Bills Digest No. 104  1999-2000 Pooled Development Funds Amendment Bill 1999

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WARNING:
This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill.

CONTENTS

Passage History
Purpose
Background
Main Provisions
Endnotes
Contact Officer and Copyright Details

Passage History

Pooled Development Funds Amendment Bill 1999

Date Introduced: 8 December 1999

House: House of Representatives

Portfolio: Industry, Science and Resources

Commencement: Royal Assent. The amendments contained in the Bill will generally apply from the commencement of the 1999-2000 financial year. Amendments relating to interposed entities will apply to investments made after 4 August 1999.

Purpose

To alter the rules applicable to approved deposit funds (PDF) by:

• allowing PDFs to reduce their share capital
• allowing PDFs to acquire non-transferrable share options in, or make a loan to, a company in which the PDF has an investment
• requiring companies in which a PDF has invested to follow the same investment rules as apply to PDFs
• exempting widely-held superannuation funds from ownership restrictions, and
• allowing PDFs to merge.

Background

Pooled Development Funds (PDFs) were established in 1992 to assist the allocation of capital to small and medium enterprises (SME). Investments in PDFs registered under the Pooled Development Funds Act 1992 (the Principal Act) receive tax concessions to encourage investment in perceived higher risk SMEs that would not otherwise be available from the general capital market. In this regard, investment in a PDF may be seen as providing a post tax return that reflects the risk attached to the SME and which would not be available without the tax concession. The assumption inherent in such a scheme is that the capital market would not provide finance based on the expected return/risk ratio of the SME. To target the assisted investment, the Principal Act contains a number of criteria that must be satisfied for the investment to qualify for the tax concessions for contributors to the PDF (see below).

The total amount of funds raised by PDFs has increased yearly since their establishment in 1992, rising progressively from $20 million as at 30 June 1993 to $328 million as at 30 June 1999. Over this period, the most noticeable increase was in 1997-98 where there was a substantial increase of $115 million, based principally on the introduction of a public float underwritten by a large established share brokerage organisation which raised $100 million. During the 6 year period 30 June 1993 to 30 June 1999 only $5 million of PDF profits have been reinvested.⁽¹⁾ The following table deals with investments in and by PDFs:

Source: Compiled from Tables 1 and 2, pp 4 & 5, Pooled Development Fund Registration Board, Annual Report 1998-99.

As the above Table shows through the differences between the cumulative amounts raised and invested, there is a lag between the raising of investment capital and its actual investment in eligible companies. This reflects the selection procedures for investee companies which look not only at the eligibility of the company but also the desire that it be profitable in the long term, but may also indicate that substantial PDF investment funds are used for other short-term purposes, such as investment in the money market. The amount not invested also contains a component for management fees.

Of PDF investments held at 30 June 1999, 38% were in the service sector, 31% in manufacturing, 25% in mining and 6% in agriculture.⁽²⁾

Eligible Investments and Other Capital Restrictions

The regulation of the investments which a PDF may make and retain its PDF status is dealt with in Part 4 of the Principal Act. The main restriction on investment are:

• Investments must be for the purchase of shares in a company and, without approval of the PDF Registration Board (the Board) the shares are not to be already owned by an entity other than by an underwriter or a person who owns the shares for sale.
• The PDF must believe on reasonable grounds that the funds raised by the sale of the shares to the PDF will be used solely or principally for establishing an eligible business (ie one that does not principally engage in an excluded activity - see below) or substantially expanding the production capacity or ability to supply services of such a business.
• The company in which the investment is to be made must have maximum assets of $50 million unless the PDF already holds shares in the company and has Board approval for further investment, which may only be granted if necessary to protect the existing investment.
• The investee company must not be a PDF and must not engage in an 'excluded activity', ie retail operations; or the acquisition, disposal or development of land unless the acquisition etc is incidental to other activities.
• Investment in a single company is not to exceed 30% of the PDFs capital without Board approval which will only be granted in the PDFs formative stage.
• Unless the Board otherwise approves, the PDFs investment must be at least 10% of the investee company's share capital. Board approval may be given in a number of circumstances, such as where two or more PDFs invest in the company and their combined stake is at least 10% or the PDF has underwritten at least 10% of the share capital.⁽³⁾
• A PDF must not raise capital through borrowings, deposits, the issue of convertible notes or debentures or make available an interest in a managed investment scheme.
• A person other than a life office or an approved deposit taking institution is not to hold more than 30% of the issued shares in a PDF either on their own or with an associate (other than a bank or life office), and
• Within 5 years of receipt of capital, unless a longer period is specified by the Board, a PDF must invest at least 65%, or such lesser percentage as specified by the Board, of that amount.

