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Thursday, 12 December 2002
Page: 7870

Senator MURRAY (1:01 PM) —I seek leave to incorporate my speech in the second reading debate on the Taxation Laws Amendment (Venture Capital) Bill 2002 and the Venture Capital Bill 2002.

Leave granted.

The speech read as follows

The Australian Democrats welcome the Venture Capital legislation. It is something that should have come forward sometime ago and is overdue.

Venture capital is the term used to describe investments in businesses at various stages of development, but is particularly important in the early stages.

Venture capital includes start-up and seed capital, expansion-stage capital, later-stage development capital, and finance for management buy-outs and buy-ins of established businesses.

Venture capital is an essential catalyst for new industries, for jobs, for a healthy economy, and for dynamic wealth creation. While venture capital is available regardless of legislative incentives, it increases enormously if there are legislated incentives.

Venture capital in Australia has helped small enterprises which began with seed capital, with some notable examples being Energy Development Ltd, Austal Ships Ltd, LookSmart, ResMed, and Cinema Plus Ltd, the Imax cinema venture.

However, there has been a disturbing decline in the provision of venture capital, even in a period of good economic growth. In 2001-02, $894.7 million was raised in venture capital by 18 firms, compared to $1.27 billion in 2000-01 by 34 firms and $1.75 billion in 1999-00 also by 34 firms.

The EM indicates that the Taxation Laws Amendment (Venture Capital) Bill 2002 (the TLA(VC) Bill) amends the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax Assessment Act 1997 (ITAA 1997) so as to extend the scope of the existing tax exemption for venture capital investment to registered Venture Capital Limited Partnerships (VCLPs) and Australian Venture Capital Funds of Funds (AFOFs).

The measures propose to alter taxation of the venture capital manager's share of gains made by a VCLP or an AFOF on the sale of eligible venture capital investments, not as income but as a capital gain.

Administrative measures are also contained in the Bill for the registration and revocation of registration of VCLPs and AFOFs.

The Government announced during the November 2001 Election a commitment to improve incentives for foreign investment in the venture capital sector. This was set to cost $60 million over three years beginning in 2003-04. The estimate has now been revised to $76 million for this period.

During the election the Government foreshadowed that it would review taxation arrangements for venture capital investment, recognising that access to venture capital is a critical factor in facilitating the growth of Australian companies.

In “The golden chance”, Business Review Weekly, June 6-12, 2002, p. 55 it said that there are good prospects for growth in the Australian venture capital sector. Economic analysis undertaken by Econtech for the Australian Venture Capital Association has estimated that the imminent limited partnerships and tax changes will attract an additional $1 billion in foreign capital over the next five years.

You need to put that $1 billion into perspective. The HSBC Report this week indicated that total foreign direct investment in Australia has been revised up to $23.2 billion for the year.

The key features of the new legislation are:

· venture capital limited partnerships will be able to access flow-through taxation treatment—allowing the income, profits, gains and losses of the partnerships to flow through to partners;

· the current Capital Gains Tax (CGT) exemption provided to certain foreign pensions funds on profits or gains from the sale of investments in eligible venture capital investments will be extended to a wider pool of foreign investors;

· general partners of limited partnerships must apply to the Pooled Development Funds (PDF) Registration Board to qualify for tax exemption;

· a venture capital manager's `carried interest' or entitlement to a distribution from a limited partnership will be taxed as a capital gain, rather than as income.

By extending the current CGT exemption, the venture capital sector should experience an increase in funds flowing in to the sector from foreign tax-exempt entities, including overseas superannuation funds and from tax paying entities.

The only drawback is that the exemption applies to a restricted list of countries, which could be seen as discriminatory, however the Australian Democrats understand that the Government has indicated it will consider adding other appropriate countries as required. We understand that the criteria for addition will be that of having a significant source of funds available for such investment.

The new provisions in respect of the carried interest paid to investment managers, which will be treated as capital gain rather than income, will make it easier to attract US or UK expertise in managing funds in Australia. Venture capitalists will be taxed at 24.25 per cent, the same as in the US.

In time the reporting processes and ongoing obligations may become a cost burden for smaller fund operators, as the registration procedures for limited partnerships and the ongoing reporting obligations will result in higher running costs for venture capital funds that qualify for tax exemption. This will be something that we will be keeping an eye on.

While the current legislation is a good outcome for Australia, we believe that it could be improved in four important ways.

Firstly, merge the benefits of PDFs into VCLPs. The venture capital initiatives provide tax-free returns to certain foreign pension funds investing through VCLPs and AFOFs, but there are no incentives to encourage Australian super funds or individuals to invest in the VCLPs or AFOFs.

(I would remind the Senate that as a real motivator, the Democrats have previously advocated a mandated 1% investment of Super Funds portfolios into risk or venture capital. At present, that would be over $4 billion.)

Australian super funds obtain tax-free returns from their investments in Pooled Development Funds (PDFs). On that principle consideration should be given to the feasibility of providing tax-free returns from their investments in VCLPs and AFOFs.

Australian individuals are effectively provided with 15% tax on their investments in a PDF, and they too should be accorded the same treatment when investing in a VCLP. It does not make sense to have two vehicles trying to do the same thing. We should therefore consider combining the best features of a PDF with a VCLP.

Secondly, the $250 million asset value cap is a restraint. The $250 million cap is the gross value of the assets of the investee business. Venture capital industries in other countries are not subject to such limits. Fund managers are able to offer to investors funds that can achieve wide diversification across early stage businesses to large buyout deals. Investors can achieve diversification by investing in funds that specialise at each of these stages.

Applying the $250 million cap as the net value of the assets of the investee business would be a simple way of increasing the diversification available to investors and fund managers.

