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Treasury Laws Amendment (2018 Measures No. 2) Bill 2018



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ISSN 1328-8091

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BILLS DIGEST NO. 97, 2017-18 5 APRIL 2018

Treasury Laws Amendment (2018 Measures No. 2) Bill 2018 Phillip Hawkins Economics Section

Contents

Glossary ................................................................... 3

Purpose of the Bill .................................................... 4

Structure of the Bill .................................................. 4

Structure of this Bills Digest ........................................ 4

Committee consideration ......................................... 4

Senate Standing Committee on Economics ................ 4 Senate Standing Committee for the Scrutiny of Bills .............................................................................. 5

Statement of Compatibility with Human Rights ........ 5 Parliamentary Joint Committee on Human Rights ..... 5 Schedule 1—FinTech Sandbox Regulatory Licensing Exemptions ............................................... 5

What is Fintech? .......................................................... 5

What is the regulatory sandbox? ................................ 5

Use of the regulatory sandbox .................................. 6

Policy Commitment ..................................................... 6

Policy position of non-government parties/independents ............................................... 7

Position of major interest groups ............................. 7

Consumer advocates ................................................... 7

Industry stakeholders .................................................. 8

Financial implications ............................................... 9

Key issues and provisions ......................................... 9

General rule ............................................................... 9

Regulation making power ......................................... 9

Date introduced: 8 February 2018

House: House of Representatives

Portfolio: Treasury

Commencement: Schedule 1 commences the day after Royal Assent

Schedule 2 commences on the first 1 January, 1 April, 1 July or 1 October to occur after Royal Assent

Links: The links to the Bill, its Explanatory Memorandum and second reading speech can be found on the Bill’s home page, or through the Australian Parliament website.

When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the Federal Register of Legislation website.

All hyperlinks in this Bills Digest are correct as at April 2018.

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Scrutiny of Bills Committee comments ..................... 10 Draft regulations ..................................................... 10

Schedule 2—Innovation measures .......................... 12

Stakeholder comments ............................................. 13

Financial implications ............................................. 13

Key issues and provisions ....................................... 13

Part 1—Venture capital investments ...................... 13 Part 2—Early stage investor tax offset .................... 13 Parts 3 and 4—Managed investment trusts and public trading trusts ................................................ 14

Scrutiny of Bills Committee comments ..................... 14

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Glossary ACL Australian Credit Licence

AFOF Australian venture capital fund of funds

AFSL Australian Financial Services Licence

ASIC Australian Securities and Investments Commission

AVCAL Australian Private Equity and Venture Capital Association Limited

Corporations Act Corporations Act 2001

EITO Early-stage investor tax offset

ESIC Early-stage innovation company

ESVCLP Early stage venture capital limited partnerships

ITAA36 Income Tax Assessment Act 1936

ITAA97 Income Tax Assessment Act 1997

MIT Managed investment trust

NCCP Act National Consumer Credit Protection Act 2009

PTT Public trading trust

VCLP Venture capital limited partnerships

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Purpose of the Bill The Treasury Laws Amendment (2018 Measures No. 2) Bill (the Bill) comprises two Schedules which have different purposes:

• Schedule 1 amends the Corporations Act 2001 and the National Consumer Credit Protection Act 2009 (NCCP Act) to allow conditions to be imposed on providers of financial and credit products who utilise the Australian Securities and Investments Commission’s (ASIC) existing regulatory sandbox arrangements to test new, innovative ‘Fintech’ products in the Australian market and

• Schedule 2 makes minor amendments to the Income Tax Assessment Act 1997 (ITAA97) and the Income Tax Assessment Act 1936 (ITAA36) to ensure that the venture capital and early stage tax concessions in the ITAA97 and ITAA36 operate as intended.

Structure of the Bill Schedule 1 of the Bill is divided into two parts:

• Part 1 amends provisions of the Corporations Act to change the regulatory sandbox arrangements for providers of financial services and

• Part 2 amends provisions of the NCCP Act to change the regulatory sandbox arrangements for providers of credit products.

Schedule 2 of the Bill is divided into three parts:

• Part 1 amends provisions in the ITAA97 relating to capital gains tax concessions for Venture Capital Limited Partnerships (VCLPs) and Early Stage Venture Capital Limited Partnerships (ESVCLPs)

• Part 2 amends provisions in the ITAA97 relating to the early-stage investor tax offset (EITO)

• Part 3 amends provisions in the ITAA97 relating to managed investment trusts (MITs) and

• Part 4 amends provisions in the ITAA36 relating to public trading trusts (PTTs).