Tax Concessions

Concessional tax rates apply to income related to PDF activities. Income from investments in eligible companies is taxed at the rate of 15% after deductions related to the earning of that income are taken into account. Capital gains from the disposal of interests in eligible investments are also taxed at 15%.

Income from unregulated investments, ie investments made between receiving money and making an eligible investment, are subject to tax at the rate of 25%. Certain other categories of income related to PDF activities, such as management fees charged by the PDF, are also taxed at the 25% rate.

While income may be subject to a concessional rate of tax, for the purposes of dividend imputation (ie where payments of company tax are credited against shareholders to prevent double taxation) franked PDFs dividends are taken to be subject to tax at the full company rate (franking occurs where payments of tax are allocated to dividends). A taxpayer in receipt of franked dividends from a PDF will have the option of whether to include the amount in assessable income and it will usually be in the taxpayers advantage to include franked dividends as the franking credit can be used to offset other tax obligations. Unfranked dividends are tax exempt, as is income from the sale of shares in a PDF.

In common with most schemes which offer tax concessions, it is difficult to determine the cost of the PDF scheme. While data is readily available where assistance takes the form of direct expenditure on a program, data regarding the cost to revenue of tax concessions allowed in various schemes is much more difficult to obtain. Similarly, it is extremely difficult, if not impossible, to establish how much of the funds invested by PDFs would have been available had the tax concessions not been available. As a result, it is impossible to determine the benefits and cost of the PDF scheme by saying the scheme attracted X additional dollars for investment in eligible companies that would have not been available had Y dollars of tax concessions not been available.

Announced Changes

In the Coalition industry policy document Making Industry Stronger released prior to the October 1998 general election, the following changes to the PDF program were announced:

• Regulated superannuation funds, similar overseas pension funds and partnerships of such organisations would be able to wholly own a PDF.
• PDFs would be able to buy back their own shares and return capital to investors in specified circumstances (which were not specified in the document).
• PDFs would be able to make loans to companies in which they have an equity investment to a maximum of 20% of their capital base; and
• Mergers of PDFs would be allowed where there is no payment to investors other than as a 'genuine dividend'.

Further changes were announced in the 1999-2000 Budget. These changes are largely of an administrative nature and principally will increase the power of the Board to monitor and enforce compliance with the requirements of the Principal Act. The above measures are to have effect from 1 July 1999 and are estimated to cost $2 million in 2000-01, $3 million in 2001-02 and $5 million in 2002-03.⁽⁴⁾

On 4 August 1999 the Minister and the Treasurer jointly announced that the Principal Act would be amended to prevent PDFs from 'participating indirectly in investments that are not in keeping with the objectives of the PDF program.'⁽⁵⁾ Schemes to circumvent the investment restrictions worked by a PDF investing in an eligible investee company which in turn invested in an activity which was an excluded activity. In this way a PDF could obtain the tax concessions while avoiding the investment requirements through the use of an interposed investee company. The Treasurer and Minister announced that from 4 August 1999 investee companies would also be required to comply with the requirements of the Principal Act, so that if there is a chain of investments (ie an investee company makes a complying investment in another investment company which makes a complying investment in another investee company etc) the Board will be required to check each for compliance and may revoke a PDFs registration if an investment does not comply, no matter how far removed from the initial investment (see item 15 below). The restrictions are to apply only to investments made after 4 August 1999.