Thirdly, investors need to be encouraged from Countries other than those already listed.

There are very large investors located in other countries than those already listed in the legislation and who are already significant investors in venture capital funds around the world. Many of these investors are interested in investing in the Australian venture capital industry but are deterred by having to pay tax on the gains from their investments.

Australia should examine whether the already existing “portfolio investor” concession in the income tax system (any investor from any country holding less than 10% of the equity of a listed company is not taxed on the gains from these investments) should be extended to the venture capital industry.

That would mean that any investor from any country would be entitled to tax free returns from their investments in VCLPs and AFOFs provided they hold less than 10% of the committed capital of the VCLP or AFOF.

Fourthly, there is a need to support Australian venture capital backed companies. Australia has a chronic shortage of venture capital. Yet one Australian super fund, as an example, Military Super, invests more in offshore private equity than Australia. So while our SAS Officers are fighting a war against terrorism in Afghanistan, Military Super here in Canberra is happily investing truck loads of their dollars in offshore private equity. Surely their first priority ought to be to help us commercialise our own ideas.

ResMed is an example of what can happen. ResMed was backed by Australian venture capital, and is now a world-leading medical device company, with the majority of its employees in Sydney. One of their proudest achievements is making the Forbes 200 Best Small Companies in America list (with revenues of about A$ 1 billion), for the past 6 consecutive years.

Given the poor record of some Australian Super funds in supporting Australian venture capital backed companies like ResMed, we ought as a nation require that all Australian super funds commit a set percentage of their funds to Australian venture capital. There are some enlightened super funds that are doing this—but at best many of them have only a token commitment to the sector.

Australian superannuation funds do continue to be the largest source of venture capital, with 35 per cent of the $4.9 billion (or $1.733 billion) committed for investment at the end of June 2000, followed by non-residents with 21 per cent. While this figure compares favourably with the percentage of venture capital sourced from pension funds in other countries, it still represents only 0.5 per cent of the superannuation funds' investment portfolio.

The relative importance of super funds as a source of venture capital is borne out in industry surveys, although the proportion of super funds' contribution to the growth of venture capital in Australia is declining. According to the 2000 Australian Venture Capital Yearbook, contributions from these sources accounted for 31 per cent of all capital under management, a decrease from 38 per cent in 1999 and from 40 per cent in 1998.

One of the things that seems to be passed over by many people is the issue of how much money is being put into compulsory super funds. This is of importance when one looks at the issue of the investment that is needed within regional and rural Australia. This cannot be done without looking at both the issue of venture capital and super fund support.

In regional and rural Australia it has been found that monies paid into super funds by employers under the superannuation guarantee provisions are flowing out of these local regions, rather than being invested in them.

During the mid-1980's compulsory superannuation was introduced initially through industrial awards. Later the superannuation guarantee legislation came into effect in 1992. This has led to a rapid growth in superannuation fund assets. Studies have shown that a particular problem for regional Australia has emerged in that the savings (or potential consumer spending) of regional employees have generally been diverted away from regional areas.

Compulsory contributions to super funds from regional areas is substantial. It has been estimated by the Australian Regional Investment Plan Alliance (the Alliance) that over $5.7 billion in compulsory superannuation is generated annually in regional Australia. Not surprisingly the majority of this is from NSW, some $1.9 billion.

These studies have also pointed out that most of the funds derived from contributors in regional areas are invested in metropolitan or overseas equities. This continues to significantly affect economic opportunities within regional economies. Aside from the estimated annual $5.7 billion from regional communities, the Senate Superannuation and Finance Services Select Committee received from the Bendigo Bank an estimate that less than one per cent of the $400 billion held by super funds—that is, only $4 billion—is invested in regional Australia.

The Committee noted in its Issues Paper Investing Superannuation Funds in Rural & Regional Australia released in February 2002, that access to capital is a major constraint to regional development. It is not only the absence of economic capital but the potential collapse of social capital which is at stake.

The Committee considered that superannuation funds have the potential to make a major difference to rural and regional areas by reinvesting in projects and businesses in these areas. `Gems' such as the Colac meat processing venture are indicative of the sort of projects which have demonstrated the success of a regional investment initiative.

With an estimated $5 billion in compulsory superannuation being generated annually in regional Australia, superannuation funds have the potential to make a major difference to rural and regional areas by investing in projects and businesses in these areas. This is one of the ways in which there could be a narrowing of the great divide between the country and the city.

The Australian Democrats believe that increasing investment in infrastructure is crucial to our nation's future development, job security and wealth creation.

Recent research by `new growth theory' economists and the World Bank has highlighted the vital importance that spending on infrastructure has on economic growth, on improving productivity, on job creation, and on building national competitive advantage for nations in a globalised economy.

Yet, despite the compelling evidence, Government spending on infrastructure in Australia has collapsed to pretty well its lowest level since World War II, with Governments focussing on recurrent expenditure and budget cuts ahead of longer term planning.

A significant targeted increase in infrastructure spending is needed, funded by a combination of normal capital budget allocations and public borrowings, and assisted through sympathetic financing and tax policy where appropriate.

It is also crucial to addressing unemployment, with research by the National Institute of Economic Research showing that each $1 billion of infrastructure spending creates as many as 18,000 public sector and 7000 private sector jobs when flow-on effects are taken into account.

The ability for us to be able to make an impact into the financial and economic problems across regional a rural Australia is often seen as such an overwhelming task. Before us are two mechanisms that can be used, that is super funds and venture capital, which can make significant impacts on many of these ailing communities.

In closing, I would like to thank Andrew Green and Mark Goldsmith for their assistance in backgrounding me on the venture capital issues. The Australian Democrats will support these bills.