Structure of this Bills Digest As the matters covered by each of the Schedules are independent of each other the relevant background, stakeholder comments (where available) and analysis of the provisions are set out under each Schedule number.

Committee consideration

Senate Standing Committee on Economics The Bill was referred to the Senate Standing Committees on Economics (the Economics Committee) for inquiry and report.1 The Economics Committee released its report on 15 March 2018.2 Industry stakeholders and consumer advocates made submissions to the inquiry which are discussed below.

The Economics Committee recommended that the Bill be passed.3 The Australian Labor Party (Labor) Senators made additional comments to the report, which are canvassed below.4

1. The terms of reference, submissions to the Economics Committee and the final report are available on the inquiry homepage. 2. Senate Economics Legislation Committee, Report on the Treasury Laws Amendment (2018 Measures No. 2) Bill 2018 [provisions], The Senate, Canberra, March 2018. 3. Ibid., p. 13.

4. Australian Labor Party, Additional comments to Senate Economics Committee, Inquiry into the provisions of the Treasury Laws Amendment (2018 Measures No. 2) Bill 2018, The Senate, Canberra, 2018, p. 15.

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Senate Standing Committee for the Scrutiny of Bills The Senate Standing Committee for the Scrutiny of Bills (the Scrutiny of Bills Committee) considered the Bill its Scrutiny Digest of 14 February 2018.5 These comments are canvassed below.

Statement of Compatibility with Human Rights As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Bill’s compatibility with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that the Bill is compatible.6

Parliamentary Joint Committee on Human Rights The Parliamentary Joint Committee on Human Rights considered the Bill in its Scrutiny Report of 13 February 2018 and determined that the Bill does not raise human rights concerns.7

Schedule 1—FinTech Sandbox Regulatory Licensing Exemptions

What is Fintech? Fintech (an abbreviation of financial technology) refers to the use of innovative technology in providing financial products and services to consumers. Fintech has applications across lending, financial advice, investment management and payment services.8 Some examples of Fintech companies operating in Australia are available from the Australian FinTech website.9

According to research by KPMG, investment in Fintech in Australia has grown from around $US53 million in 2012 to $US675 million in 2016.10

What is the regulatory sandbox? In order to facilitate the development of new Fintech products, ASIC’s ‘regulatory sandbox’ allows new products to be tested in the Australian market for 12 months without requiring financial advisers or dealers of the product to first obtain an Australian Financial Services Licence (AFSL)11 or Australian Credit Licence (ACL).12

The licensing exemption is limited to those providing financial advice on the relevant products or those dealing in the products. It is not available to issuers of the product.13

The purpose of providing an exemption is to reduce barriers to new product development by reducing the time and the costs associated with bringing new financial products to the market and allowing for the viability of a new financial product to be tested in the market. Further it may assist advisers and dealers to satisfy the conditions for obtaining an AFSL or ACL following the 12 month testing period.14

5. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 2, 2018, The Senate, Canberra, 14 February 2018, p. 51. 6. The Statement of Compatibility with Human Rights can be found at pages 10-11 and page 23 of the Explanatory Memorandum to the Bill. 7. Parliamentary Joint Committee on Human Rights, Scrutiny report, 2, 2018, The Senate, Canberra, p. 42. 8. M Blake, P Vanham and D Hughes, ‘Five things you need to know about Fintech’, World Economic Forum, 20 April 2016. 9. Australian FinTech, ‘Directory of Australian FinTech companies’, Australian FinTech website. 10. I Pollari and J Mabbott, ‘Australian Fintech Landscape’, KPMG website, 1 August 2017. 11. ASIC Corporations (Concept Validation Licensing Exemption) Instrument 2016/1175. 12. ASIC Credit (Concept Validation Licensing Exemption) Instrument 2016/1176. 13. Australian Securities and Investments Commission (ASIC), Testing fintech products and services without holding an AFS or

credit licence, Regulatory Guide 257, ASIC, Canberra, August 2017, pp. 18-19. 14. Ibid., pp. 15-16.

