments are made, the offset that may be claimed from investments made in any one year is capped at $200,000.

1.43               Potential investors should take these limits into account (as well as the CGT treatment of qualifying shares) when making investment decisions.

1.44               The $200,000 annual cap on the value of the offset for an investor applies on an affiliate-inclusive basis in order to prevent entities entering into arrangements to circumvent the cap.

1.45               For example, this would prevent an investor entity obtaining the benefit of multiple offsets, exceeding the $200,000 cap, in situations where an investor enters into arrangements with its affiliates in order to trade the value of offsets.

Other characteristics of the tax offset

1.46               The tax offset is non-refundable, so it is of no immediate benefit to an entity without an income tax liability. However, the tax offset may be carried forward. By making the tax offset carry-forward, it reduces the chance that the benefit of the offset will be lost to investors. As a carry-forward tax offset, recipients should apply offsets that cannot be refunded or carried forward first and before refundable offsets, so the benefit of these offsets is not lost or deferred. There are only minimal differences in the relative priority of this offset compared with other existing carry-forward offsets. This offset falls in priority below the carry-forward tax offset for ESVCLP investment (refer Schedule 2 of this Bill) but above carry-forward offsets arising under the R&D tax incentive.

1.47               An investor entity may only carry forward so much of the tax offset that it would be eligible to claim if it had an income tax liability. This means that the amount an investor entity may carry forward is capped at $200,000.

Example 1.3  

During the 2016-17 income year, Michael (a sophisticated investor) is issued with $3,000,000 of shares in Shar Rock Services Co (which is a qualifying ESIC immediately after that time). Subject to meeting the other eligibility requirements, Michael is eligible to claim a tax offset of $200,000 in relation to those shares for 2016-17 (whilst 20 per cent of $3,000,000 is $600,000, the value of the offset is capped at $200,000).

However, Michael does not have a tax liability in 2016-17, so the tax offset is of no value to him in that income year. Michael may carry forward the $200,000 offset to apply against his income tax liability in 2017-18. Michael can only carry forward the portion of the tax offset that he is entitled to and has not used in the current income year ($200,000 and not the full $600,000). The remaining $400,000 that does not qualify for the tax offset in the 2016-17 income year is not carried forward for use as a tax offset in any future income years.

Members of trusts or partnerships

Entitlement to the tax offset

1.48               As flow-through entities, partnerships are not subject to tax in their own right and trusts are generally not subject to tax in their own right, and in such cases would not receive any benefit from a tax offset. Instead, this measure provides an equivalent tax offset for members of trusts or partnerships, who are, in substance, the ultimate investors.

1.49               A member of a trust or partnership (a beneficiary or unit holder of a trust or a partner in a partnership - see section 960-130) at the end of an income year is entitled to a carry-forward tax offset for that income year, if the trust or partnership were an individual and would be entitled to a tax offset in the general case discussed in paragraphs 1.24 to 1.32. [Schedule 1, item 1, subsection 360-15(2)]

1.50               In some cases the members of a trust or partnership may include another trust or partnership. In this situation the members of that other trust or partnership are generally entitled to the offset. If those members are themselves trusts or partnerships, then the offset will also pass to the members of these entities under the same process outlined in paragraphs 1.51 to 1.56 below, until it ultimately reaches an entity that is not a trust or partnership. [Schedule 1, item 1, subsection 360-15(2)]

Amount of the tax offset

1.51               The amount of the offset is the product of:

•        the determined share of notional tax offset — that is the member’s share of the offset as determined by the trustee or partnership; and

•        the notional tax offset amount — that is the amount of the offset that would be available to the trust or partnership were it an individual.

[Schedule 1, item 1, subsections 360-30(1) and (2)]

1.52               The partnership or trustee must notify the member of the share that has been determined for them within three months of the end of the income year, or such further time as the Commissioner may allow. This notice must inform the member about the amount that has been determined to be their share of the tax offset. [Schedule 1, item 1, subsection 360-30(4)]

1.53               If no determination is made or the determination does not allocate all of the available tax offset then no member will be entitled to the amount of the tax offset to the extent of the shortfall in amounts or proportions determined by the trustee.

1.54               If a member of a trust or partnership is entitled to a fixed proportion of any capital gain from investments that would result in the trust or partnership being entitled to the tax offset if that entity was an individual, then the member’s share of the offset must be that proportion. For example, such a fixed entitlement normally exists for the holders of units in unit trusts. Where such a fixed entitlement exists, the trustee must determine that the member is entitled to that amount or proportion and cannot make a contrary determination. [Schedule 1, item 1, subsection 360-30(3)]

1.55               Whether a taxpayer has a fixed entitlement is based on the terms of the trust or partnership. It is not relevant whether the trust has a capital gain or net income for an income year or is in a loss position or how any such income or loss may have been distributed. In particular, it is not relevant if, for example, a trustee of a discretionary trust may have distributed the income or capital of a trust in different proportions to the offset.

1.56               For the avoidance of doubt, the amendments make it clear that the trustee or partnership may not determine that the members of the trust or partnership are entitled to more than 100 per cent of the notional tax offset that would have been available to the trust or partnership. [Schedule 1, item 1, subsection 360-30(5)]

Trustees that are liable for tax

Entitlement to the tax offset

1.57               Although trusts are generally not subject to income tax in their own right, in certain circumstances trustees are required to pay tax on behalf of the trust. Depending on the nature and circumstances of the trust and its beneficiaries, the trustee may be the only entity liable for tax on the net income of the trust.

1.58               Despite the rule that the offset is available to the beneficiaries or unit holders of a trust (refer paragraphs 1.48 to 1.50), a trustee of a trust is entitled to a tax offset if:

•        the trust would be entitled to the tax offset if it was an individual; and

•        the trustee of the trust is liable to some extent for tax in respect of the activities of the trust (under sections 98, 99 or 99A of the Income Tax Assessment Act 1936 (ITAA 1936)).

 [Schedule 1, item 1, subsection 360-15(3)]

Amount of the tax offset

1.59               The amount of the offset available to the trustee is the amount that would be available to the trust if it were an individual, less any tax offset amounts to which beneficiaries of the trust are entitled to that relate to the same equity interests which give rise to the trustee’s tax offset entitlement. [Schedule 1, item 1, section 360-35]

1.60               The only amount of the offset that the trustee is entitled to is the portion of any capital gains (if any) the trustee is not entitled to distribute to beneficiaries of the trust. This means that where the trustee is required to distribute all capital gains (such as, for example, unit trusts), the trustee can never be entitled to any amount of the offset, as there can be no undistributed amount.

What is a qualifying ESIC?

1.61               Generally, an Australian-incorporated company will qualify as an ESIC if it is at an early stage of its development (the early stage limb) and it is developing new or significantly improved innovations with the purpose of commercialisation to generate an economic return (the innovation limb). Specific, objective threshold tests apply to determine if the company is at an early stage of its development whereas a combination of tests may apply to determine if the company is developing a type of innovation. These different tests recognise that whilst objective tests are easier to apply in Australia’s self-assessment income tax system, companies may be innovating in a variety of different ways and so may need to apply a combination of different tests depending on their circumstances.

The early stage limb

1.62               A company must pass four tests to satisfy the early stage limb of the qualifying ESIC test. Each of these tests is discussed below.

It has been recently incorporated or registered in the Australian Business Register

1.63               The company:

•        must have been incorporated in Australia within the last three income years (the latest being the current income year at the test time); or

•        if it has not been incorporated within the last three income years — then it must have been registered in the Australian Business Register (ABR) within the last three income years (the latest being the current income year at the test time); or

•        if it has not been registered in the ABR within the last three income years — then:

-                it must have been incorporated in Australia within the last six income years; and

-                it and any wholly-owned subsidiaries must have incurred expenses of no more than $1,000,000 in total across all of the last three income years (the latest being the current income year at the test time).

[Schedule 1, item 1, paragraph 360-40(1)(a)]

1.64               The ATO’s company tax return requires companies to report ‘total expenses’ at item six as part of the total profit or loss calculation. A company that has submitted a company tax return in the previous income year must rely on the amount reported in item six for the purposes of this test. Alternatively, if the company was not required to submit a company tax return, it may use the amount corresponding to this item.

1.65               A company that does not meet any of these three requirements will not qualify as an ESIC.

It has total expenses of $1 million or less

1.66               The company and any of its wholly-owned subsidiaries must have not incurred ‘total expenses’ (as explained in paragraph 1.64) of more than $1,000,000 in the previous income year. [Schedule 1, item 1, paragraph 360-40(1)(b)]

It has assessable income of $200,000 or less

1.67               The company and any of its wholly-owned subsidiaries must have derived assessable income of no more than $200,000 in the previous income year. [Schedule 1, item 1, paragraph 360-40(1)(c)]

1.68               Companies that had no assessable income in the previous income year will satisfy this test.

1.69               In determining the company’s assessable income, the company may disregard the value of an Accelerating Commercialisation Grant it received in that year (refer also to paragraph 1.93). [Schedule 1, item 1, subsection 360-40(2)]

It is not listed on a stock exchange

1.70               The company must not be listed on any stock exchange (either in Australia or overseas). These tax incentives target companies experiencing difficulty accessing equity finance and without access to fundraising via listed securities. [Schedule 1, item 1, paragraph 360-40(1)(d)]

The innovation limb

1.71               The principle-based definition of innovation is designed to provide enough legislative flexibility to accommodate both existing and future forms of innovations while specifically targeting high growth potential companies based on the innovation company’s focus and potential business capabilities.

1.72               However, recognising that not all companies will want to self-assess, or seek a ruling from the ATO about whether they satisfy such a test, these amendments also provide some objective activity-based criteria that companies can apply against their own circumstances. In practice, this may be the simplest and fastest way for companies to determine if they satisfy the innovation limb of the qualifying ESIC test.

1.73               As such, companies may choose to:

•        apply their circumstances against the objective tests;

•        self-assess their circumstances against the principles-based test; or

•        seek a ruling from the Commissioner about whether their circumstances satisfy the principles-based test.

1.74               In providing a ruling, the ATO may need to consult with the Department of Industry, Innovation and Science in considering if the company meets the principles-based test. The ruling would only apply to the facts given in the ruling request and the company may need to reassess its eligibility if circumstances change.

1.75               These amendments also provide that the regulations may specify types of activities or forms of innovation that are excluded from being able to satisfy the innovation test. This provides ongoing flexibility should the Government wish to more tightly target the TIFESI in the future or if the incentive is being used for inappropriate purposes. [Schedule 1, item 1, subsections 360-40(3) and (4)]

The principles-based test

1.76               Implicit in the definition of innovation is the requirement that the company is developing a new or significantly improved type of innovation such as a product, process, service, marketing or organisational method. This list of various types of innovations provides flexibility for innovation companies and is adaptable to current and future innovations. The Oslo Manual, published by the Organisation for Economic Co-operation and Development (OECD) provides a description of these different types of innovations and a copy of this manual is available on the OECD website ( www.oecd.org ).

1.77               A qualifying ESIC will need to be genuinely focused on developing its new or significantly improved innovation for the purpose of commercialisation and show that the business relating to that innovation:

•        has the potential for high growth;

•        has scalability;

•        can address a broader than local market; and

•        has competitive advantages.

Further information about these elements is set out below . [Schedule 1, item 1, paragraph 360-40(1)(e)]

1.78               A qualifying ESIC could demonstrate how it satisfies the different elements of this test through the use of its existing documentation such as business plans, commercialisation strategies, competition analysis or other company documents. In addition, the company must show that tangible steps have been or will be undertaken in relation to that focus or capability.

New or significantly improved

1.79               The innovation that is being developed by a qualifying ESIC must either be new or significantly improved for the applicable addressable market. A company’s addressable market refers to the available revenue opportunity or market demand arising from the innovation, or the business relating to that innovation. The addressable market identified by the ESIC must be objective and realistic. For example, if the addressable market for the innovation was the Australian market, then the innovation must be new or significantly improved for that market. [Schedule 1, item 1, paragraph 360-40(1)(e)(i)]

1.80               Improvements resulting from the customisation of existing products, minor extensions such as updates to existing equipment or software, changes to pricing strategies, changes to goods resulting from cyclical or seasonal change and the trading of new products for a wholesaler, retail outlet or distribution business where activities are similar to the approach of competitors are unlikely to satisfy the significantly improved threshold. Further, ceasing to utilise a process or method will not satisfy the new or significantly improved thresholds.

Example 1.4  

PAM One Co is a start-up clothing company that has developed a new organisational method where the company utilises an integrated cross-functional structure resulting in reduced response times to shifting customer styles. PAM One Co has also identified that the company’s addressable market is the Australian market.

As existing clothing companies in PAM One Co’s addressable market are typically organised around individual functions, the integrated cross-functional structure is new to that addressable market. As a result, PAM One Co has developed a new or significantly improved organisational method.

Example 1.5  

JM Technology Co is a new wholesale distribution company which specialises in personal technology products. If JM Technology Co begins to sell a new personal technology product which was released by one of their offshore suppliers, JM Technology Co has not developed a new or significantly improved service or innovation.

Commercialisation

1.81               In addition, the company must be focussed on developing its innovation for a commercial purpose, or in other words, for the purpose of generating economic value and revenue for the ESIC. This requirement draws the distinction between simply having an idea and generating economic value from that idea. Commercialisation encompasses a spectrum of activities including those leading to the sale of new or significantly improved product, process or service as well as activities involving the implementation of a new, or significantly improved, process or method, where the process, or method directly leads to the generation of economic value for the company. [Schedule 1, item 1, paragraph 360-40(1)(e)(i)]

Example 1.6  

JS&RD Co is a small start-up company in the pharmaceutical industry seeking funding to develop a new process to manufacture a known pain relief medication. If the company can successfully scale up its process, the new process promises to be more efficient and more environmentally friendly than the conventional manufacturing process used by incumbents.

Even though JS&RD Co does not intend to licence the innovation to another company, the innovation has the potential to provide the company with a direct competitive advantage over its rivals and generate significant economic value. As a result, JS&RD Co has developed the innovation for a commercial purpose.

High growth potential

1.82               The TIFESI is specifically designed to encourage capital investment into innovative companies with high growth potential, as distinct from typical small to medium enterprises such as cafes, local retail stores, local service providers that service a single local market. Specifically, a qualifying ESIC would need to show that it has the potential for high growth within a broad addressable market. [Schedule 1, item 1, paragraph 360-40(1)(e)(ii)]

Example 1.7  

Sheng Da Co is a company developing a new mobile application which provides specialised on demand concierge services for the convenience of its users. While the company initially aims to test the service in Melbourne, it shows its high growth potential through its ability to expand the use of its mobile platform and the location of the services to include all major cities in Australia and beyond. The company has outlined this expansion strategy in its business plan and has started to contact service providers in other major cities. As a result, Sheng Da Co has high growth potential.

Scalability

1.83               A qualifying ESIC must have the potential to successfully scale its business. As the company increases its share of the market or enters into new markets, the company needs to have operating leverage, where existing revenues can be multiplied through incurring a reduced or minimal increase in operating costs. [Schedule 1, item 1, paragraph 360-40(1)(e)(iii)]

Example 1.8  

RTing Co, a start-up manufacturing company is developing a new formula for a perishable consumer goods product which allows the product to have an extended shelf life.