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To balance the testing regime with the need to protect consumers, strict conditions apply to licensing exemptions provided under the sandbox arrangements:

• the exemption is limited to certain financial products and credit contracts

- a full list of financial products to which a licensing exemption can apply is available from ASIC’s regulatory guidance document.15 They include listed or quoted Australian securities, securities issued by the Australian Government, simple managed investment schemes, deposit products, some general and life insurance products, payment products and some credit contracts • consumers must be informed that the product sold to them is being tested in the regulatory

sandbox, that the provider of the product is not licensed and that some of the normal protections associated with receiving services from a licensed provider will not apply16

• the services and products that can be issued under a licence exemption are subject to limits in order to minimise the risk of losses to consumers. These include:

- businesses relying on an exemption can only provide services to up to 100 ‘retail’ clients17 - the maximum exposure to a financial product for each retail client is $10,000 - the maximum credit contract that can be provided is $25,000 - the amount insured under a general insurance contract is limited to $50,000 - there are no individual exposure limits for wholesale or sophisticated clients, but the total

exposure of all clients must be limited to $5 million. 18

Use of the regulatory sandbox ASIC’s regulatory sandbox has been in place since 15 December 2016.19 According to ASIC, as at December 2017 four Fintech businesses had utilised the licensing exemption and another 12 have contacted ASIC about utilising the exemption.20 According to a survey of Australia Fintech companies conducted by Ernst and Young, one percent of surveyed Australian Fintechs currently use the regulatory sandbox and a further nine per cent intend to do so in the next 12 months.21

Policy Commitment The Government announced reforms to extend the sandbox rules in the 2017-18 Budget.22 The intention is to enhance Australia’s capabilities as a leading Fintech Hub in the Asia-Pacific.23

The Bill would extend the sandbox framework to a broader selection of financial products than it currently applies to, including financial advice in relation to superannuation, life insurance and domestic and international securities, issuing and facilitating consumer credit, issuing non-cash payment products and providing a crowd-funding service.24 It also proposes to extend the maximum licence exemption period from the current 12 months to 24 months.

15. Ibid., pp. 18-19. 16. Ibid., p. 23. 17. Retail clients are defined under section 761G of the Corporations Act. The general rule, as specified in subregulation 7.1.19(2) of the Corporations Regulations 2001, is that a retail client is an individual who purchases a financial product with a value of

less than $500,000. 18. ASIC, Regulatory guide 257, op. cit., p. 27. 19. S Morrison (Treasurer), Launch of innovative regulatory sandbox for fintech, media release, 15 December 2016; R Gluyas,

‘ASIC to launch fintech "sandbox"’, The Australian, 16 December 2016, p. 23. 20. Australian Securities and Investments Commission, Retaining ASIC’s fintech licensing exemption, Consultation Paper 297, December 2017, p. 9. 21. FinTech Australia, ‘EY Fintech Australia Census 2017’, Ernst & Young, 2017, p. 19. 22. S Morrison (Treasurer), Building an accountable and competitive banking system, media release, 9 May 2017, p. 3. 23. S Morrison (Treasurer), Draft legislation and regulations - enhanced FinTech regulatory sandbox, media release,

24 October 2017. 24. Ibid.

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The proposed framework is being implemented through changes to the Corporations Act and the NCCP Act as well as regulations made under these Acts. Treasury conducted a consultation in relation to the draft regulations.25

Policy position of non-government parties/independents In their additional comments in the Economics Committee’s report, the Labor Senators indicated broad support for the Bill but agreed with submissions from Choice and Fintech Australia that there should be a test on entry into the regulatory sandbox. Labor supported Choice’s view that this test should evaluate whether the products to be tested are genuinely innovative and provide a consumer benefit.26 The Labor Senators recommended that the Bill should include a mandatory review mechanism for the enhanced FinTech sandbox starting no later than 12 months after Royal Assent of the Bill.27

Position of major interest groups Stakeholders have made submissions to the Economics Committee and to Treasury’s consultation on the draft regulations. Generally speaking, submissions were supportive of the intent of the legislation but a number of submissions, particularly from consumer advocacy groups, raised specific concerns about the perceived inadequacy of consumer protections.

Consumer advocates Choice, the Consumer Action Law Centre and the Financial Rights Legal Centre made joint submissions to the Economics Committee and to the Treasury consultation process. Both of these submissions raised concerns that the proposed reforms could expose consumers to greater financial risks and cautioned that not all innovations have benefits to consumers:

While we support the intent of encouraging competition to create new services for consumers we are extremely concerned about the risks that this approach involves. The legislation would allow, for example, unlicensed financial advice on superannuation products, insurance and long-term investments. These services are too complex and too important to the long-term well-being of consumers to be offered without the adequate protections that the sandbox removes. Rather than watering down consumer protections, the financial industry needs much higher standards to prevent the scandals that have drained consumer savings and investments …

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… Innovation can produce significant benefits for consumers. However, not every product innovation is necessarily in consumers’ best interests. This is particularly the case in complex markets such as financial services, where the risks of bad product design and misselling can have catastrophic consequences. For example, we have recently seen “innovation” from payday lenders which has led to more online targeting and quick loan applications for high-cost debt.

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The consumer advocacy groups noted that other jurisdictions, including the United Kingdom and Singapore require an assessment of whether a financial service is both innovative and beneficial to consumers before licensing exemptions are granted.30 They argue that ASIC’s powers to cancel a

25. The Treasury, ‘Enhanced regulatory sandbox’, Consultation, The Treasury website, 1 December 2017. 26. Australian Labor Party, Additional comments, Senate Economics Committee, Inquiry into the provisions of the Treasury Laws Amendment (2018 Measures No. 2) Bill 2018, op. cit., pp. 15-17. 27. Ibid., 16-17. 28. E Turner (Choice), K Temple (Consumer Action Law Centre) and K Cox (Financial Rights Legal Centre), Submission to the

Treasury consultation, Treasury Laws Amendment (2018 Measures No. 2) Bill 2018, 3 November 2017, p. 1. 29. Ibid. 30. Ibid., p. 2.

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licence exemption are inadequate, and that Australia should similarly assess products before an exemption is granted. The consumer advocacy groups argue that without pre-assessment:

We believe it is likely that the sandbox regulatory exemption will be used by some unscrupulous parties to sell products that are harmful to consumers. This is a risk to consumers and the fintech industry’s reputation. 31

While their preferred option is to require ASIC pre-approval, the consumer advocacy groups suggested that, as an alternative, ASIC could be provided with greater intervention powers to act against any products or services which are misleading or detrimental to consumers.32

Industry stakeholders Industry stakeholders generally support the reforms, but have raised concerns that if conditions on the use of the regulatory sandbox are too strict it could continue to limit its usefulness to the industry. Australian Private Equity and Venture Capital Association Limited (AVCAL) made a submission to both the Economics Committee and to the Treasury consultation. In its response to the Treasury consultation on the draft regulations it stated:

Overall, while we strongly support the principle underpinning the proposed enhanced regulatory sandbox, we have concerns that the conditions that will be imposed on FinTechs are unnecessarily restrictive, meaning that there will be limited take-up by industry. 33

AVCAL advocates lifting the regulatory limits on transactions for retail clients from $10,000 to $25,000, lifting the aggregate transaction limit from $5 million to $10 million and raising the limits on the number of retail clients from 100 to 500.34 It also argues that the limitations on the scope of products that can be tested in the regulatory sandbox are too narrow and that the proposed license exemption period of 24 months could be extended in some circumstances.35 They also disagree with proposals that ASIC’s pre-approval be required before a product can be tested in the regulatory sand-box environment:

As a result of the amendments proposed in the Bill, eligible entities will be able to test services in relation to certain financial products without an Australian Financial Services License (AFSL) or Australian Credit Licence (ACL) under certain conditions set out in the Regulations. This is a well-considered approach, rather than requiring firms to proactively seek ASIC approval (instead mere notification of their reliance on the exemption).

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Similarly the Australian Bankers’ Association raised concerns about limitations on the scope of the Fintech sandbox arguing that access should be available to existing AFSL licence holders as well as new entrants. The ABA argues that denying access to existing licensees is at odds with other countries regimes.37

31. Ibid., p. 3. 32. E Turner (Choice), K Temple (Consumer Action Law Centre) and K Cox (Financial Rights Legal Centre), Submission to the Senate Economics Legislation Committee, Inquiry into the Treasury Laws Amendment (2018 Measures No. 2) Bill 2018 [provisions], 28 February 2018, pp. 3-4.

33. Y El-Ansary (Australian Private Equity & Venture Capital Association), ‘FinTech-enhanced regulatory sandbox’, Submission to the Treasury consultation, Treasury Laws Amendment (2018 Measures No. 2) Bill 2018, 1 December 2017, p. 1. 34. Ibid., p. 2. 35. Ibid. 36. Y El-Ansary (AVCAL), Submission to the Senate Economics Legislation Committee, Inquiry into the Treasury Laws Amendment

(2018 Measures No. 2) Bill 2018 [provisions], 7 March 2018, p. 2. 37. Pip Freebairn (Australian Bankers’ Association) Submission to the Treasury consultation, Treasury Laws Amendment (2018 Measures No. 2) Bill 2018, 6 November 2017, p. 1.