The company has outlined its strategy to acquire its own manufacturing plant as the demand for the product grows. If production of the product is increased, the company has further indicated that the cost per unit can be reduced by leveraging the existing operating costs of the plant as it sells the product into new markets. As a result, RTing Co has the potential to successfully scale its business.

Example 1.9  

Yien-Yih Co is a new local service provider of dental care. The company’s strategy for high growth is to expand the number of clinics to increase its revenue. However, the company’s operating costs (new premises, staff, etc.) increase by the same amount as the additional revenue generated from each clinic and so Yien-Yih Co does not possess the potential to successfully scale the business.

Broader than local market

1.84               A qualifying ESIC would need to demonstrate that it has the potential to address a market that is broader than a local city, area or region. While the company does not need to have a serviceable market at a national, multinational or global scale at the test time, it does need to show the capability to address a market that is broader than a local market and also show that this business can be adapted to a national, multinational or global scale in the future. [Schedule 1, i tem 1, paragraph 360-40(1)(e)( iv)]

Example 1.10  

Further to example 1.8, RTing Co plans to initially test and sell its new product to the Victorian market and has an expansion strategy to sell to the broader Australian market and if successful, eventually adapt its product for the Asia-Pacific market. As a result, RTing Co has the potential to service a broader than local market and adapt to a global scale.

Competitive advantages

1.85               A qualifying ESIC will need to demonstrate that it has the potential to have competitive advantages, such as a cost or differential advantage over its competitors which are sustainable for the business. A method of evaluating a competitive advantage can be through the measures of the level of value for customers, rarity, imitability and substitutability of the advantage. [Schedule 1, item 1, paragraph 360-40(1)(e)( v)]

Example 1.11  

SLIS Tech Co is developing a new peer to peer service providing website for the Australian market. After conducting a competition analysis of the marketplace, a differentiating competitive advantage identified was the website’s use of a marketplace platform.

SLIS Tech Co has identified that this attribute will allow the company to outperform its competition. In addition, the company has taken initial steps in developing the platform and has also started to engage with the service providers to be part of the websites network. As a result, SLIS Tech Co has the potential to have competitive advantages.

Objective tests

1.86               As an alternative to satisfying the principle-based test for a qualifying ESIC, a company may be a qualifying ESIC if it has at least 100 points for meeting certain objective innovation criteria. [Schedule 1, item 1, paragraph 360-40(1)(e) and subsection 360-45(1)]

Research and development claims above a certain threshold

1.87               A company will be awarded 75 points if it has at least 50 per cent of its total expenses for the previous income year constituting expenses which are eligible for the tax offset for R&D activities provided under Division 355. [Schedule 1, item 1, item 1 in the table in subsection 360-45(1)]

1.88               A company will be awarded 50 points if it has at least 15 and less than 50 per cent of its total expenses for the previous income year constituting expenses which are eligible for the tax offset for R&D activities provided under Division 355. [Schedule 1, item 1, item 3 in the table in subsection 360-45(1)]

1.89               For the purposes of these criteria, ‘total expenses’ will correspond to the amount reported by the entity in the previous income year’s company tax return as ‘total expenses’ (refer to paragraph 1.64).

1.90               The points described in paragraph 1.88 are not available if an entity is relying on points described in paragraph 1.87.

1.91               The fact that a company has invested in R&D does not necessarily mean the company is focused on developing for commercialisation a new or significantly improved product, process, service, marketing or organisational method. However, spending a significant amount on R&D is likely to be a strong indicator that this is the case.

Received an Accelerating Commercialisation Grant

1.92               A company will be awarded 75 points if, at any time, it has received an Accelerating Commercialisation Grant under the Accelerating Commercialisation element of the Commonwealth’s Entrepreneurs’ programme. [Schedule 1, item 1, item 2 in the table in subsection 360-45(1)]

1.93               Note: For the purposes of calculating a company’s assessable income in order to assess whether the company is a qualifying ESIC, the value of an Accelerating Commercialisation Grant may be disregarded (refer paragraphs 1.67 to 1.69). This prevents a company being precluded from satisfying the requirements for a qualifying ESIC because the value of such a grant results in the company exceeding the $200,000 assessable income threshold. [Schedule 1, item 1, subsection 360-40(2)]

1.94               The Commonwealth’s Accelerating Commercialisation Grant is targeted at assisting entrepreneurs commercialize a novel product, process or service. A company that has received such a grant is therefore likely to also meet the principle-based definition of a qualifying ESIC.

Completed or undertaking eligible accelerator programme

1.95               A company will be awarded 50 points if it is undertaking or has completed an eligible accelerator programme. An eligible accelerator programme is a programme that provides time-limited support for start-ups, for which an open, independent and competitive application process is required for entry, provided the entity running that programme has been operating for at least a six month period and has provided a complete programme of this kind to at least one cohort of entrepreneurs . Accelerator programmes that cannot provide value adding support (mentorship, training, education and networks) to the accepted companies or have had no successful companies coming through the programme are unlikely to be effective accelerator programmes. [Schedule 1, item 1, item 4 in the table in subsection 360-45(1)]

1.96               Entry into an accelerator programme involves a merits-based screening process, where entities with business and start-up experience select promising start-ups to support in the commercialisation process for a new innovation. A company that has been selected through such a process is likely to meet the principle-based test for a qualifying ESIC.

1.97               Requiring the entity running the accelerator programme to have been operating for a minimum period and to have provided a complete accelerator programme to at least one cohort of entrepreneurs minimises opportunities to manipulate this criterion.

Third party has previously invested at least $50,000

1.98               A company will be awarded 50 points if it has previously (at least one day before) issued shares to a third party, provided that the third party:

•        paid at least $50,000 for those shares;

•        was not an associate (within the meaning of section 318 of the ITAA 1936) of the company immediately before the time those shares were issued; and

•        did not acquire those shares primarily to assist another entity become entitled to the TIFESI.

[Schedule 1, item 1, item 5 in the table in subsection 360-45(1)]

1.99               These criteria recognise situations where a genuine third party investor has identified an innovative company and has been willing to invest a significant amount of their own money in support of the company. However, the points are not available if the third party investor has invested in the company primarily to assist the other investor (the investor seeking access to the tax offset) qualify for the TIFESI.

Holds certain enforceable intellectual property rights

1.100           A company will be awarded 50 points if it has one or more enforceable rights on an innovation through a standard patent or plant breeder’s right that has been granted in Australia or an equivalent intellectual property right granted in another country. The property right must have been granted in the last 5 years. [Schedule 1, item 1, item 6 in the table in subsection 360-45(1)]

1.101           A company will be awarded 25 points if it has one or more enforceable rights on an innovation through an innovation patent or design right or an equivalent intellectual property right granted in another country. Where the property right relates to an innovation patent or foreign equivalent, the right must have been granted and certified within the last 5 years. Where the property right relates to a design or foreign equivalent, it must have been registered within the last 5 years. [Schedule 1, item 1, item 7 in the table in subsection 360-45(1)]

1.102           The points described in paragraph 1.101 are not available if an entity is relying on points described in paragraph 1.100.

1.103           It is likely that a company that has an intellectual property right of the kind described above is focused on developing for commercialisation a new or significantly improved product, process, service, marketing or organisational method. Generally, this requires the company to have gone through a rigorous registration process.

1.104           A company that holds a licence to the intellectual property of another party may also qualify for these points. The inclusion of licensing in this criterion recognises that this is a common strategy for commercialising intellectual property and the objective of these amendments is to facilitate the extraction of economic value from such underlying creations or inventions.

Collaborative agreement with research organisation or university to commercialise an innovation

1.105           A company will be awarded 25 points if it has a written agreement to co-develop and commercialise an innovation with either:

•        an institution or body listed in Schedule 1 to the Higher Education Funding Act 1988; or

•        an entity registered under section 29A of the Industry Research and Development Act 1986.

[Schedule 1, item 1, item 8 in the table in subsection 360-45(1)]

1.106           The list in Schedule 1 to the Higher Education Funding Act 1988 captures institutions or bodies eligible for special research assistance under that Act.

1.107           The entities registered under section 29A of the Industry Research and Development Act 1986 captures entities that are assessed as having the appropriate scientific or technical expertise and resources to perform R&D on behalf of other companies. This registration process is managed by Innovation Australia and the criteria for registration is contained in Part 3 of the I ndustry Research and Development Regulations 2011 .

Adding additional criteria

1.108           Additional criterion may be specified by regulation in the future. This flexibility allows for the future provision of objective criteria that provide greater certainty to entities, making it easier for prospective innovation companies and investors to self-assess meeting these requirements. [Schedule 1, item 1, subsection 360-45(2)]

1.109           Some examples of possible criteria that could be developed and specified in the future are criteria relating to:

•        a company’s acceptance into a Commonwealth, State or Territory government innovation-related programme;

•        a company’s acceptance into an eligible incubator programme; and

•        a company’s acceptance into an accelerator programme that has been through an accreditation or approval process (this could attract a higher number of points than the criteria described at paragraphs 1.95 to 1.97 above).

What CGT treatment applies to shares in qualifying ESICs?

1.110           An investor that acquires shares in a qualifying ESIC will be taken to hold these shares on capital account. This means that the disposal of these shares, for example, would give rise to a capital gain or a capital loss rather than other income tax consequences. The core CGT rules are contained in Parts 3-1 and 3-3. [Schedule 1, item 1, subsection 360-50(2)]

1.111           In determining what shares qualify for this modified treatment, it does not matter whether the investor has actually received the tax offset in relation to the shares. This is because the relevant test is whether the investor has an entitlement to the tax offset in relation to those shares. [Schedule 1, item 1, subsection 360-50(1)]

1.112           It also does not matter if the company which issued the shares subsequently ceases to be a qualifying ESIC. Refer to paragraph 1.30 above.

Example 1.12  

John is an individual, sophisticated investor.

During the income year, John invests $1,000,000 in an ESIC (‘Innovation Co’) that issues shares to him for his investment. In the same income year, John also invests $500,000 in another ESIC (‘Designer Co’) that also issues shares to him.

If there was no cap on the offset, John would have been eligible for a 20 per cent offset in respect of the shares issued to him by both Innovation Co and Designer Co (assuming all of the other remaining conditions, such as John not being an affiliate of Innovation Co or Designer Co, were satisfied).

However, because the maximum amount of the offset in an income year (taking into account any amount carried forward to the current year) cannot exceed $200,000, not all of the shares that have been issued to John from Innovation Co and Designer Co, in the income year will entitle John to an offset. For example, John will only be able to claim the offset in relation to the shares issued to him by Innovation Co (i.e. these shares represented a $1,000,000 investment, 20 per cent of which equals $200,000, the maximum amount of offset for the income year).

Even though John is not able to claim a tax offset for the shares issued to him during the income year by Designer Co, the CGT modifications will still apply to those shares.

1.113           The specific CGT consequences arising for these shares depends on:

•        when the investor entity deals with the shares (and the relevant CGT event happens); and

•        whether the investor entity realises a capital gain or a capital loss from that event.

1.114           In addition, specific rules apply in situations when the shares qualify for a CGT roll-over. The CGT provisions provide various roll-overs in specific situations to defer the immediate consequences of a change in ownership of CGT assets. These rules are explained in paragraphs 1.120 to 1.124.

1.115           Additional rules apply in relation to shares held by partnerships. These rules recognise that for CGT purposes, each partner in a partnership is taken to hold a separate CGT asset whereas other entities, including trustees, hold CGT assets directly. [Schedule 1, item 1, section 360-55]

Shares held for less than 12 months

1.116           An investor that has continuously held a qualifying share for less than 12 months may not disregard any capital gains arising to that share but must disregard any capital losses. [Schedule 1, item 1, subsections 360-50(3) and (4)]

Shares held for more than 12 months and less than ten years

1.117           An investor that has continuously held a qualifying share for between 12 months and less than ten years may disregard a capital gain arising from the share. As noted in paragraph 1.7, capital losses are disregarded. [Schedule 1, item 1, subsections 360-50(3) and (4)]

Shares held for ten years or more

1.118           An investor that has continuously held a qualifying share for at least ten years will receive a market value, as determined on the ten year anniversary date, as the first element of the cost base and reduced cost base of the share. [Schedule 1, item 1, subsection 360-50(5)]

1.119           Providing a market value for the first element of the cost base and reduced cost base ensures that any incremental gains (or losses) in value after 10 years will be taxable. The ATO provides guidance about acceptable methods for calculating an asset’s market value, including those that are not regularly traded.

Shares subject to CGT roll-over

1.120           As noted in paragraph 1.114, the CGT rules provide a number of different roll-overs to defer the CGT consequences arising from a change in asset ownership (same asset roll-overs) or a change in ownership of assets (replacement asset roll-overs).

1.121           In most cases, these amendments preserve the modified treatment for qualifying shares that are subject to a CGT roll-over by preserving the original acquisition date of the qualifying shares. However, in some other cases, these amendments provide a mechanism to terminate the modified treatment early.

Same asset roll-overs

1.122           To the extent a share otherwise qualifies for a CGT same asset roll-over, then that asset is taken to have been acquired by the new entity at the same time the share was initially issued by a qualifying ESIC to the original investor. [Schedule 1, item 1, section 360-60]

Replacement asset roll-overs

1.123           With some exceptions (see below), to the extent a share otherwise qualifies for a CGT replacement asset roll-over, then the replacement assets are taken to have been acquired by the investor entity at the same time the shares in the qualifying ESIC were originally issued. [Schedule 1, item 1, section 360-60]

The scrip for scrip and newly incorporated company roll-overs

1.124           To the extent that a share qualifies for the scrip for scrip roll-over (see Subdivision 124-M) or a newly incorporated company roll-over (see Division 122) then the share receives a market value as the first element of the cost base and reduced cost base immediately before the exchange of assets under the roll-over. This rule ensures that any accrued capital gains or capital losses in the share are not subsequently subject to CGT when the replacement asset is realised. [Schedule 1, item 1, section 360-65]

Integrity rules to deter tax evasion and tax avoidance

Schemes to reduce income tax

1.125           These amendments insert a reference to an innovation tax offset to Part IVA of the ITAA 1936, which ensures that the innovation tax offsets come within the scope of the general anti-avoidance rules in Part IVA. These rules will apply to prevent taxpayers from being able to obtain tax benefits by entering into artificial or contrived arrangements to access the TIFESI tax offset (introduced by this Schedule) or the ESVCLP tax offset (introduced by Schedule 2).

1.126           Part IVA of the ITAA 1936 applies in situations where a scheme or arrangement is entered into in order to obtain a tax benefit. These rules allow the Commissioner to cancel the relevant tax benefit where the conditions under Part IVA are satisfied. For example, this can include situations where a taxpayer enters into an arrangement with a dominant purpose of securing a tax benefit that is an innovation tax offset. Part IVA pf the ITAA 1936 also applies where the scheme or arrangement is undertaken to secure the CGT concessions and thereby not include an amount in the taxpayer’s assessable income or results in a capital loss in situations when such tax benefits would not reasonably be expected to have been made had the taxpayer not entered into the scheme. [Schedule 1, items 2-11]

1.127           Whether a taxpayer has entered into an artificial scheme to qualify for the tax offset or the modified CGT treatment for shares in a qualifying ESIC, or contriving an arrangement to qualify for both the tax offset and any subsequent CGT outcome, will be a question of fact and subject to the same enquiries and considerations as ordinarily undertaken by the Commissioner in the application of Part IVA.

Example 1.13  

Lucy is an individual who invests $50,000 in a qualifying ESIC and receives a tax offset of 20 per cent ($10,000) that she can use to offset against her income tax liability. In the event that the ESIC is not successful and the value of its shares decreases and become worthless, Lucy will not be able to utilise any capital loss resulting from those shares.

To circumvent this, Lucy contrives an artificial scheme utilising interposed entities, enabling her to indirectly obtain the benefit of the tax offset and directly obtain the tax benefit of the capital losses (which could arise from Lucy’s interest in the interposed entity) resulting from the investment in the  shares in the ESIC. If the scheme had not been entered into, then Lucy would not have been able to utilise those capital losses.

As a result, Part IVA will apply to this scheme and the Commissioner may determine that the whole part of the capital loss (relating to the ESIC shares) was not incurred. Further, the Commissioner may impose additional administrative penalties for the intentional disregard of the law which would equate to 75 per cent of the tax shortfall resulting from the Commissioner’s amended assessment.

The promoter penalty regime

1.128           In addition, Division 290 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) provides a legislative framework for deterring the promotion of tax avoidance schemes and tax evasion schemes, commonly known as the promoter penalty regime. Entities that seek to promote such schemes, including any schemes relating to the TIFESI, may be subject to injunctions and civil penalties. Depending on the conduct of the promoter, criminal penalties, including criminal convictions may also apply.

ESIC reporting requirements

1.129           ESICs that receive investments from one or more investor entities in a financial year will need to provide information about those entities to the Commissioner 31 days after the end of the financial year. For most companies, this would be 31 July of the following financial year. ESICs will need to provide this information in the ‘approved form’. The concept of approved forms, as set out in section 388-50 of Schedule 1 to the TAA 1953, is used in the taxation laws to provide the Commissioner with administrative flexibility to specify the form of information required and the manner of providing it. The Government expects the ATO will develop a form that is designed to minimise the compliance costs for ESICs. [Schedule 1, items 17 and 18]

1.130           This information, including information relating to the shares acquired by the investors, will assist the ATO in administering this regime, minimise opportunities for entities to inappropriately claim the tax offset and provide sufficient information to assure the Government that the measure remains appropriately targeted and effective.

Consequential amendments

1.131           This schedule makes consequential amendments to incorporate this tax offset within the standard legislative framework for tax offsets, disregard the tax offset amount from the calculations of Pay As You Go (Instalments) payments and incorporate the cost base and reduced cost base modifications in the CGT regime. [Schedule 1, items 12-16]

1.132           This schedule also includes guidance material for Division 360. [Schedule 1, item 1, sections 360-5 and 360-10]

Application and transitional provisions

1.133           These amendments apply in relation to shares issued on, or after, the later of 1 July 2016 or Royal Assent.

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Schedule 1 of the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016

1.134           This Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 .

Overview

1.135           Schedule 1 to this Bill inserts new Division 360 to create an early stage investor regime that provides tax incentives for qualifying investors through a non-refundable tax offset and CGT exemption on innovation related investments. The Schedule also creates new reporting obligations requiring ESICs to report on specific innovation related investments, which will be inserted into the third party reporting regime in Subdivision 396-B of Schedule 1 to the TAA 1953.

Human rights implications

1.136           The amendments made by this Schedule engage the prohibition on arbitrary or unlawful interference with privacy contained in Article 17 of the International Covenant on Civil and Political Rights (ICCPR), as third parties will need to provide personal information to the Commissioner that they collect about their investors that may qualify for the non-refundable tax offset.

1.137           These reporting obligations are compatible with the prohibition, as they are neither arbitrary nor unlawful. In addition, they are aimed at a legitimate objective of allowing the ATO to effectively administer the TIFESI regime, as introduced by these amendments. The reporting obligations constitute a proportionate means of achieving this objective as only the minimum amount of information necessary to identify relevant taxpayers, investments and assess eligibility for the tax concessions introduced by these amendments is required to be reported.

1.138           The United Nations Human Rights Committee has stated, in their General Comment No. 16, that:

•        ‘unlawful means that no interference can take place except in cases envisaged by the law. Interference authorized by States can only take place on the basis of law, which must itself comply with the provisions, aims and objectives of the Covenant [the ICCPR]’; and

•        ‘the concept of arbitrariness is intended to guarantee that even interference provided for by law should be in accordance with the provisions, aims and objectives of the Covenant and should be, in any event, reasonable in the particular circumstances’. [1]

1.139           The objective of requiring ESICs to report on their investors that may qualify for the tax offset is to allow the ATO to verify taxpayer claims in relation to their eligibility for the tax concessions introduced by these amendments, in a way that minimises the compliance burden for all parties involved in such investments.

1.140           This approach provides more certainty and consistency of treatment for entities than the alternative, where the Commissioner collects information under his or her general information gathering powers on an ad-hoc basis. The information to be reported by entities would typically be limited to that information they already hold having collected it in the ordinary course of their business. Taxpayer information held by the ATO is subject to strict confidentiality rules that prohibit tax officials from making records or disclosing this information unless a specific legislative exemption applies.

1.141           Subject to the amendments introduced by the Schedule, the third party reporting regime in Subdivision 396-B of Schedule 1 to the TAA 1953 provides that the Commissioner may only require third parties to report information that relates to the identification, collection or recovery of a possible tax-related liability or the identification of a possible reduction of a possible tax-related liability, as well as the identity of the taxpayer to which the tax-related liability may arise. Subdivision 396-B of Schedule 1 to the TAA 1953 also allows the ATO to exempt entities from reporting where, for example, the Commissioner does not expect to be able to productively use the information or where reporting the information places disproportionately high compliance costs on the third party relative to the benefit of providing the information to the ATO.

1.142           The Commissioner also has the flexibility to vary the timeframes for reporting, to achieve a balance between the needs of the Commissioner to receive timely information to administer the TIFESI regime and any increase in compliance costs that short timeframes may impose on entities reporting under the third party reporting regime.

Conclusion

1.143           This Bill is consistent with Article 17 of the ICCPR on the basis that its engagement of the right to privacy will neither be unlawful nor arbitrary. To this extent, the Bill complies with the provisions, aims and objectives of the ICCPR.



Chapter 2          

Venture capital investment

Outline of chapter

2.1                   Schedule 2 to the Bill amends the early stage venture capital limited partnership (ESVCLP) and venture capital limited partnership (VCLP) regimes within the Venture Capital Act 2002 (VCA 2002) and Income Tax Assessment Act 1997 (ITAA 1997) to improve access to capital and make the regimes more attractive to investors. These changes are intended to encourage innovation, risk-taking, and an entrepreneurial culture in Australia.

2.2                   The amendments provide an additional tax incentive for limited partners in new ESVCLPs, relax restrictions on ESVCLP investments and fund size and clarify the legal framework for venture capital investment in Australia.

2.3                   All legislative references in this Chapter are to the ITAA 1997, unless otherwise stated.

Context of amendments

Operation of existing law

2.4                   Venture capital is a mechanism for financing new companies at the start-up and growth stages of commercialisation. Venture capitalists typically invest funds in such companies in return for an equity share. The funds are used to develop a company’s ideas to the stage where their commercial potential is sufficient for venture capitalists to sell their equity in the company to another party.

2.5                   The Government provides various tax concessions to encourage Australian venture capital investments, including the VCLP and ESVCLP programs.

2.6                   The programs provide beneficial tax treatment to eligible investors, with the aim of encouraging both local and foreign investment in Australia. A second aim is to develop venture capital management skills and experience in Australia.

Venture Capital Limited Partnership

2.7                   The VCLP regime was introduced in 2002 to support investment in eligible venture capital investments that would otherwise have difficulty in attracting investment through normal commercial means.

2.8                   A VCLP is taxed on a ‘flow-through’ basis, rather than being treated as a company for tax purposes like other limited partnerships (see subsection 94D(2) of the Income Tax Assessment Act 1936 (ITAA 1936)). This results in the partners rather than the ‘partnership’ being taxed. One of the key benefits of the program is that certain foreign partners are exempt from income tax on capital and revenue gains from disposals of investments made by VCLPs, with corresponding losses also being disregarded (sections 51-54 and 118-405). In addition, amounts received by certain partners for their successful management of the partnership’s investments (‘carried interests’) are taxed on capital account. This entitles them to the capital gains tax (CGT) discount where they have been a partner for over 12 months (section 118-21).

2.9                   To be eligible for this treatment, a range of requirements must be satisfied. The key requirement is that the VCLP must have at least $10 million of committed capital in total from its partners (paragraph 9-1(1)(d) of the VCA 2002), whilst the total value of the assets of the entity in which the VCLP invests must not exceed $250 million at the time of the investment (subsection 118-440(9)).

Early Stage Venture Capital Limited Partnership

2.10               The ESVCLP regime was introduced in 2007 to provide additional tax concessions for early stage venture capital activities, because of concerns that the VCLP program was not adequately targeting these entities.

2.11               Like VCLPs, an ESVCLP is taxed on a ‘flow through’ basis (subsection 94D(2) of the ITAA 1936). However, the tax concessions are more generous than the VCLP regime as both Australian and foreign investors are exempt from income tax on capital and revenue gains from disposals of investments made by the ESVCLP. Corresponding losses are also disregarded (sections 51-54 and 118-407). Income derived from the partnership, such as from dividends, is also exempt from income tax (section 51-52).

2.12               Recognising the more generous concessions available under the ESVCLP regime, this regime requires a minimum investment of $10 million in total from its partners, but with a maximum cap of $100 million (paragraph 9-3(1)(d) of the VCA 2002). In addition, the entities the ESVCLP invests in must be valued at less than $50 million, and they must be divested once the total value of the entity’s assets exceeds $250 million on the last day of the previous income year (paragraph 118-440(9)(a) and subsection 9-3(6) of the VCA 2002).

Summary of new law

2.13               Schedule 2 amends the ESVCLP and VCLP regimes within the VCA 2002 and ITAA 1997 to support further venture capital investment. The amendments generally apply from 1 July 2016. However, the tax offset is available only for qualifying contributions made to ESVCLPs that become unconditionally registered as an ESVCLP on or after 7 December 2015.

2.14               The reforms include:

•        providing non-refundable carry-forward tax offsets for limited partners in ESVCLPs, equal to up to 10 per cent of contributions made by the partner to the ESVCLP during an income year;

•        increasing the maximum fund size for ESVCLPs from $100 million to $200 million;

•        removing the requirement that an ESVCLP divest an investment in an entity once the value of the entity’s assets exceeds $250 million, but restricting tax concessions for such investments; and

•        allowing entities in which a VCLP, ESVCLP or an Australian venture capital fund of funds (AFOF) has invested (the investee entity) to invest in other entities, provided that after the investment:

-                  the investee entity controls the other entity; and

-                  the other entity broadly satisfies the requirements to be an eligible venture capital investment (within the meaning of sections 118-425 and 118-427).

Comparison of key features of new law and current law

New law

Current law

ESVCLP offset

A limited partner in an ESVCLP is entitled to a non-refundable carry-forward tax offset. The tax offset is equal to up to 10 per cent of contributions made by the partners to the ESVCLP during an income year. However the amount of the tax offset is reduced to the extent that the amounts contributed by the partners are not, in effect, used by the ESVCLP to make eligible venture capital investments within that income year or the first two months after the end of that income year.

If a limited partner is a partnership or trust, the offset will generally instead be available to the ultimate individual or corporate partners or beneficiaries.

Not applicable.

Maximum fund size for new ESVCLPs

The maximum committed capital of an ESVCLP is $200 million.

The maximum committed capital of an ESVCLP is $100 million.

ESVCLP divestiture registration requirements

There is no requirement that an ESVCLP divest an investment in an entity once the investee’s market value exceeds $250 million. However, if an ESVCLP does not dispose of an investment in an entity within six months after the end of an income year in which the investee’s market value exceeds $250 million, then the ESVCLP will only be entitled to a partial CGT exemption. The amount exempt will be limited to the amount of the exempt capital gain that would have arisen had the investment been sold at the end of six months after the income year in which the $250 million threshold was first exceeded.

An ESVCLP must divest itself of its investment in a company or unit trust when the company or trust’s market value exceeds $250 million.

 

 

Investments by investees

An entity in which a VCLP, ESVCLP or AFOF has invested (the investee entity) can invest in other entities while remaining an eligible venture capital investment, provided that after the investment:

•         the investee entity controls the other entity; and

•        the other entity broadly satisfies the requirements to be an eligible venture capital investment.

Following the investment, when applying the predominant activity test, the investee entity must take into account the activities of the other entity as well as its own.

An investment by a VCLP, ESVCLP or AFOF in a company that is formed for the sole purpose of making eligible venture capital investments is treated as satisfying the predominant activity test for a six month period from when the investment first occurs.

An entity must not invest in any other entity, except an entity that it controls and which broadly satisfies the requirements to be an eligible venture capital investment.

However, entities that have a sole purpose of investing in another entity that is an eligible venture capital investment can be eligible venture capital investments.

 

Auditor appointment threshold for entities that are eligible venture capital investments

An entity that is an eligible venture capital investment only requires an auditor to be appointed for an income year if:

•        it is a public company or a large proprietary company within the meaning of the Corporations Act 2001 for the financial year corresponding with that income year;

•        it is a unit trust and if it was a company it would have been a public company or a large proprietary company within the meaning of the Corporations Act 2001 for the financial year corresponding with that income year; or



•        the value of the assets of the entity exceeds $12.5 million.

If an entity has not and is not required to appoint an auditor, the value of the assets of the entity for certain purposes is the market value stated by the board or trustee of the entity in a statutory declaration, subject to integrity rules.

For a company or trust to be an eligible venture capital investment it must have an auditor that is registered as an auditor under the laws of a State or Territory or, if the entity is not an Australian resident, the jurisdiction in which the entity is a resident.

Further, for certain purposes the value of the assets of the entity is the value stated in the audited accounts or an audited financial statement.

Binding guidance from Innovation Australia

Innovation Australia can make a public or private ruling that an activity is not an ineligible activity. Such a ruling binds Innovation Australia and also the Commissioner of Taxation (Commissioner) in the Commissioner’s administration of the tax law, until the end of the income year after the income year in which the declaration was withdrawn.

Innovation Australia continues to have a power to determine that an activity is not an ineligible activity if it is satisfied that the activity warrants making such a determination.

Innovation Australia can determine that a particular activity is not an ineligible activity in specific circumstances. This allows Innovation Australia to make such a determination if it is satisfied that the activities warrant it.

MITs and venture capital

An entity may disregard its interests as a limited partner in a VCLP or ESVCLP in determining if it is a trading trust (or carrying on or controlling a trading business) for the purposes of eligibility to be a managed investment trust (MIT), provided it and its associates have provided no more than 30 per cent of the committed capital of the VCLP or ESVCLP and the MIT is not a general partner.

To the extent a MIT has an interest in a CGT asset as a result of being a limited partner in a VCLP or ESVCLP, that asset is treated as an asset it owns for the purposes of an election it has made or may make for CGT to be the primary code in relation to the assets of the MIT.