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Financial implications The Explanatory Memorandum states that the amendments made by Schedule 1 of the Bill are estimated to have nil financial impact.38

Key issues and provisions The Bill proposes to amend the Corporations Act and the NCCP Act to allow ASIC to apply conditions on AFSL or ACL exemptions which are provided under the regulatory sandbox arrangements. The detail of the new regulatory sandbox arrangements would be implemented through proposed Corporations Regulations and NCCP Regulations.

General rule Currently subsection 911A(1) of the Corporations Act requires that a person who carries on a financial services business must hold an Australian Financial Services Licence (AFSL). Subsection 911A(2) sets out exemptions from that general rule. Section 911B sets out the conditions that must be fulfilled in order for a person (the provider) to provide financial services on behalf of a principal. In most circumstances the principal or the provider will be required to hold an AFSL. However, paragraph 911B(1)(e) allows a provider to provide financial services on behalf of a provider in cases where, if the service was provided by the principal directly, the principal would not need an AFSL because the service would be exempt under subsection 911A(2).

Item 1 of Part 1 in Schedule 1 to the Bill expands paragraph 911B(1)(e) of the Corporations Act so that it will also cover circumstances where the principal would not need an AFSL because the service would be exempt under regulations made in accordance with subsection 926B(1).

Regulation making power Subsection 926B(1) of the Corporations Act provides that the regulations may:

(a) exempt a person or class of persons from all or specified provisions of Part 7.6 (about licensing of providers of financial services)

(b) exempt a financial product or a class of financial products from all or specified provisions of Part 7.6 or

(c) provide that Part 7.6 applies as if specified provisions were omitted, modified or varied as specified in the regulations.

Item 2 of Part 1 in Schedule 1 to the Bill inserts proposed subsections 926B(3)-(5) into the Corporations Act so:

• ASIC may apply conditions to an AFSL exemption provided to a person or class of persons to enable testing of particular financial services: proposed subsection 926B(3)

• a person who receives an AFSL exemption subject to conditions must comply with those conditions. In addition, ASIC may apply for a Court order requiring the person to comply with those conditions: proposed subsection 926B(4) and

• ASIC is empowered to determine how an AFSL exemption to enable testing of particular financial services starts or ceases to apply to a person or class of person: proposed subsection 926B(5).

Item 5 of Part 2 in Schedule 1 to the Bill makes analogous amendments to the NCCP Act in relation to ACL exemptions by inserting proposed subsections 110(2)-(4) into that Act.

38. Explanatory Memorandum, Treasury Laws Amendment (2018 Measures No. 2) Bill 2018, pp. 5-6.

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Scrutiny of Bills Committee comments The Scrutiny of Bills Committee raised concerns that the amendments in Schedule 1 of the Bill confer overly broad powers on ASIC to apply exemptions from requirements to hold an AFSL or an ACL. Although the Explanatory Memorandum contains guidance about how ASIC’s exemption powers would be applied, the Scrutiny of Bills Committee was concerned that this guidance is not sufficiently reflected in the Bill:

… the committee remains concerned that the Bill would permit the regulations to confer a broad power on ASIC to determine when particular exemptions apply. The committee is also concerned that, while the explanatory memorandum provides some guidance around when ASIC's powers would be exercised, this guidance is not reflected on the face of the bill.

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Further, the Scrutiny of Bills Committee raised concern that decisions made by ASIC may not be subject to sufficient Parliamentary scrutiny:

The committee acknowledges that the relevant regulations would be disallowable legislative instruments. However, it is not apparent that decisions made under those regulations, as to when exemptions would start and cease to apply, would also be legislative instruments. The committee is therefore concerned that proposed paragraphs 926B(5) and 110(4) would permit ASIC to make relatively significant decisions relating to the application of exemptions without subjecting those decisions to appropriate levels of parliamentary scrutiny.