As a result of being a limited partner in a VCLP or ESVCLP, a trust may be considered to be a trading trust (or to be either carrying on or controlling a trading business) and therefore ineligible to be a MIT.

Assets in which a MIT has an interest through a VCLP or ESVCLP may not be assets for which a MIT can elect that CGT is the primary code to apply as the MIT does not own the assets.

Detailed explanation of new law

2.15               This Schedule makes a number of changes to improve the existing tax regimes applicable to venture capital investments and provides additional tax incentives for investors in ESVCLPs.

2.16               Broadly, these amendments:

•        provide a non-refundable carry-forward tax offset for investors in new ESVCLPs;

•        relax restrictions on ESVCLP investments and fund size; and

•        make a number of reforms to simplify the tax concession framework for venture capital investment in Australia.

ESVCLP tax offset

Tax offset for ESVCLP investment

2.17               The measure introduces an additional tax incentive for limited partners in ESVCLPs, in the form of a non-refundable carry-forward tax offset. The tax offset arises when a limited partner makes contributions to an ESVCLP in an income year. [Schedule 2, item 2, subsection 61-760(1)]

2.18               The purpose of the ESVCLP tax offset is to encourage additional investment in early stage venture capital by reducing the effective cost of such investments.

2.19               The amount of the offset is equal to 10  per cent of the lesser of:

•        the partner’s contributions to the ESVCLP for the income year; and

•        the partner’s investment related amount (broadly the proportionate share of the investments made by the ESVCLP).

[Schedule 2, item 2, subsection 61-765(1)]

2.20               As a result the partner is entitled to the offset in relation to the amount they have contributed towards the eligible venture capital investments of the ESVCLP, subject to the timing rule on the making of such investments.

Amount of the offset - contributions

2.21               A partner’s contributions are those amounts the partner provides to the ESVCLP, consistent with the definition of committed capital in section 118-445.

2.22               However, in determining the amount of the offset, contributions do not include:

•        commitments to provide money or other property at a future date;

•        contributions made by a partner to an ESVCLP that the ESVCLP is, or will in the future become, obliged to repay to the partner, or will on demand by the partner be required to repay; or

•        contributions a partner makes to an ESVCLP that, during the income year, are repaid to the partner within 12 months of the contribution being made.

[Schedule 2, item 2, subsection 61-765(2)]

2.23               Contributions made by a partner to an ESVCLP that the ESVCLP is, or will become, obliged to repay to the partner include amounts in relation to which there is an obligation to repay the partner, whether or not the obligation to make the repayment arises during the income year and whether or not it is linked to a request by the partner for repayment. Contributions that an ESVCLP is obliged to repay to a partner include repayments made at the direction of the partner for the benefit of a third party. There is no time limit on when an obligation to repay must arise for a contribution to be excluded. This means that even if there is no obligation to repay an amount for 10 years or until a particular event occurs, the amount is still not a contribution if such an obligation or a contingent obligation exists. [Schedule 2, item 2, subsection 61-765(2)]

2.24               Likewise, in some cases an ESVCLP may repay amounts without being under any obligation. If such a voluntary repayment occurs within 12 months of a contribution being made, the contribution will also be disregarded to the extent it has been refunded. [Schedule 2, item 2, subsection 61-765(2)]

Amount of the offset - investment related amount

2.25               However, the amount of the offset is also limited by the partner’s investment related amount for the relevant ESVCLP.

2.26               A partner’s investment related amount for an ESVCLP is the total amount the ESVCLP has spent making eligible venture capital investments over the period starting at the beginning of the relevant income year and ending two months after the end of that income year, multiplied by the partner’s proportionate share of the capital of the ESVCLP at the end of the relevant income year. That is, it is in effect the partner’s share of the ESVCLP’s investment expenditure. [Schedule 2, item 2, subsection 61-765(3)]

2.27               As the partner’s share is based on their interest at the end of the income year, if they make contributions but then cease to be a partner before the end of the income year, they will not be entitled to any offset in relation to these contributions. This simplifies the calculation of the tax offset and encourages longer term commitment by partners to ESVCLPs.

2.28                Linking the offset to the amounts contributed that are invested within two months after the end of that income year ensures that the offset is only available for actual venture capital investment, rather than creating an incentive to passively hold such contributions. It is not expected to impact adversely on ESVCLPs because they generally only call on partners for contributions shortly before an investment is made.

2.29               As outlined above, the investment related amount is determined based on the total amount the ESVCLP has spent making investments over the period. This is not limited to the amount of the eligible venture capital investments the ESVCLP has made, but also includes incidental costs of making such investments as well as any administrative costs associated with those investments . [Schedule 2, item 2, subsection 61-765(3)]

2.30               The amendments contain an integrity provision to ensure that if an eligible venture capital investment is made in the two months following the end of an income year, then it is not taken into account in determining ESVCLP tax offset entitlements in the following income year. This ensures that investments made in the first two months following the end of an income year do not potentially qualify for tax offsets in two income years. [Schedule 2, item 2, subsection 61-765(4)]

2.31               A transitional rule applies to contributions and investments made before 1 July 2016 for ESVCLPs that become unconditionally registered on or after 7 December 2015. Details of this transitional rule are set out in paragraphs 2.145 to 2.150.

Nature and priority of the offset

2.32               The amendments provide that the ESVCLP tax offset will be a carry-forward tax offset. This reduces the chance that the benefit of the offset will be lost to investors if they cannot use the offset in the income year to which the offset relates. However, consistent with other carry-forward tax offsets, the offset is not refundable. [Schedule 2, item 3, table item 32 of subsection 63-10(1)]

2.33               As a carry-forward tax offset, recipients must apply the ESVCLP tax offset after any tax offsets that cannot be refunded or carried forward, but before refundable tax offsets can be applied. This ensures that the benefits of any offsets that are not refundable or able to be carried forward are not lost or deferred. It also maximises the amount of any refundable offset that will be refunded.

2.34               Within the list of carried forward offsets, the priority of the ESVCLP tax offset is below the landcare and water tax offset, but above carry-forward offsets under the research and development tax incentive. This priority for application of the ESVCLP tax offset avoids the need for entities to distinguish between the different types of offset arising under the research and development tax incentive when determining relative priority. [Schedule 2, item 3, table item 32 of subsection 63-10(1)]

2.35               Should a taxpayer undertake a tax avoidance scheme to benefit from this offset, Part IVA may apply - see paragraph 1.125 in the other Chapter to this Explanatory Memorandum.

Members of trusts and partnerships

2.36               As flow-through entities, trusts and partnerships are generally not subject to tax in their own right and in such cases do not receive any benefit from a tax offset. Accordingly, trusts and partnerships are not typically entitled to the ESVCLP offset. [Schedule 2, item 2, paragraph 61-760(1)(b)]

2.37               Instead, these amendments provide an equivalent tax offset to the members of trusts or partnerships (a beneficiary or unit holder of a trust or a partner in a partnership - see section 960-130), who are in substance the ultimate investors, based on a determination by the partnership or trustee of the members’ share of the tax offset. [Schedule 2, item 2, subsection 61-760(2)]

2.38               As a result, a member of a trust or partnership is generally entitled at the end of an income year to a non-refundable carry-forward tax offset for that income year. The amount of the offset is the product of:

•        the amount of the ESVCLP offset that would be available to the trust or partnership were it an individual (notional tax offset amount); and

•        the members’ share of the offset as determined by the trustee or partnership (determined share of notional tax offset).

[Schedule 2, item 2, section 61-770]

2.39               The partnership or trustee must notify members of the partnership or trust of their determination of the share of the tax offset and provide sufficient information to allow the member to work out their share of the offset. The notice must be provided within three months of the end of the income year to which the offset relates, or such further time as the Commissioner may allow. [Schedule 2, item 2, subsection 61-770(4)]

2.40               If no determination is made then members do not have any entitlement to any tax offset. Similarly if the determination does not allocate the entire available tax offset, then members are only entitled to so much of the tax offset as has been allocated to them by the trustee. [Schedule 2, item 2, subsection 61-770(1)]

2.41               In some cases members of trusts or partnerships are entitled to a fixed proportion of any capital gain from investments, as a result of the terms and conditions under which the trust or partnership operates. For example, such a fixed entitlement exists for the holders of units in unit trusts. If a member of a trust or partnership is entitled to such a fixed proportion, the member’s share of the tax offset must be determined by the trustee to be that proportion. [Schedule 2, item 2, subsection 61-770(3)]

2.42               In all other cases, the amount of the offset each member receives is at the discretion of the partnership or trustee. It is not relevant and does not limit what share of an offset a member may be determined to be entitled to, whether the trust or partnership has a capital gain or net income for a particular income year, or is in a loss position, or how any such income, capital gain or loss may have been distributed. Accordingly, it is not relevant if, for example, a trustee of a discretionary trust has distributed the income or capital of a trust in a particular way in an income year. The trustee may determine which discretionary beneficiaries are entitled to the offset on a completely different basis.

2.43               In some cases the members of a trust or partnership that is a limited partner in an ESVCLP may include another trust or partnership. In this situation the members of that other trust or partnership are generally entitled to the offset (however, see paragraphs 2.45 to 2.47 below concerning trustees). If those members are themselves trusts or partnerships, then the offset will also pass to the members of these entities in the same way, until it ultimately reaches an entity that is not a trust or partnership (subject to a trustee of a trust being liable for tax in their capacity as a trustee - see below). [Schedule 2, item 2, section 61-770]

2.44               For the avoidance of doubt, the amendments make it clear that the trustee or partnership may not determine that the members of the trust or partners of the partnership are entitled to more than the amount of the notional tax offset that would have been available to the trust or partnership. [Schedule 2, item 2, subsections 61-770(2) and (5)]

Trustees that are liable for tax

2.45               Although generally trusts are not subject to tax in their own right, in certain circumstances trustees are required to pay tax on behalf of the trust. Depending on the nature and circumstances of the trust and its beneficiaries, the trustee may be the only entity liable for tax on the net income of the trust.

2.46               Despite the general rule that the offset is available to the beneficiaries or unit holders of a trust, a trustee of a trust is entitled to a tax offset if:

•        the trust would be entitled to the ESVCLP tax offset if it was an individual;

•        the trustee has not validly determined that the beneficiaries of the trust are entitled to the whole amount of the ESVCLP tax offset; and

•        the trustee of the trust is liable or has been assessed for tax in respect of the activities of the trust (under sections 98, 99 or 99A of the ITAA 1936).

[Schedule 2, item 2, subsection 61-760(3) and sections 61-765 and 61-775]

2.47               The amount of the offset available to the trustee is the amount that would be available to the trust if it were an individual, less any tax offset amounts to which beneficiaries of the trust are entitled to that relate to the same contributions which give rise to the trustee’s tax offset entitlement. As a result, the trustee will not be able to obtain the offset if all of the tax offsets available to the trust have been validly distributed to beneficiaries . [Schedule 2, item 2, section 61-775]

Example 2.1 : ESVCLP tax offset natural persons as partners

Ariane becomes a limited partner in a new ESVCLP that is unconditionally registered on 2 July 2016. Ariane is one of five limited partners. Each limited partner contributes $10 million to the ESVCLP during the 2016-17 income year. Accordingly, the fund has received total contributions of $50 million.

As a limited partner in an ESVCLP, Ariane is entitled to a non-refundable carry-forward tax offset equal to up to 10 per cent of contributions made as a limited partner during the income year used for eligible venture capital investment purposes either during that income year or within two months of the end of that income year.

Ariane has a 1/5 th share in the ESVCLP’s investments. The total $50 million is used by the ESVCLP for making eligible venture capital investments within the required time period. The total offset for partner contributions is 10 per cent of the $50 million contribution, which is $5 million. Given that Ariane has a 1/5 th share in the ESVCLP’s investments, she is entitled to a $1 million tax offset for the 2016-17 income year.

During the 2017-18 income year, each of the limited partners contributes $5 million to the ESVCLP. Accordingly, the fund receives total contributions of $25 million. $5 million of this amount is not used by the ESVCLP to invest in eligible venture capital investments within two months of the end of the 2017-18 income year. Accordingly, $5 million is subtracted from the total contributions before calculating the tax offset.

The tax offset for partner contributions is 10 per cent of the $20 million, which is $2 million. Given that Ariane has a 1/5 th share in the ESVCLP’s investments, she is entitled to a $400,000 tax offset for the 2017-18 income year.

Example 2.2 : Tax offset for ESVCLP partners that are trusts

An ESVCLP is unconditionally registered on 8 December 2015. There are four limited partners in the ESVCLP. Two of these partners are trusts (trust A and trust B) and two are natural persons. Trust A is a fixed trust with two beneficiaries, with each beneficiary entitled to 50 per cent of the income and capital gains of the trust. Trust B is a discretionary trust with three beneficiaries. The trust deed for Trust B does not contain a default beneficiary clause.

On 1 July 2016, each of the four limited partners contributes $10 million. Accordingly, the fund receives total contributions of $40 million. The total $40 million is used by the ESVCLP for making eligible venture capital investments during the 2016-17 income year.

The tax offset for partner contributions is 10 per cent of the $40 million contribution, which is $4 million. Given that each of the limited partners has a 1/4 th share in the ESVCLP’s investments, each partner is entitled to a tax offset of $1 million.

As trust A is a fixed trust with its two unit holders having a 50 per cent interest each, they each are entitled to a $500,000 tax offset.

The trustee for trust B does not exercise its discretion to make any of the three beneficiaries presently entitled to the trust’s net income. Accordingly, the trustee is liable to pay tax on the net income of the trust estate (subsection 99A(4) of the ITAA 1936). In this situation, the trustee of trust B is entitled to the $1 million tax offset for the 2016-17 income year.

Increasing the flexibility of ESVCLPs

Increase in cap for ESVCLP committed capital

2.48               Schedule 2 amends the VCA 2002 to increase the cap on the committed capital of an ESVCLP from $100 million to $200 million. As a result, in order to become and remain registered as an ESVCLP, the committed capital of an ESVCLP must be at least $10 million, but not more than $200 million. [Schedule 2, item 6, subparagraph 9-3(1)(d)(ii) of the VCA 2002]

2.49               The committed capital of an ESVCLP is broadly defined as the total amount partners may be obliged to contribute to the partnership under the partnership agreement.

2.50               The cap limits the size of investments that can be made by an ESVCLP, both in total, as the capital available to the ESVCLP is limited, and in respect of particular investments, as an ESVCLP cannot invest more than a fixed percentage of its committed capital into a single investment. The fixed percentage is generally 30 per cent, or 20 per cent where the ESVCLP is acquiring an existing investment (see paragraphs 118-425(1)(d), 118-427(1)(d) and 118-428(1)(c)). Increasing the cap therefore allows ESVCLPs to invest more overall and also more in individual entities.

Example 2.3 : Increase in the cap on ESVCLP committed capital

An ESVCLP is unconditionally registered on 1 August 2016. The ESVCLP has six partners. Each of the six partners has committed in the partnership agreement to provide $20 million to the fund. Accordingly, the committed capital of the ESVCLP is $120 million.

Under the previous fund size rules, this ESVCLP would exceed the $100 million cap for committed capital. However, the amendments increase the cap for committed capital to $200 million. Accordingly the ESVCLP is under the cap and satisfies the committed capital requirements for registration as an ESVCLP.

Alternative to ESVCLP divestiture requirement

2.51               Schedule 2 amends the registration requirements for ESVCLPs (see sections 9-3 and 9-5 of the VCA 2002) to remove the requirement that an ESVCLP must divest itself of an investment in an entity (the investee) within 6 months, once the total value of the investee’s assets (including the assets of any entities it controls) exceeds $250 million at the end of an income year. This increases flexibility by allowing ESVCLPs to decide if such an investment should be divested, and if so, at what time. [Schedule 2, items 15 and 16, paragraph 9-3(1)(i) and subsections 9-3(3) and (6) of the VCA 2002]

Limiting tax concessions relating to investments

2.52               However, in place of the current divestiture threshold, the amendments impose a limit or cap on the extent to which tax concessions are available for such investments after the $250 million threshold has been exceeded by the investee.

2.53               If the total value of the assets of an entity (and any connected entities) exceeds $250 million at the end of an income year, and the entity does not dispose of the investment within six months of that income year, any capital gain arising in relation to the investment will only be partially exempt. [Schedule 2, item 13, section 118-408]

2.54               The amount of the partially exempt capital gain that is not disregarded in a later income year is:

 

2.55               In this formula:

•        the normal capital gain is the capital gain that would otherwise arise under the income tax law as a result of the CGT event happening excluding any disregarded capital gain that would otherwise apply under the ESVCLP tax concessions;

•        the valuation year capital gain is the capital gain that would have arisen had the same CGT event occurred in relation to the same CGT asset at the end of the day six months after the end of the income year in which the $250 million threshold was first exceeded.

[Schedule 2, item 13, subsections 118-408(2)]

2.56               As a result, if the entire investment is subsequently disposed of, the capital gain will be taxable to the extent it exceeds the capital gain that would have resulted had it been disposed of at the end of the period ending six months after the end of the income year in which the $250 million threshold was crossed (i.e. the time by which the asset would have been required to be disposed of as a result of the divestiture requirement). [Schedule 2, item 13, subsections 118-408(2) and (3)]

2.57               Similarly, if parts of an investment are sold at different times, the capital gain resulting from the disposal of each part of the investment will be taxable to the extent that the capital gain resulting from the sale of that part exceeds the capital gain that would have arisen had it been sold six months after the end of the income year in which the investee entity first exceeded the threshold.

2.58               This means that, in effect, any increase in the value of the investment or of the assets that make up the investment after that time will be subject to tax as the increase in value will be reflected in a higher capital gain that will not be disregarded.

2.59               Once an investment has become subject to the tax concession cap, the cap continues to apply, even if the value of the assets of the investee entity falls below the $250 million threshold. This also means that the cap is not reset if the value of the entity falls and rises again - the amount of any partially exempt gain that is taxable is always determined by reference to the gain that would have arisen had the event occurred six months after the end of the income year in which the threshold was first crossed. [Schedule 2, item 13, subsection 118-408 (1)]

2.60               These changes only apply where an exempt capital gain would otherwise arise. Consistent with the prior law, a loss, whether revenue or capital, arising in relation to an eligible venture capital investment by an ESVCLP is disregarded (see subsections 26-68(1) and 118-407(1)). This continues to apply even where the investee entity has exceeded the $250 million threshold but the gain will only be partially exempt.

2.61               Further, currently if any income from the disposal of a venture capital asset would be disregarded were it a capital gain, it will also be exempt income (see section 51-54). The amendments modify this rule. To the extent a capital gain from the disposal would only be partially exempt, only the equivalent amount of gain or profit will be exempt income. No change is made to the current denial of deductions for a share of a loss made by an ESVCLP from the disposal of an eligible venture capital investment. [Schedule 2, item 8, subsection 51-54(1A)]

2.62               Although the availability of tax concessions for investments in an entity is curtailed once an investee’s value exceeds the $250 million, this does not affect the status of investments in that entity as eligible venture capital investments. Accordingly, ESVCLPs will be able to hold and carry on activities in relation to such investments without breaching the registration requirements under section 9-3 or 9-5 of the VCA 2002.

Example 2.4 : Removal of ESVCLP divestiture requirement

An unconditionally registered ESVCLP has a 10 per cent investment in Ariad, a company that is an eligible venture capital investment. The interest was acquired when the total value of Ariad was $100 million. The total value of Ariad’s assets is $200 million on 30 June 2015, $260 million on 30 June 2016 and increases to $300 million on 31 December 2016.

As a result, Ariad would exceed the current divestiture threshold for the ESVCLP at the end of the 2015-16 income year. Despite Ariad exceeding this threshold on 30 June 2016, the ESVCLP has until 31 December 2016 to divest its interest in Ariad after which any future capital gains from the sale become partially assessable.

The ESVCLP decides to continue to hold the interest in Ariad after breaching the threshold but finally decides to sell the interest on 20 June 2019 when the total value of Ariad is $400 million.

The exempt gain that the ESVCLP partners would have made if the ESVCLP had disposed of its 10 percent interest in Ariad on 31 December 2016 is (10 per cent interest x ($300 million - cost base of $100 million) $20 million (valuation year capital gain). Accordingly, the amount of the capital gain on the sale of the 10 per cent stake is calculated as:

Normal capital gain - valuation year capital gain

•        normal capital gain (10 per cent interest x ($400 million - cost base of $100 million) = $30 million capital gain

•        valuation year capital gain = $20 million

i.e. $30 million (normal capital gain) - $20 million (valuation year capital gain) = $10 million capital gain is assessed to the ESVCLP partners in the 2019-20 income year.

The balance of the capital gain of $20 million is exempt for the ESVCLP partners in the 2019-20 income year.

CGT exemption for distributions of exempt venture capital gains by trusts

2.63               The income tax law provides that the CGT consequences are disregarded for a partner when an ESVCLP disposes of an eligible venture capital investment of the partnership (section 118-407). Similarly, a partner’s share of any gain or profit that arises in relation to an eligible venture capital investment is exempt income (section 51-54).

2.64               However, prior to these amendments, if a partner in an ESVCLP was a trustee of a unit trust or other fixed trust, a CGT taxing point could occur when the trust distributed these proceeds to its beneficiaries. In particular, CGT event E4 would often result in the CGT cost base of the fixed interest of a beneficiary in the trust being reduced by the amount of a capital gain that the trust distributed to them. If the amount of the gain reduced the cost base of the unit or interest below zero, then the distribution would result in a corresponding capital gain (section 104-70).

2.65               These amendments modify CGT event E4 by adding amounts that are exempt or disregarded under the ESVCLP tax concessions in sections 51-54 and 118-407 to the list of amounts that are excluded when applying CGT event E4 under section 104-71. [Schedule 2, items 21 and 22, paragraphs 104-71(3)(aa), (c) and (d)]

2.66               Accordingly, CGT consequences do not arise for a beneficiary in respect of the beneficiary’s share of a capital gain that is disregarded or an amount of income that is exempt in the hands of the trustee, because of ESVCLP tax concessions.

2.67               This ensures that the same CGT outcome arises for the ultimate investors in ESVCLPs regardless of whether they invest directly, through a fixed trust (including a unit trust), another partnership or a discretionary trust.

Example 2.5 : Distribution of CGT exempt amount to unit holder

In November 2016 Sheldon invests $100,000 in a unit trust. The unit trust, among other investment activities, is a limited partner in an ESVCLP.

In January 2017 the ESVCLP disposes of an eligible venture capital investment that it owns at a profit. It distributes the proceeds to its partners. As the unit trust is a partner and the capital gain relates to an eligible venture capital investment, the capital gain the trust derives is disregarded.

The trustee of the unit trust distributes the gain to its unit holders. Sheldon’s share is $300,000.

If CGT event E4 applied, the cost base of the units of the beneficiaries would be reduced by the amount of the distribution. Sheldon’s cost base as a unit holder is $100,000. Subtraction of the $300,000 gain from the $100,000 cost base would have resulted in the units having a cost base of zero and Sheldon having a capital gain of $200,000.

However, because of the amendments, CGT event E4 does not occur as the distribution is only non-assessable because of the ESVCLP tax concessions and so is disregarded.

Accordingly, no amount is included in Sheldon’s assessable income due to the distribution, he does not have a capital gain and the cost base of his units in the unit trust is unaffected.

Reforms to the tax concessions for venture capital investments

Eligible venture capital investment - investments in other entities

2.68               For an investment in an entity to qualify as an eligible venture capital investment it must satisfy a number of requirements including requirements relating to its predominant activity, location and investments.

2.69               The predominant activity requirement is contained in subsections 118-425(3) and 118-427(4). Broadly, to satisfy this requirement, more than 75 per cent of at least two of following must not relate to ineligible activities in subsections 118-425(13) and 118-427(14):

•        the entity’s assets:

•        the entity’s employees; or

•        the entity’s income.

2.70               The location within Australia test is detailed in subsections 118-425(2) and 118-427(3). Broadly, to satisfy this requirement, if the entity is a company it must be an Australian enterprise and have more than 50 per cent of its assets and employees in Australia for a period of generally 12 months. If it is a trust it must carry on business in Australia, be either managed and controlled in Australia or most of its beneficiaries must be Australian residents and the trust must have more than 50 per cent of its assets and employees in Australia for a period of generally 12 months.

2.71               The investment requirement is detailed in subsections 118-425(4) and 118-427(5). Broadly, prior to these amendments, an entity would cease to be an eligible venture capital investment if it invested in any other entity, except an entity that it controlled and that met most of the requirements to be an eligible venture capital investment (excluding those requirements that relate to the capital of the partnership). The entity must also have not used any part of the amount invested in its capacity as a trustee of another entity.

2.72               These amendments modify the investment requirement so that an entity can invest in another entity and remain an eligible venture capital investment, provided the other entity meets certain requirements.

2.73               Specifically, an investment in an entity (the first entity) will not cease to be an eligible venture capital investment solely because the first entity (that is an entity in which a VCLP, ESVCLP or AFOF has invested) invests in another entity (the second entity), if:

•        after the investment has been made, the second entity is a connected entity of the first entity because it is controlled by the first entity; and

•        the investment in the second entity meets the requirements of subsections 118-425(3) and (5) to (7) (for an investment in a company) or subsections 118-427(4) and (6) to (8) (for an investment in a unit trust).

[Schedule 2, items 26 and 32, subsections 118-425(4) and 118-427(5)]

2.74               The existing clarification that a company or unit trust can deposit money with an authorised deposit-taking institution or a body authorised under a foreign law to carry on a banking business in a foreign country whilst remaining an eligible venture capital investment is retained. [Schedule 2, items 2 and 32, subsections 118-425(4) and 118-427(5)]

2.75               Following the investment, in determining whether an investee entity meets the predominant activity test in subsections 118-425(3) and 118-427(4), the assets, activities, employees and assessable, exempt and non-assessable non-exempt income of that entity are taken to include those of any entities that it controls. An entity controls another entity if it would control the entity in a way described by section 328-125 (concerning small business entities). [Schedule 2, items 24, 25, 30 and 31, subsections 118-425(3) and 118-427(4)]

2.76               The other elements of the predominant activity test remain the same as under the current law. To satisfy the test, 75 per cent of the assets, employees, or assessable, exempt and non-assessable non-exempt income of the entity and any controlled entities must not relate to ineligible activities in subsections 118-425(13) and 118-427(14). [Schedule 2, items 24, 25, 30 and 31, subsections 118-425(3) and 118-427(4)]

2.77               This approach means entities have more flexibility to make acquisitions, whilst still preventing entities from avoiding rules about investments made by ESVCLPs and VCLPs.

2.78               The notes to subsections 118-425(3), (4), 118-427(4) and (5) are amended to reflect the changes. [Schedule 2, items 25, 26, 31 and 32, subsections 118-425(3), (4), 118-427(4) and (5)]

2.79               The amendments do not change the existing requirement that a company or unit trust must not use any part of the amount invested in the capacity of a trustee of another entity. [Schedule 2, items 26 and 32, subsections 118-425(4A) and 118-427(5A)]

Extending Innovation Australia’s discretion: eligible venture capital investment

2.80               In addition, these amendments provide for Innovation Australia to modify the operation of some of the eligible venture capital investment requirements to allow the complementary activities of a controlled entity to be disregarded for a specified period when applying the predominant activity test or the location within Australia test. [Schedule 2, items 28, 33 and 42, subsections 118-425(14B), (14C), 118-427(15A) and (15B) of the ITAA 1997 and subsections 25-15(1) and (1A) of the VCA 2002]

2.81               To allow the activities of a controlled entity to be disregarded when applying the predominant activity test to an entity for a period, Innovation Australia must be satisfied that:

•        the activities of the controlled entity are complementary to the activities of the controlling entity or other controlled entities that are not ineligible activities;

•        the principal activities of the whole group of entities are not ineligible activities; and

•        in all of the circumstances it is appropriate to disregard the activities of the controlled entity for that period.

[Schedule 2, items 28 and 33, subsections 118-425(14B) and 118-427(15A)]

2.82               This discretion is only available in limited circumstances. The principal activities of the first entity must not be ineligible activities. While the second entity may have significant ineligible activities, ineligible activities must not make up a majority of the activities of the first entity and all of its controlled entities taken together. [Schedule 2, items 28 and 33, paragraphs 118-425(14C)(b) and 118-427(15B)(b)]

2.83               Further, the activities of the controlled entity must be complementary to these principal activities. This requires Innovation Australia to be satisfied that there is not just an association between the activities, but that engaging in one of the activities assists or provides some advantage in engaging in the other . [Schedule 2, items 28 and 33, paragraphs 118-425(14C)(a) and 118-427(15B)(a)]

2.84               Finally and most importantly, Innovation Australia must consider that it is appropriate in all of the circumstances that the activities of the second entity be disregarded. As the purpose of the wider test is specifically to take account of all of the activities within an entity’s control, the exercise of this discretion requires some form of special or exceptional circumstances . [Schedule 2, items 28 and 33, paragraphs 118-425(14B)(c) and 118-427(15A)(c)]

2.85               Some potential circumstances that may make it appropriate to disregard the activities of a controlled entity include if:

•        it is expected that the activities of the controlled entity would cause the entity to fail the test on a temporary basis (for example if the controlled entity has significant ineligible activities relating to assets and income that the entity intends to sell as soon as possible);

•        the controlled entity would be an eligible venture capital investment if acquired directly by the VCLP or ESVCLP;

•        the acquisition of the controlled entity would significantly increase the expected future growth of the entity or help facilitate innovation; or

•        the nature of the activities involved means that it would be impractical or involve significant cost or forgone benefits were the ineligible activity to cease.

2.86               The amendments also provide Innovation Australia with a similar discretion to determine that a controlled entity does not need to meet the location in Australia requirement. [Schedule 2, items 28 and 33, subsections 118-425(14C) and 118-427(15B)]

2.87               To determine that the location in Australia requirement does not apply to a controlled entity for a period, Innovation Australia must be satisfied that:

•        the activities of the controlled entity are complementary to activities of the controlling entity or other controlled entities; and

•        in all of the circumstances it is appropriate to disregard the activities of the controlled entity for that period.