40

That being the case, the Scrutiny of Bills Committee asked the Treasurer to provide further justification for conferring broad powers on ASIC to determine when exemptions from licensing conditions start and cease to apply, and advice on whether a decision by ASIC, of this nature, is a legislative instrument subject to Parliamentary scrutiny.41 In his response, the Treasurer stated that the changes amend existing powers to enable ASIC to impose or vary conditions on licensing exemptions, and that this flexibility is necessary to allow ASIC to respond flexibly to changing market circumstances. The Treasurer also confirmed that decisions made by ASIC under the regulations would not be legislative instruments and would therefore not be subject to Parliamentary scrutiny.42

Draft regulations As stated above, the detail of the Fintech regulatory sandbox will be contained in regulations. Without discussion of these draft regulations, this Bills Digest would not provide a complete picture of the legislation’s potential impact. Importantly the final details of the regulations are not known. This means that this discussion is based on the form of the regulations which was available at the time of publication of this Bills Digest and which may be different from the final form.

The draft Corporations (FinTech Sandbox Australian Financial Services Licence Exemption) Regulations 2017 (draft AFSL Regulations) apply regulatory requirements to the provision of an AFSL licence exemption for providers of financial products and the draft National Consumer Credit Protection (FinTech Sandbox Australian Credit Licence Exemption) Regulations 2017 (draft Credit Licence Regulations) apply equivalent requirements for ACLs and providers of credit products.

The provision of an AFSL exemption is subject to certain limitations under the proposed Regulations being:

39. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 2, 2018, op. cit., p. 52. 40. Ibid., p. 53. 41. Ibid., p. 53. 42. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 3, 2018, The Senate, 21 March 2018, pp. 295-8.

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• an AFSL exemption is for a period of 24 months (called the testing period): proposed section 7

• an exemption ceases if the exempt entity fails to meet certain conditions of the exemption: proposed section 843

• providing financial services in relation to particular types of financial products such as derivatives and margin lending facilities is prohibited: proposed section 9 of the draft AFSL Regulations

• the list of eligible financial products that can be provided to retail clients under an AFSL exemption is set out in proposed section 10 of the draft AFSL Regulations. The proposed Regulations would extend the scope of exemptions to superannuation products, life insurance products and certain listed domestic and international securities.44

• there are individual product exposure limits for individual retail clients:

- the exposure limit for financial products would be retained at $10,000: proposed subsection 11(2) of the draft AFSL Regulations - the exposure limit for general insurance products would be raised from $50,000 to $85,000: proposed subsection 11(4) - the exposure limit for life insurance products is $300,000: proposed subsection 11(5) - the exposure limit for superannuation products is $40,000: proposed subsection 11(6) - the regulation continues to limit the provider to 100 retail clients: proposed

subsection 11(7). • the current maximum exposure limit for all financial services is retained at $5 million: proposed section 12 of the draft AFSL Regulations and proposed section 10 of the draft Credit Licence Regulations.

The regulations allow for an AFSL licence exemption to be cancelled. Proposed section 13 provides the power to ASIC to cancel an exemption if, for example, it believes that the conditions for the exemption have not been met, or if ASIC believes the provider is not of good fame or character or has failed to act fairly, efficiently or honestly in providing financial or credit services.

The conditions for an exemption are outlined in proposed Part 5 of the regulations. The conditions include:

• a provider of a financial service must notify a client that they have an AFSL exemption and that some of the normal consumer protections that would apply under an AFSL or ACL will not apply: proposed section 16 of the draft AFSL Regulations and proposed section 14 of the draft Credit Licence Regulations

• a client is to be notified of certain information about the provider of the financial service or product including the remuneration arrangements of the provider, any relationships they have with issuers of the financial products, and the available dispute mechanisms: proposed section 17 of the draft AFSL Regulations

• a client is to be notified of certain events, including if the provider ceases to carry on a financial services business, is placed into administration or becomes bankrupt. They are also required to notify a client if they obtain an AFSL or cease to rely on the AFSL exemption, or if the financial product or services they provided to the client have changed or are no longer being offered to clients: proposed section 18 of the draft AFSL Regulations and proposed section 15 of the draft Credit Licence Regulations

43. The relevant conditions are those set out in Division 1 of Part 3 of the Corporations (FinTech Sandbox Australian Financial Services Licence Exemption) Regulations 2017 and Division 1 of Part 3 of the National Consumer Credit Protection (FinTech Sandbox Australian Credit Licence Exemption) Regulations 2017.

44. Compared to the type of products that can be provided under the ASIC Corporations (Concept Validation Licensing Exemption) Instrument 2016/1175.

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• the provider must maintain an internal dispute resolution service and be a member of an external dispute resolution regime: proposed section 19 of the draft AFSL Regulations and proposed section 16 of the draft Credit Licence Regulations

• the provider must act in the best interests of the client: proposed regulation 20 of the draft AFSL Regulations.