[Schedule 2, items 28 and 33, subsections 118-425(14C) and 118-427(15B)]

2.88               The location in Australia requirement is an important part of the targeting of the ESVCLP and VCLP tax concessions. These concessions are intended to help promote investment in businesses in Australia. They are not intended to be available for investments in entities without a sufficiently clear connection with Australia. Further, ESVCLPs and VCLPs should not be able to avoid this requirement simply by making their investment through an Australian entity.

2.89               However, despite this, in special circumstances the location within Australia requirement may be too strict.

2.90               This discretion would allow Innovation Australia to in effect waive the location within Australia requirement for an investment that would otherwise satisfy venture capital investment requirements. This discretion can only be exercised if Innovation Australia is satisfied that:

•        the controlling entity is an Australian resident (or, if they are a trust, satisfy the requirements of paragraphs 118-427(3)(a) and (b) - that is, carries on business in Australia and either has its management located in Australia or the majority of the interests in the income or property of the trust are held by Australian residents); and

•        the acquisition was complementary to its existing business activities.

[Schedule 2, item 28, subsection 118-425(14C)]

2.91               Consistent with the discretion to disregard the activities of the controlled entity for the predominant activity test, Innovation Australia must also consider that it is appropriate in all of the circumstances that the activities of the second entity be disregarded. As the purpose of the wider test is specifically to take account of all of the activities within an entity’s control, the exercise of this discretion requires some form of special circumstances to exist. This could include, for example, unique opportunities for rapid expansion tied to acquiring an overseas entity engaged in complementary activities.

Holding companies

2.92               These amendments also remove the holding company exception in subsection 118-425(11). [Schedule 2, items 27 and 29, subsections 118-425(11) and (16)]

2.93               The holding company exception was intended to allow entities that have a sole purpose of investing in another entity that is an eligible venture capital investment to be an eligible venture capital investment. It did so by allowing such holding companies to disregard the predominant activity and investment requirements that a holding company could not satisfy.

2.94               The changes to the investment requirements (discussed above) mean that investments in entities that have a sole purpose of investing in an eligible venture capital investment are an eligible venture capital investment. As a result, the holding company exception is generally no longer necessary.

2.95               However, if the holding company exception were simply removed, the regime would be more restrictive in the period between the time when the holding company receives the investment from the ESVCLP, VCLP, AFOF or eligible venture capital investor and the time when it invests that amount. Although a company may take six months to make any acquisition, the general changes (discussed above) would require that the holding company control an eligible venture capital investment at the time of the investment by the VCLP, ESVCLP, AFOF or eligible venture capital investor in order to satisfy the predominant activity test.

2.96               To address this issue, the amendments include a special rule allowing a company to satisfy the predominant activity test in relation to an investment by a VCLP, ESVCLP, AFOF or eligible venture capital investor in the company. This rule will be taken to be satisfied if:

•        the sole purpose of the company is to make an investment or investments that are eligible venture capital investments (disregarding the requirement relating to the committed capital of the partnership); and

•        within six months of the first investment made by that VCLP, ESVCLP, AFOF or eligible venture capital investor in that entity, the company has used all of the amount invested in it to:

-                  make eligible venture capital investments (disregarding the requirement relating to the committed capital of the partnership); or

-                  engage in activities that are ancillary or incidental to that purpose.

[Schedule 2, item 28, subsection 118-425(14A)]

2.97               However, the rule will only be taken to be satisfied for the period starting immediately before the first investment made by that VCLP, ESVCLP, AFOF or eligible venture capital investor in that entity, and ending six months after that first investment. From this time, the holding company will need to satisfy the revised predominant activity test based on the activities of its controlled entities . [Schedule 2, item 28, subsection 118-425(14A)]

Example 2.6 : Bolt-on acquisition - complementary activity

An ESVCLP is unconditionally registered on 3 July 2016. The ESVCLP makes an investment in ProsGEN on 30 July 2016. ProsGEN is a prosthetics start-up, specialising in 3D printing. ProsGEN is an eligible venture capital investment .

In December 2018, ProsGEN acquires a controlling interest in Bluprinted, a state-of-the-art 3D printing company in America. This acquisition provides ProsGEN with opportunities for rapid expansion. Bluprinted does not meet the location within Australia requirement, but would otherwise be an eligible venture capital investment.

A general partner of the ESVCLP applies to Innovation Australia requesting that Innovation Australia exercise its discretion to determine that the location of Blueprinted should be disregarded for the purposes of the predominant activity test for a two year period. The ESVCLP expects that the activities of Bluprinted would only fail the predominant activity test for a two year period, as Bluprinted will transfer 70 per cent of Bluprinted staff and assets to Australia in the next two years.

Innovation Australia decides that the investment remains an eligible ESVCLP because:

•        the activities of Bluprinted are complementary to one or more activities of ProsGEN; and

•        in all the circumstances, the failure of the location within Australia test will only be temporary.

Accordingly, Innovation Australia makes a determination in writing to the ESVCLP’s general partner that the location of Blueprinted should be disregarded for the purposes of the location within Australia requirement for a two year period.

Example 2.7 : Investment in holding company - six month rule

On 5 January 2017, a VCLP invests $20 million in Retention, a holding company. Retention’s only purpose is to make eligible venture capital investments. On 12 March 2017, Retention uses all of the $20 million to make eligible venture capital investments.

Accordingly, Retention satisfies the predominant activity test in relation to the VCLP’s investment because:

•        the sole purpose of Retention is to make investments that are eligible venture capital investments (disregarding the requirement relating to the committed capital of the partnership); and

•        within six months of the first investment made by the VCLP, Retention has used all of the $20 million invested in it to make eligible venture capital investments (disregarding the requirement relating to the committed capital of the partnership).

Widely held FVCFFs

2.98               This Schedule amends the ITAA 1997 and the VCA 2002 to allow a foreign venture capital fund of funds (FVCFF) to hold more than 30 per cent of the committed capital of an ESVCLP and extend their access to CGT and other income tax concessions in relation to eligible venture capital investments, if the FVCFF is a widely held FVCFF at the time of the CGT event. [Schedule 2, items 46 and 52, paragraph 118-420(1)(ba) of the ITAA 1997 and paragraph 9-3(5)(e) of the VCA 2002]

2.99               Prior to these amendments, no investor in an ESVCLP could hold more than 30 per cent of the committed capital of the partnership (paragraph 9-3(1)(e)) without a specific waiver by Innovation Australia (section 9-4 of the VCA 2002) unless the investor was an authorised deposit-taking institution, life insurance company, certain public authorities or widely held complying superannuation funds.

2.100           Further, an investor would not be an eligible venture capital partner (and hence entitled to the relevant tax concessions for their investment made through a VCLP or AFOF) if the sum of their investments (together with any investments by their connected entities) exceeded 30 per cent of the committed capital of the partnership (see section 118-420).

2.101           These amendments allow widely held FVCFFs to hold larger stakes in Australian eligible venture capital investments as their widely held ownership means that they do not need to be subject to the same control test as other entities with potentially more closely held ownership structures.

2.102           An entity is a widely held FVCFF if:

•        the entity is a FVCFF;

•        each other entity that:

-       if the entity is a limited partnership - is a general partner of the partnership; or

-       otherwise - exercises day to day control of the entity;

is a foreign resident;

•        the entity is a ‘widely held entity’; and

•        at least 90 per cent of the rights to the income of the FVCFF are ultimately held by eligible venture capital partners that are not FVCFFs.

[Schedule 2, items 47 and 51, subsection 118-420(6) and definition of ‘widely held foreign venture capital fund of funds’ in subsection 995-1(1)]

2.103           ‘Widely held entity’ has the meaning given by subsection 842-230(2) and section 842-235 . [Schedule 2, items 48, 49 and 51, paragraph 842-230(1)(aa), subsection 842-230(2) and the definition of ‘widely held entity’ in subsection 995-1(1)]

2.104           An entity will be a widely held entity if, broadly, no other entity directly or indirect holds an interest in the first entity of more than 20 per cent and no five entities have interests in the entity that would together amount to more than 50 per cent (see subsection 842-230(2)).

2.105           An entity will also be a widely held entity if it does not meet this test but either:

•        has not met this test at any point but is actively seeking to expand its membership in such a way as to become widely held (such as a new fund that is in the process of gathering investment); or

•        the entity does not meet this test as it is in the process of closing down.

2.106           This test ensures that ownership interests in widely held FVCFF are genuinely widely dispersed.

2.107           The concept of a widely held entity forms part of the definition of ‘IMR widely held entity’, for the purposes of the Investment Manager Regime set out in Subdivision 842-I. These amendments have created a separate term (widely held entity) for this element of the definition in section 842-230 in order to allow it to be used in the context of other provisions. They have also made other minor changes to the structure of the provision as a consequence of the creation of this new defined term. The amendments do not alter the meaning of IMR widely held entity. [Schedule 2, items 48, 49 and 50, paragraph 842-230(1)(aa), subsection 842-230(2) and paragraph 842-235(6)(a)]

2.108           More information of the meaning of a widely held entity can be found in the Explanatory Memorandum for the Tax and Superannuation Laws Amendment (2015 Measures No.1) Bill 2015, which first introduced the concept of an IMR widely held entity.

Example 2.8 : Widely held FVCFF

An FVCFF is unconditionally registered on 6 July 2016. The FVCFF invests in a VCLP and an ESVCLP during the 2016-17 income year. The FVCFF holds more than 30 per cent of the committed capital of both the VCLP and the ESVCLP.

The FVCFF is a widely held FVCFF, because all of the general partners of the FVCFF are foreign residents, it is widely-held, and at least 90 per cent of the value of the FVCFF is ultimately held by eligible venture capital investment partners that are not FVCFFs.

A CGT event occurs on 7 January 2017 as the FVCFF receives capital gains from both its VCLP and ESVCLP. The FVCFF is able to disregard the capital gains because it is a widely held FVCFF at the time of the CGT event.

Rulings by Innovation Australia on ineligible activities

2.109           VCLPs, ESVCLPs and AFOFs may not always be certain whether a particular activity is or would be an ineligible activity. In order to minimise investor uncertainty, these amendments provide a mechanism for Innovation Australia to provide public or private guidance about whether particular activities are ineligible activities.

2.110           Specifically, Innovation Australia may make a public or private ruling that a particular activity is not or would not be an ineligible activity in relation to an investment in an entity by a VCLP, ESVCLP or AFOF. These rulings may be about the status of an activity generally or be limited to specified circumstances. [Schedule 2, item 61, Division 362 of the TAA 1953]

2.111           Innovation Australia may make public rulings as appropriate. However, Innovation Australia may only make a private ruling in response to an application by a general partner of a limited partnership registered as a VCLP, ESVCLP or an AFOF. [Schedule 2, item 61, sections 362-5, 362-25 and 362-30 in Schedule 1 to the TAA 1953]

2.112           While these rulings are made by Innovation Australia, they are made under the Taxation Administration Act 1953 (TAA 1953) and are generally subject to the same processes, rules and requirements as public and private rulings by the Commissioner. [Schedule 2, item 61, sections 362-70 and 362-75 in Schedule 1 to the TAA 1953]

2.113           A ruling by Innovation Australia is a public ruling if it is published and also states that it is a public ruling. Innovation Australia must publish a notice of the making or withdrawal of a public ruling in the Commonwealth Gazette. If a public ruling is withdrawn, the withdrawal must not take effect before the notice is published. [Schedule 2, item 61, subsections 362-5(2) and (3) and sections 362-15 and 362-20 in Schedule 1 to the TAA 1953]

2.114           Although rulings by Innovation Australia are generally subject to the same or similar requirements as tax rulings by the Commissioner, they cannot be modified by the Commissioner (and nor can Innovation Australia modify rulings by the Commissioner). Consistent with this distinction, rulings (and the failure to make a private ruling) by Innovation Australia are subject to review under the processes set out in the VCA 2002 rather than the objection process under the tax law. [Schedule 2, item 62, paragraphs 29-1(k) and 29 - 1(l) of the VCA 2002]

2.115           After making a private ruling, Innovation Australia must provide notice of the ruling to the applicant and the Commissioner. If Innovation Australia refuses to make a private ruling it must notify the applicant and provide reasons for the refusal. A private ruling must state that it is a private ruling and must identify the entity it applies to and specify the activity to which it relates. [Schedule 2, item 61, sections 362-35 and 362-40 in Schedule 1 to the TAA 1953]

2.116           The applicant for a private ruling may give Innovation Australia a notice requiring Innovation Australia to make the ruling if, at the end of 60 days after the application, Innovation Australia has not made the ruling or told the applicant that Innovation Australia has declined to make the ruling. The 60 day period is extended in particular circumstances, such as where Innovation Australia requests further information. If Innovation Australia does not make a ruling within 30 days of such a notice being given, Innovation Australia is taken to have refused to make a ruling. [Schedule 2, item 61, section 362-50 in Schedule 1 to the TAA 1953]

2.117           A public or private ruling by Innovation Australia applies from the time it is published, or from the time specified in the ruling. [Schedule 2, item 61, section 362-10 and 362-45 in Schedule 1 to the TAA 1953]

2.118           A public or private ruling will cease to apply at such time as the ruling may specify, or otherwise when the ruling is withdrawn. [Schedule 2, item 61, sections 362-15 and 362-55 in Schedule 1 to the TAA 1953]

2.119           Consistent with the current requirements on the Commissioner, Innovation Australia must withdraw a public or private ruling if it is no longer satisfied that it is correct, or if the ruling is inconsistent with the decision of a court. [Schedule 2, item 61, sections 362-20 and 362-60 in Schedule 1 to the TAA 1953]

2.120           Venture capital investments are often complex and illiquid. Forcing entities that have relied upon guidance that has been found to be incorrect to swiftly dispose of such investments could potentially place them at a significant financial disadvantage. It could also significantly harm the entity in which the investment has been made. Given this, the amendments provide a period that is sufficient for investors to arrange for an orderly disposal of the investment, avoiding potential losses and other costs associated with the rushed disposal of an investment and the risk of deregistration.

2.121           As a result, unlike taxation rulings, rulings by Innovation Australia under these provisions continue to bind the Commissioner and Innovation Australia until the end of the income year after the income year in which the ruling is withdrawn, but only to the extent that the ruling affected investments made before the withdrawal took effect. [Schedule 2, item 61, section 362-65 in Schedule 1 to the TAA 1953]

2.122           It is expected that Innovation Australia will consult with the Commissioner when making or withdrawing a ruling, given the implication of Innovation Australia’s rulings for the Commissioner’s administration of the tax law. However, the final responsibility for making and withdrawing rulings rests with Innovation Australia.

Example 2.9 : Innovation Australian and private rulings

John is a general partner of a VCLP. The VCLP is considering investing in Fintech Co, a company that develops specialised transaction software for use by financial institutions for lending purposes.

John is unsure if Fintech Co is an eligible venture capital investment because he is uncertain whether the activities of Fintech Co are considered to be providing capital to others, which is included on the list of ineligible activities in (subsection 118-425(13)).

John contacts Innovation Australia about his concerns and applies for a private ruling. Having regard to all the circumstances and taking into account the material provided by John, Innovation Australia considers that the activity of the development and sale of software is not an ineligible activity, even where the software may be used by customers who engage in an ineligible activity such as finance. Innovation Australia also consults with the Commissioner.

Innovation Australia issues a private ruling to John that the activities of Fintech Co are not ineligible activities.