Schedule 2—Innovation measures The amendments in Schedule 2 to the Bill make technical amendments to a number of existing regimes which provide tax incentives to venture capital investors who invest in early-stage innovation companies. To be eligible for the tax incentives, a venture capital fund must be registered and remained registered as a VCLP. Innovation Australia’s Innovation Investment Committee (the Committee), which is managed by AusIndustry, registers VCLPs under the Venture Capital Act 2002.45

The tax concessions include:

• Venture capital limited partnerships (VCLP) which provide specific tax concessions to foreign investors who make equity investments in unlisted Australian venture capital companies.46 Australian resident investors can invest in VCLPs but may not be entitled to the available tax concessions:

- these tax concessions include exemptions from Capital Gains Tax (CGT), flow-through tax treatment of returns from the partnership47 and an option for partners to recognise their carried interest on the capital account, rather than revenue account48

- a VCLP must have at least $10 million in committed capital from partners to be registered as a VCLP49 - limits apply to the investments that a VCLP can make, including that any investee company must have total assets of less than $250 million, must be primarily operating in Australia and

cannot be a company primarily operating in property, land development, finance, insurance, construction or infrastructure.50 • Early stage venture capital limited partnerships (ESVCLP) which provide incentives to earlier stage Australian venture capital companies. Unlike VCLPs Australian domestic investors are entitled to the tax concessions from investing in an ESVCLP:

- ESVCLPs receive the tax benefits of a VCLP but investors are also entitled to a non-refundable carry-forward tax offset, generally equal to ten per cent of the value of their eligible contributions to the partnership51

- an ESVCLP must have committed capital of at least $10 million but no more than $200 million from its partners52

45. Australian Taxation Office (ATO), ‘Venture capital limited partnerships’, ATO website, last modified 1 December 2016. 46. Venture Capital Act, section 9-1. 47. R Deutsch, M Freizer, I Fullerton, P Hanley and T Snape, The Australian Tax Handbook 2018, p. 615. Flow through treatment provides that the individual partners are taxed on their share of profits from the partnership, rather than the partnership itself

being taxable. 48. ATO, ‘Shareholding as investor or share trading as business?’, ATO website, last modified 17 July 2017. The taxation treatment of investment income would generally depend on whether the partnership is carrying on a business. This depends on factors

such as the volume and regularity of share-trading and the amount of capital invested. The proceeds from the sale of shares from a share trading business would be treated as assessable income (on revenue account) rather than being subject to capital gains tax (on capital account); with access to relevant capital gains tax concessions. 49. Venture Capital Act, paragraph 9-1(1)(d). 50. Department of Industry, Innovation and Science, Venture Capital Limited Partnerships, Business investment factsheet, July 2016, p. 1. 51. Income Tax Assessment Act 1997, section 61-765 52. Venture Capital Act, paragraph 9-3(1)(d).

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- additional limits apply to ESCVLPs over VCLPs. Because an ESVCLP is intended to invest in early-stage companies, investments are limited to new shares issued by the company and the company must have assets of no more than $50 million. The ESVCLP’s investment cannot exceed 30 per cent of the company’s total issued capital.53 • Investors in newly issued shares of a qualifying Early Stage Innovation Company (ESIC) are

entitled to specific tax incentives, namely:

- the early-stage investor tax offset—a non-refundable carry-forward tax offset equal to 20 per cent of the amount paid for their investment. This is capped at a maximum $200,000 per income year for the investor and their affiliates

- modified capital gains tax treatment meaning that capital gains on shares held for at least one year and no more than 10 years is not taxable.54

Stakeholder comments Only AVCAL addressed the proposed amendments in Schedule 2 in its submission to the Economics Committee inquiry. AVCAL indicated its strong support for the changes but noted that the Bill does not address all the concerns it has raised with Treasury and the Government, notably that the proposed $200,000 limit on the EITO for partnerships in their entirety should apply at the individual tax-payer level.55

Financial implications The Explanatory Memorandum states that the amendments made by Schedule 2 of the Bill are estimated to result in a negligible impact to revenue over the forward estimates period.56

Key issues and provisions Schedule 2 to the Bill makes a number of technical amendments.