John may rely upon this ruling in relation to any investment in Fintech Co. that the VCLP in which he is a partner makes. Both Innovation Australia and the Commissioner must administer the law in relation to John’s VCLP on the basis of the view outlined in the ruling, until the end of the income year after the income year in which the ruling is withdrawn.

Example 2.10 : Innovation Australia and public rulings

Heather is a general partner of a VCLP. The VCLP is considering investing in Robuddy, a construction robotics company. Robuddy designs and produces state-of-the-art robots for use in building construction. Heather is unsure if Robuddy is an eligible venture capital investment because she is uncertain whether the activities of Robuddy are ineligible activities (for the purposes of the predominant activity test). Property development and construction of infrastructure facilities are ineligible activities (subsection 118-425(13)). Heather is unsure whether construction robotics would come within these categories of ineligible activities.

Heather contacts Innovation Australia about her concerns. Innovation Australia has received submissions from a number of other taxpayers on similar issues and considers that the activity of construction robotics is not an ineligible activity, given that the sale of robots for use in construction is distinct from directly engaging in construction itself. Innovation Australia has also consulted with the Commissioner.

Having regard to all the circumstances and taking into account the material provided by Heather and others, Innovation Australia issues a public ruling that construction robotics is not an ineligible activity.

This ruling does not affect whether the sale of construction robots is an ineligible activity. However to the extent that Robuddy or other entities act in accordance with the ruling, the Commissioner and Innovation Australia must act in accordance with the ruling until the end of the income year following the income year in which it is withdrawn.

Excluding small entities from eligible venture capital investment auditor requirements

2.123           Previously, for an investment in an entity to be an eligible venture capital investment, the entity was required to have a registered auditor by the end of the income year in which the investment was made and at all subsequent times.

2.124           However, the requirement to appoint a registered auditor and have audited accounts or an audited statement can be onerous. Small proprietary companies and many unit trusts are generally not required to appoint a registered auditor or prepare financial statements under the Corporations Act 2001 .

2.125           Accordingly, this Schedule amends the venture capital auditor requirement to align it more closely with auditor requirements for companies under the corporations law. This removes the cost of auditor fees for small entities and therefore encourages greater investment in lower value eligible venture capital investments that are more likely to be closer to start-up phase and therefore in greater need of support.

2.126           Under the amendments an entity that is an eligible venture capital investment only requires an auditor to be appointed either from the later of, the income year in which the investment is made, or a later income year in which any of the following conditions are met:

•        it is a public company or a large proprietary company within the meaning of the Corporations Act 2001 for the financial year corresponding with that income year;

•        it is a unit trust and if it was a company it would have been a public company or a large proprietary company within the meaning of the Corporations Act 2001 for the financial year corresponding with that income year; or

•        the total value of the assets of the entity exceeds $12.5 million.

[Schedule 2, items 64 and 66, subsections 118-425(5) and (5A) and subsections 118-427(6) and (6A)]

2.127           If an auditor is not required to be appointed, and the entity chooses not to have an auditor at that time and does not have audited accounts, the value of assets and investments of an eligible venture capital investment on a particular date for the purpose of Subdivision 118-F is:

•        the amount stated to be the market value in a statutory declaration made within the period of twelve months ending on that date by:

-                  the directors of the company for an entity that is a company; or

-                  the trustee of the unit trust for an entity that is a unit trust; or

•        if no statutory declaration has been made, the market value of the assets and investments on that date.

[Schedule 2, items 65, 68, 69 and 70, subsections 118-425(10A), 118-428(4) and 118-440(2A) and section 118-450]

2.128           If the Commissioner is satisfied (based on reasonable grounds) that an amount stated to be the market value of an asset or investment in a statutory declaration is inaccurate, the value of the asset or investment is instead its market value at the time, rather than the amount stated in the statutory declaration. This ensures that there is a mechanism to address wrongful declarations that are made. [Schedule 2, item 70, subsection 118-450(1)]

2.129           If an eligible venture capital investment entity:

•        has appointed a registered auditor (even if they are not required to appoint a registered auditor); or

•        is required to appoint an auditor (even if they have not done so);

then the alternative valuation method provided by these amendments is not available. The value of the asset or investment is that shown in a statement, prepared in accordance with the accounting standards and audited by the entity’s auditor, showing that value as at a time no longer than 12 months before that time. [Schedule 2, item 67 and 68, subsections 118-427(11) and 118-428(4)]

2.130           An auditor is required to be appointed from the end of the income year in which the investment is made if the auditor appointment requirement is met for that income year. Alternatively, if the criteria for appointment is first satisfied in a later income year, then the auditor needs to be appointed from the time that the criteria for appointment is met in that later income year. [Schedule 2, items 64 and 66, subsections 118-425(5A) and 118-427(6A)]

2.131           If an auditor must be appointed, they must be registered as an auditor:

•        in any State or Territory in Australia; or

•        under a law that applies in the country in which the entity is a resident.

[Schedule 2, item 71, the definition of ‘registered auditor’ in subsection 995-1(1)]

Example 2.11 : Auditor appointment - valuation of assets

An EVCLP invests in Leaco, a private company, by buying 20 per cent of its share capital in the 2017-18 income year. Leaco has assets with a total market value of approximately $10 million.

Leaco is an eligible venture capital investment for the EVCLP. No auditor needs to be appointed for the 2017-18 income year as the gross value of Leaco’s assets does not exceed $12.5 million in that income year and Leaco is not a public company or large proprietary company.

The value of Leaco’s assets for the purposes of the venture capital rules is the current market value. In August 2017 the directors of Leaco make a statutory declaration of the market value of Leaco’s assets. The declaration states that Leaco has $10 million in assets. There is no contrary evidence of the value of Leaco’s assets.

Consequently, for the purposes of the venture capital rules, the value of Leaco’s assets is $10 million for the 2017-18 income year.

In the 2019-20 the assets of Leaco for the first time exceed $12.5 million in value. The directors are required to appoint auditors for the 2019-20 income year.

Improving access to funding from managed investment trusts

Addressing uncertainty about venture capital investment and trading requirements

2.132           Currently, there is uncertainty about whether MITs can participate as a limited partner in an ESVCLP or VCLP without affecting their status as a MIT.

2.133           This uncertainty arises as one of the requirements for an entity to be a managed investment trust is that it must not:

•        if it is a unit trust, be a trading trust for the purposes of Division 6C of Part III of the ITAA 1936; or

•        if it is not a unit trust, either:

-       carry on a trading business within the meaning of Division 6C of Part III of the ITAA 1936; or

-       control or be able to control another entity that carries on such a business.

2.134           These restrictions are intended to ensure that MITs are primarily engaged in passive investment. However, in the context of investments in VCLPs and ESVCLPs, the unusual features of these types of entities mean that there are concerns that these restrictions may be breached merely by being a limited partner in such a partnership.

2.135           The amendments address these concerns by allowing a MIT to disregard its investment in and through an ESVCLP or VCLP when determining if it is a trading trust, carries on a trading business or controls an entity that carries on such a business, in certain circumstances.

2.136           An interest that a MIT has in a VCLP or ESVCLP is disregarded when determining if a trust is a trading trust, carries on a trading business (within the meaning of Division 6C of Part III of the ITAA 1936) or controls or is able to control (directly or indirectly) another entity, provided that:

•        the MIT is not the general partner of the ESVCLP or VCLP; and

•        the MIT does not hold more than 30 per cent of the committed capital of the ESVCLP or VCLP.

[Schedule 2, items 73 and 75, subsections 275-10(4A) and (4B) of the ITAA 1997 and subsections 12-400(2A) and (2B) in Schedule 1 to the TAA 1953]

2.137           The requirement that the MIT must not hold more than 30 per cent of the committed capital includes capital committed by entities that are its associates, but not associates that are authorised deposit-taking institutions, life insurance companies (including public authorities that carry on life insurance business) or widely held complying superannuation funds within the meaning of section 4A of the Pooled Development Funds Act 1992 (this is the same requirement that applies to most investors in ESVCLPs as a result of the operation of paragraph 9-3(1)(e) and subsections (4) and (5) of the VCA 2002). [Schedule 2, items 73 and 75, subsections 275-10(4A) and (4B) of the ITAA 1997 and subsections 12-400(2A) and 12-400(2B) in Schedule 1 of TAA 1953]

2.138           Some of the provisions affected by these amendments are also being amended by the Tax Laws Amendment (New Tax System for Managed Investment Trusts) Bill 2015 . This Schedule includes contingent commencement provisions for some of its amendments linked to the commencement of that Bill. This will ensure that the same outcome arises regardless of whether or not that Bill has commenced. [Schedule 2, section 2 and items 73 and 75, subsections 275-10(4A) and (4B) of the ITAA 1997 and subsections 12-400(2A) and (2B) of the TAA 1953]

Addressing uncertainty about capital account elections

2.139           The amendments also address uncertainty about whether a MIT is eligible to elect to have the CGT regime apply as the primary code for determining tax outcomes for venture capital investments.

2.140           Generally, MITs may choose to have any gains or losses resulting from certain investments they own taxed on capital rather than revenue account (see section 275-100). However, such a choice may only be made in relation to investments that the fund owns. For investments made through a VCLP or ESVCLP, as the limited partnership is itself a separate legal entity, it is not clear that the MIT owns the asset.

2.141           The amendments provide that for the purposes of making this choice, a MIT should be treated as owning an asset to the extent that the MIT has an interest in the asset as a limited partner in a VCLP or ESVCLP. This ensures that MITs are able to elect that CGT is the primary code for calculating MIT gains or losses in such circumstances. [Schedule 2, item 74, subsection 275-100(1A)]

Consequential amendments

2.142           This Schedule includes a number of minor and consequential amendments to the tax law, including changes to guidance material, to reflect the substantive changes to the tax concessions for venture capital investments. [Schedule 2, items 1, 9 to 12, 14, 25, 31, 34, and 54 to 61, the item headed early stage venture capital limited partnerships in the list in section 13-1, subparagraph 118-407(1)(d)(iv), notes 1 and 2 to subsection 118-407(1), subsection 118-407(5), definition of ‘divestiture registration requirement’ in subsection 995-1(1), note 3 to subsection 118-425(3), note 4 to subsection 118-427(4), subsection 118-435(1), note to subsections 118-425(13) and 118-427(14) and the definitions of private ruling and public ruling in s.995-1 in the ITAA 1997 as well as section 357-1, subsection 357-5(3) and the note to section 357-50 in Schedule 1 to the TAA 1953]

2.143           This Schedule also includes a number of minor and consequential amendments to the VCA 2002. [Schedule 2, items 17 to 19, 35 to 41 and 43, section 17-3, paragraph 17-5(1)(ab), section 17-15, paragraphs 15-1(ga) and (gb), 15-10(c), (d) and (e), 21-20(g), (h), (i) and (j) and 29-1(i) and (j) of the VCA 2002]

2.144           This Schedule also makes a technical amendment to the rules for conditional registration in the VCA 2002. This amendment clarifies that conditional registration is available in circumstances in which a partnership has complied with all of the requirements in applying to Innovation Australia for registration, but has not yet met the substantive requirements to be unconditionally registered. [Schedule 2, items 77 to 82, paragraphs 13-5(1)(b) and (c), 13-5(1A)(b) and (c) and 13-5(2)(b) and (c) of the VCA 2002]

Application and transitional provisions

Application provisions

ESVCLP tax offset

2.145           The ESVCLP tax offset is available for contributions made at any time to ESVCLPs but only if they became unconditionally registered on or after 7 December 2015, subject to the transitional requirement outlined below. [Schedule 2, item 4]

Example 2.12 : ESVCLP registered after 1 July 2016

An ESVCLP is unconditionally registered after 1 July 2016 and its partners contribute $20 million to the ESVCLP for the 2016-17 income year. The contributions are invested in eligible venture capital investments by 31 August 2017. Accordingly, the partners of the ESVCLP are entitled to a non-refundable carry-forward tax offset equal to up to $2 million each for the 2016-17 income year.

Example 2.13 : Contributions made to ESVCLPs registered before 7 December 2015

The limited partners of an ESVCLP that becomes unconditionally registered prior to 7 December 2015 make contributions of $30 million each on 1 July 2016. These contributions are used by the ESVCLP for eligible venture capital investments by 30 June 2017. No tax offset applies to these contributions or any later contributions made because the ESVCLP was unconditionally registered prior to 7 December 2015, being the date of announcement of this measure. However the other amendments in Schedule 2 apply.

2.146           The only form of registration that is taken into account for the purposes of this application rule is unconditional registration (noting that conditionally registered ESVCLPs are not ESVCLPs). Accordingly, an ESVCLP tax offset is not available in any circumstances if a partnership became unconditionally registered as an ESVCLP before 7 December 2015, but is available for contributions to funds that were conditionally registered before this time and then became unconditionally registered on or after 7 December 2015.

2.147           In many cases, the date of effect of an ESVCLP’s unconditional registration is backdated to the date it first became conditionally registered. Any such backdating of the time of registration prior to the time at which the registration requirements in section 13-1 of the VCA 2002 are met is not taken into account in working out if an ESVCLP became unconditionally registered on or after 7 December 2015. The application provision refers to the date that an ESVCLP became registered, ie. the day registration was granted, not the date from which their registration was effective. [Schedule 2, item 4]

2.148           The amendments also include a transitional rule affecting the treatment of contributions to ESVCLPs that become unconditionally registered on or after 7 December 2015 for the first income year starting on or after 1 July 2016 and earlier income years. Such contributions mostly comprise contributions to entities that were conditionally registered as an ESVCLP at the time of the contribution and later become unconditionally registered and had the effect of their unconditional registration backdated.

2.149           In such circumstances the tax offset available in relation to contributions in any income years prior to the income year starting on or after 1 July 2016 is recognised in the 2016-17 income year. The contributions are treated as being contributions made in the 2016-17 income year, including for the purposes of notifying members. However, unless a partner is a member of the ESVCLP on 30 June 2017 they will not be entitled to a tax offset. [Schedule 2, item 5]

2.150           Although the transitional rule applies to contributions made prior to Royal Assent, it is wholly beneficial to affected partners of ESVCLPs as it provides a benefit to affected parties in the form of a tax offset.

Example 2.14 : Contributions made before 1 July 2016 to ESVCLPs registered on or after 7 December 2015

An ESVCLP is conditionally registered on 7 December 2015 and becomes unconditionally registered on 21 February 2016. The ESVCLP has four limited partners. The four partners make contributions of $20 million each to the fund on 1 March 2016. These contributions are used by the ESVCLP for eligible venture capital investments during the 2015-16 income year.

As the ESVCLP was unconditionally registered on or after the date of announcement of the measure, the tax offset applies to the contributions made on 1 March 2016 as these amounts are invested in eligible venture capital investments by 30 June 2016. Under the transitional provision the tax offset is available for the 2016-17 income year.

All other amendments in Schedule 2 also apply to the ESVCLP from 1 July 2016.

Increase to ESVCLP fund size cap

2.151           The increase to the ESVCLP fund size cap applies to the registration of partnerships under the VCA 2002 as ESVCLPs on or after 1 July 2016 including both new and existing ESVCLPs. [Schedule 2, item 7]

Removal of ESVCLP divestiture registration requirement

2.152           The removal of the divestiture requirement applies in relation to the 2016-17 income year and later income years. This means that following 30 June 2016, taxpayers no longer need to dispose of investments that previously exceeded the divestiture threshold, as this will no longer form part of the registration requirements for an ESVCLP. [Schedule 2, item 20]

2.153           Entities that exceed the divestiture threshold at the end of the 2015-16 income year are not required to divest, but if they dispose of the asset more than six months after the start of the 2016-17 income year, any capital gain will only be partially disregarded.