Part 1—Venture capital investments A cap applies to the available capital gains tax concessions on an investment made by an ESVLCP where the value of the start-up business’s assets grows to over $250 million (at the end of a financial year). If the ESVLP does not dispose of their investment within six months of the income year then the capital gain relating to that investment will only be partially exempt:57

• item 1 amends subsection 118-408(2) of the ITAA97 relating to the disposal of investments made by the ESVCLP to clarify how the partial capital gains tax exemption is calculated in the event that the ESCVLP did not dispose of the investment within this six month period

• item 2 amends subparagraph 118-428(1)(c) of the ITAA97 to clarify an existing requirement on ESCVLPs which limits the amount of pre-owned investments that an ESVCLP can make to 20 per cent of its total invested capital.

Part 2—Early stage investor tax offset Division 360 in Part 3-45 of the ITAA97 deals with early stage investors in innovation companies. Items 5-13 of Part 2 in Schedule 2 to the Bill amend that Division. Notably:

53. Department of Industry, Innovation and Science, Comparison of Venture Capital Limited Partnerships (VCLPs) and Early Stage Venture Capital Limited Partnerships (ESVCLPs), July 2016, pp. 1-2. 54. Australian Taxation Office, ‘Tax incentives for early stage investors’, ATO website, last modified 2 August 2017. 55. El-Ansary (AVCAL), Submission to the Senate Economics Legislation Committee, op. cit., p. 2. 56. Explanatory Memorandum, Treasury Laws Amendment (2018 Measures No. 2) Bill 2018, pp. 3-4. 57. Ibid., p. 15.

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• item 5 inserts proposed subparagraph 360-15(1)(a)(ia) into the ITAA97 and item 7 amends subsection 360-15(2) of that Act to provide that investors in an ESCVLP are not also entitled to the EITO for those investments

• item 8 repeals and replaces subsection 360-25(1) to amend the amount of the EITO from 20 per cent of the amount paid by the investor for their initial share investment to 20 per cent of the sum of any cash or non-cash benefits that the company received from the investor in return for the issue of shares

• currently the amount of EITO that an investor can receive is capped at $200,000 per income year.58 However, there is no limit applied if the investment is made through a partnership or trust. Item 9 inserts proposed subsection 360-30(1A) to limit the amount of EITO that can be claimed through by all members of a partnership or a trust to $200,000.

• item 13 amends the definition of early-stage innovation company under subsection 360-40 of the ITAA97 so that they can no longer be foreign companies. This would have the effect of removing eligibility for the EITO for investors in foreign companies.

Parts 3 and 4—Managed investment trusts and public trading trusts Parts 3 and 4 of Schedule 2 to the Bill make minor amendments to the ITAA97 relating to managed investment trusts and public trading trusts.

Items 15 and 16 in Part 3 of Schedule 2 to the Bill amend existing subsection 275-10(4A) and paragraph 275-10(4A)(a) respectively to allow Managed Investment Trusts (MITs) to invest in Australian venture capital fund of funds (AFOFs). AFOFs are a type of limited partnership that makes investments in VCLPs or ESVCLPs.59

Item 18 in Part 4 of Schedule 2 to the Bill inserts proposed subsection 102R(5) into the ITAA36 to specify that investments in VCLPs, ESVCLPs and AFOFs are disregarded in determining whether an MIT is a public trading trust (PTT). The effect of current legislation is that if a trust is a PTT it cannot be an MIT.60 Without the amendment, investments made by an MIT in an VCLP, ESVCLP or an AFOF could result in it inadvertently satisfying the criteria for being a PTT.61

Scrutiny of Bills Committee comments As stated above, the changes proposed in Schedule 2 of the Bill seek to address unintended consequences of the existing legislation. However, the Scrutiny of Bills Committee raised concerns that some of these changes apply on a retrospective basis, with potential adverse consequences for individuals.62

Accordingly, the Scrutiny of Bills Committee sought a response from the Treasurer as to why the changes should apply retrospectively and whether this retrospective application will cause detriment to any individual.63 In his response the Treasurer clarified that the proposed amendments are ‘wholly beneficial to affected entities’64 and are ‘necessary to avoid potentially significant adverse consequences for any affected trusts’.65

58. ITAA97, subsection 360-25(2). 59. Venture Capital Act, section 9-5. Explanatory Memorandum, Treasury Laws Amendment (2018 Measures No. 2) Bill 2018, p. 17. 60. Ibid. 61. Ibid. 62. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 2, 2018, op. cit., p. 53. 63. Ibid., p. 54. 64. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 3, 2018, op. cit., p. 299. 65. Ibid.

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