CGT exemption for fixed and unit trust beneficiaries of partners in ESVCLPs

2.154           The CGT exemption applies in relation to payments made, in respect of a unit or interest in a trust, in an income year starting on or after 1 July 2016. [Schedule 2, item 23]

Requirements for entities in which VCLPs, ESVCLPs and AFOFs invest

2.155           The amendments made to the ITAA 1997 concerning entities in which VCLPs, ESVCLPs and AFOFs can invest generally apply in relation to the 2016-17 income year and later income years. [Schedule 2, subitem 44(1)]

2.156           The amendments to sections 15-1 and 21-20 of the VCA 2002 apply in relation to the first financial year to start on or after Schedule 2 commences and to later financial years. Schedule 2 commences on the later of Royal Assent and 1 July 2016. [Schedule 2, subitem 44(2)]

2.157           The amendments to section 15-10 of the VCA 2002 apply in relation to the first quarter to start on or after the commencement of Schedule 2 and to later quarters. [Schedule 2, subitem 44(3)]

Pending applications under section 25-15 of the VCA 2002

2.158           Special transitional rules also apply to determinations concerning ineligible activities under section 25-15 of the VCA 2002. These rules ensure that pre-existing applications are not affected by the restructuring of this provision as a result of the amendments.

2.159           The amendments to section 25-15 of the VCA 2002 apply after the commencement of Schedule 2 to applications made under subsection 25-15(1) of that Act that were pending immediately before that commencement as if they had been made under paragraph 25-15(1)(a) of that Act as so amended. This ensures that pending applications are not invalidated by the changes. [Schedule 2, subitem 45(1)]

2.160           The amendments of section 25-15 of the VCA 2002 apply after the commencement of Schedule 2 to applications made under subsection 25-15(1A) of that Act that were pending immediately before that commencement as if they had been made under paragraph 25-15(1)(d) of that Act as so amended. Similarly, this ensures that pending applications are not invalidated by the changes. [Schedule 2,subitem 45(2)]

Foreign venture capital funds of funds

2.161           The amendments made by Part 6 apply in relation to the 2016-17 income year and later income years. [Schedule 2, item 53]

Innovation Australia rulings that activities are not ineligible activities

2.162           The amendments made by Part 7 apply in relation to the 2016-17 income year and later income years. [Schedule 2, item 63]

Auditor appointment requirements

2.163           The change to the auditor requirements for eligible venture capital investments applies in determining auditor appointments for the 2016-17 income year and later income years. [Schedule 2, item 72]

Venture capital investment and MITs

2.164           The amendments made concerning MITs apply in relation to the 2016-17 income year and later income years. [Schedule 2, item 76]

2.165           The amendments to the MIT regime in the ITAA 1997 to allow MITs to disregard their investment in and through an ESVCLP or VCLP when determining if they are a trading trust, carry on a trading business or control an entity that carries on such a business only commence from the date that Schedule 4 to Tax Laws Amendment (New Tax System for Managed Investment Trusts) Bill 2016 commences and do not commence at all if it is not enacted. [Schedule 2, Item 4 of clause 2 to the Bill]

2.166           The amendments to the MIT regime in the TAA 1953 to allow MITs to disregard their investment in and through an ESVCLP or VCLP when determining if they are a trading trust, carry on a trading business or control an entity that carries on such a business only commence if Schedule 4 to Tax Laws Amendment (New Tax System for Managed Investment Trusts) Bill 2016 has not commenced prior to 1 July 2016. [Schedule 2, Item 6 of clause 2 to the Bill]

 

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Schedule 2 of the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016

2.167           This Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 .

Overview

2.168           Schedule 2 amends the Early Stage Venture Capital Limited Partnership (ESVCLP) and Venture Capital Limited Partnership (VCLP) regimes within the Venture Capital Act 2002 and Income Tax Assessment Act 1997 to improve access to tax concessions for venture capital investments.

2.169            The amendments provide an additional tax incentive for limited partners in new ESVCLPs, relax restrictions on ESVCLP investments and fund size and clarify the legal framework for both ESVCLPs and VCLPs and also Australian venture capital fund of funds and foreign venture capital fund of funds.

2.170           The amendments generally apply from 1 July 2016. However, the tax offset from investments in new ESVCLPs applies to contributions made on or after 1 July 2016 to ESVCLPs that become unconditionally registered on or after 7 December 2015.

Human rights implications

2.171           This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

2.172           This Schedule is compatible with human rights as it does not raise any human rights issues.



 

Schedule 1: Tax incentives for early stage investors

Bill reference

Paragraph number

Item 1, paragraph 360-15(1)(a) and subsections 360-15(2) and 360-15(3)

1.16

Item 1, section 360-20

1.21

Item 1, subsection 360-15(1) and section 360-20

1.24

Item 1, paragraphs 360-15(1)(b) and (c) and (e)

1.25

Item 1, paragraph 360-15(1)(d)

1.33

Item 1, paragraph 360-15(1)(f)

1.37

Item 1, section 360-25

1.40

Item 1, subsection 360-15(2)

1.49, 1.50

Item 1, subsections 360-30(1) and (2)

1.51

Item 1, subsection 360-30(4)

1.52

Item 1, subsection 360-30(3)

1.54

Item 1, subsection 360-30(5)

1.56

Item 1, subsection 360-15(3)

1.58

Item 1, section 360-35

1.59

Item 1, paragraph 360-40(1)(a)

1.63

Item 1, paragraph 360-40(1)(b)

1.66

Item 1, paragraph 360-40(1)(c)

1.67

Item 1, subsection 360-40(2)

1.69, 1.93

Item 1, paragraph 360-40(1)(d)

1.70

Item 1, subsections 360-40(3) and (4)

1.75

Item 1, paragraph 360-40(1)(e)

1.77

Item 1, paragraph 360-40(1)(e)(i)

1.79, 1.81

Item 1, paragraph 360-40(1)(e)(ii)

1.82

Item 1, paragraph 360-40(1)(e)(iii)

1.83

Item 1, paragraph 360-40(1)(e)(iv)

1.84

Item 1, paragraph 360-40(1)(e)(v)

1.85

Item 1, paragraph 360-40(1)(e) and subsection 360-45(1)

1.86

Item 1, item 1 in the table in subsection 360-45(1)

1.87

Item 1, item 3 in the table in subsection 360-45(1)

1.88

Item 1, item 2 in the table in subsection 360-45(1)

1.92

Item 1, item 4 in the table in subsection 360-45(1)

1.95

Item 1, item 5 in the table in subsection 360-45(1)

1.98

Item 1, item 6 in the table in subsection 360-45(1)

1.100

Item 1, item 7 in the table in subsection 360-45(1)

1.101

Item 1, item 8 in the table in subsection 360-45(1)

1.105

Item 1, subsection 360-45(2)

1.108

Item 1, subsection 360-50(2)

1.110

Item 1, subsection 360-50(1)

1.111

Item 1, section 360-55

1.115

Item 1, subsections 360-50(3) and (4)

1.116, 1.117

Item 1, subsection 360-50(5)

1.118

Item 1, section 360-60

1.122, 1.123

Item 1, section 360-65

1.124

Item 1, sections 360-5 and 360-10

1.132

Items 2-11

1.126

Items 12-16

1.131

Items 17 and 18

1.129

Schedule 2: Venture capital investment

Bill reference

Paragraph number

Items 1, 9 to 12, 14, 25, 31, 34, and 54 to 61, the item headed early stage venture capital limited partnerships in the list in section 13-1, subparagraph 118-407(1)(d)(iv), notes 1 and 2 to subsection 118-407(1), subsection 118-407(5), definition of ‘divestiture registration requirement’ in subsection 995-1(1), note 3 to subsection 118-425(3), note 4 to subsection 118-427(4), subsection 118-435(1), note to subsections 118-425(13) and 118-427(14) and the definitions of private ruling and public ruling in s.995-1 in the ITAA 1997 as well as section 357-1, subsection 357-5(3) and the note to section 357-50 in Schedule 1 to the TAA 1953

2.142

Item 2, subsection 61-765(1)

2.19

Item 2, subsection 61-765(2)

2.22

Item 2, subsection 61-765(2)

2.23, 2.24

Item 2, subsection 61-765(3)

2.26, 2.29

Item 2, subsection 61-765(4)

2.30

Item 2, paragraph 61-760(1)(b)

2.36

Item 2, subsection 61-760(2)

2.37

Item 2, section 61-770

2.38

Item 2, subsection 61-770(4)

2.39

Item 2, subsection 61-770(1)

2.40

Item 2, subsection 61-770(3)

2.41

Item 2, section 61-770

2.43

Item 2, subsections 61-770(2) and (5)

2.44

Item 2, subsection 61-760(3) and sections 61-765 and 61-775

2.46

Item 2, section 61-775

2.47

Items 2 and 32, subsections 118-425(4) and 118-427(5)

2.74

Item 2, subsection 61-760(1)

2.17

Item 3, table item 32 of subsection 63-10(1)

2.32

Item 3, table item 32 of subsection 63-10(1)

2.34

Item 4

2.145, 2.147

Item 4 of clause 2 to the Bill

2.165

Item 5

2.149

Item 6, subparagraph 9-3(1)(d)(ii) of the VCA 2002

2.48

Item 6 of clause 2 to the Bill

2.166

Item 7

2.151

Item 8, subsection 51-54(1A)

2.61

Item 13, section 118-408

2.53

Item 13, subsections 118-408(2)

2.55

Item 13, subsections 118-408(2) and (3)

2.56

Item 13, subsection 118-408(1)

2.59

Items 15 and 16, paragraph 9-3(1)(i) and subsections 9-3(3) and (6) of the VCA 2002

2.51

Items 17 to 19, 35 to 41 and 43, section 17-3, paragraph 17-5(1)(ab), section 17-15, paragraphs 15-1(ga) and (gb), 15-10(c), (d) and (e), 21-20(g), (h), (i) and (j) and 29-1(i) and (j) of the VCA 2002

2.143

Item 20

2.152

Items 21 and 22, paragraphs 104-71(3)(aa), (c) and (d)

2.65

Item 23

2.154

Items 24, 25, 30 and 31, subsections 118-425(3) and 118-427(4)

2.76

Items 24, 25, 30 and 31, subsections 118-425(3) and 118-427(4)

2.75

Items 25, 26, 31 and 32, subsections 118-425(3), (4), 118-427(4) and (5)

2.78

Items 26 and 32, subsections 118-425(4A) and 118-427(5A)

2.79

Items 26 and 32, subsections 118-425(4) and 118-427(5)

2.73

Items 27 and 29, subsections 118-425(11) and (16)

2.92

Items 28 and 33, subsections 118-425(14B) and 118-427(15A)

2.81

Items 28 and 33, paragraphs 118-425(14C)(b) and 118-427(15B)(b)

2.82

Items 28 and 33, paragraphs 118-425(14C)(a) and 118-427(15B)(a)

2.83

Items 28 and 33, paragraphs 118-425(14B)(c) and 118-427(15A)(c)

2.84

Items 28 and 33, subsections 118-425(14C) and 118-427(15B)

2.86

Items 28 and 33, subsections 118-425(14C) and 118-427(15B)

2.87

Item 28, subsection 118-425(14C)

2.90

Items 28, 33 and 42, subsections 118-425(14B), (14C), 118-427(15A) and (15B) of the ITAA 1997 and subsections 25-15(1) and (1A) of the VCA 2002

2.80

Item 28, subsection 118-425(14A)

2.96, 2.97

Items 46 and 52, paragraph 118-420(1)(ba) of the ITAA 1997 and paragraph 9-3(5)(e) of the VCA 2002

2.98

Items 47 and 51, subsection 118-420(6) and definition of ‘widely held foreign venture capital fund of funds’ in subsection 995-1(1)

2.102

Items 48, 49 and 50, paragraph 842-230(1)(aa), subsection 842-230(2) and paragraph 842-235(6)(a)

2.107

Items 48, 49 and 51, paragraph 842-230(1)(aa), subsection 842-230(2) and the definition of ‘widely held entity’ in subsection 995-1(1)

2.103

Item 53

2.161

Item 61, Division 362 of the TAA 1953

2.110

Item 61, sections 362-5, 362-25 and 362-30 in Schedule 1 to the TAA 1953

2.111

Item 61, sections 362-70 and 362-75 in Schedule 1 to the TAA 1953

2.112

Item 61, subsections 362-5(2) and (3) and sections 362-15 and 362-20 in Schedule 1 to the TAA 1953

2.113

Item 61, sections 362-35 and 362-40 in Schedule 1 to the TAA 1953

2.115

Item 61, section 362-50 in Schedule 1 to the TAA 1953

2.116

Item 61, section 362-10 and 362-45 in Schedule 1 to the TAA 1953

2.117

Item 61, sections 362-15 and 362-55 in Schedule 1 to the TAA 1953

2.118

Item 61, sections 362-20 and 362-60 in Schedule 1 to the TAA 1953

2.119

Item 61, section 362-65 in Schedule 1 to the TAA 1953

2.121

Item 62, paragraphs 29-1(k) and 29 - 1(l) of the VCA 2002

2.114

Item 63

2.162

Items 64 and 66, subsections 118-425(5A) and 118-427(6A)

2.130

Items 64 and 66, subsections 118-425(5) and (5A) and subsections 118-427(6) and (6A)

2.126

Items 65, 68, 69 and 70, subsections 118-425(10A), 118-428(4) and 118-440(2A) and section 118-450

2.127

Item 67 and 68, subsections 118-427(11) and 118-428(4)

2.129

Item 70, subsection 118-450(1)

2.128

Item 71, the definition of ‘registered auditor’ in subsection 995-1(1)

2.131

Item 72

2.163

Items 73 and 75, subsections 275-10(4A) and (4B) of the ITAA 1997 and subsections 12-400(2A) and (2B) in Schedule 1 to the TAA 1953

2.136

Items 73 and 75, subsections 275-10(4A) and (4B) of the ITAA 1997 and subsections 12-400(2A) and 12-400(2B) in Schedule 1 of TAA 1953

2.137

Item 74, subsection 275-100(1A)

2.141

Item 76

2.164

Items 77 to 82, paragraphs 13-5(1)(b) and (c), 13-5(1A)(b) and (c) and 13-5(2)(b) and (c) of the VCA 2002

2.144

Section 2 and items 73 and 75, subsections 275-10(4A) and (4B) of the ITAA 1997 and subsections 12-400(2A) and (2B) of the TAA 1953

2.138

Subitem 44(1)

2.155

Subitem 44(2)

2.156

Subitem 44(3)

2.157

Subitem 45(1)

2.159

Subitem 45(2)

2.160

 

 

 




[1] United Nations Human Rights Committee , CCPR General Comment No. 16: Article 17 (Right to Privacy), The Right to Respect of Privacy, Family, Home and Correspondence, and Protection of Honour and Reputation , 8 April 1988, available at: http://www.refworld.org/docid/453883f922.html.