Main Provisions

It is currently a condition of registration that a PDF not reduce its share capital or buy shares in itself [paragraph 18(c)]. Item 6 of Schedule 1 of the Bill will insert a new paragraph 18(c) which will remove this restriction and substitute the condition that a PDF is not to reduce its share capital or buy shares in itself within 2 years of becoming a PDF or merging with another PDF.

The range of investments that a PDF may make will be expanded to include acquiring non-transferable options to buy shares and lending money to corporations. Such investments will be subject to the existing restrictions on investments, so that the PDF must acquire at least 10% of the share capital of any company in which it invests, including investments through the acquisition of non-transferable options or loans (item 7 which will amend section 19 of the Principal Act). The total loans made by a PDF must not exceed 20% of its capital (proposed section 20B).

Any amount paid for options that have yet to be exercised and any outstanding loan amounts are to be included with any amount outstanding for shares acquired when calculating the percentage of a PDFs capital that has been committed to an investee company (section 25 of the principal Act restricts investment in any one investee company to 30% of the capital of the PDF) (item 13).

Proposed section 27A will require a PDF to notify the Board as soon as practicable, or within 30 days, of an investment in a new company (item 14).

The tracing of investments and the requirement that investee companies comply with the investment rules applicable to a PDF is dealt with in proposed section 28A which provides that the Principal Act applies to PDF investments through interposed entities as if those investments were made by the PDF itself (item 15). (As noted above, this requirement will apply, and a PDF potentially liable to lose its tax concession status, even if a chain of investment companies are used and the PDF is unaware of the nature of the subsequent investments.)

Section 31 of the Principal Act imposes a general limit on individual investors from holding more than 30% of the issued shares in a PDF and then exempts approved deposit taking institution and life companies from this requirement. Items 17 and 18 will amend section 31 to provide that widely-held superannuation funds will also be exempt from the ownership restrictions.

Mergers of PDFs will be allowed by proposed section 32A which will be inserted into the Principal Act by item 20. The proposed section also provides that any consideration given to shareholders in the 'investee PDF' (ie the PDF in which shares are to be acquired by another PDF defined to be the investor PDF) may only consist of:

• Shares in the investor PDF, and/or
• A 'genuine dividend' payable from any undistributed profits of the investee PDF (the term 'genuine dividend' is not defined in the Bill, the Principal Act or Corporations Law. The distinction between a 'genuine dividend' and another sort of dividend is unclear).

Section 41 of the Principal Act requires PDFs to provide an annual report to the Board and lists the matters that must be covered by the report. Item 21 will require annual reports to contain details of the proportion of an investee company's capital held by the PDF at the end of the financial year and profits, gains or losses made by each investment in an investee company. The report will also be required to contain details of unregulated investments held at the end of the financial year and the profits, gains or losses resulting from unregulated investments during the year.

A Table in section 50 of the Principal Act lists the maximum fines applicable for breaches of various provisions of the Principal Act. Item 26 will substitute a new Table where the maximum fine is expressed in penalty units rather than monetary value. A penalty unit is currently $110 (section 4AA of the Crimes Act 1914) and the new penalties represent an increase of 10% over the current maximum penalties.

Endnotes

2. Pooled Development Fund Registration Board, Annual Reports 1997-98 and 1998-99.

3. ibid., p. 8.

4. Refer to Statement of Board Policy, Policy Paper No. 3 [November 1996] at Appendix F of the Board's 1998-99 Annual Report.

5. Budget Measures 1999-2000 (Budget Paper No. 2), p. 6.

6. Treasurer and Minister for Industry, Science and Resources, Joint Media Release, 4 August 1999.

Contact Officer and Copyright Details

Chris Field
25 January 2000
Bills Digest Service
Information and Research Services

This paper has been prepared for general distribution to Senators and Members of the Australian Parliament. While great care is taken to ensure that the paper is accurate and balanced, the paper is written using information publicly available at the time of production. The views expressed are those of the author and should not be attributed to the Information and Research Services (IRS). Advice on legislation or legal policy issues contained in this paper is provided for use in parliamentary debate and for related parliamentary purposes. This paper is not professional legal opinion. Readers are reminded that the paper is not an official parliamentary or Australian government document.

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ISSN 1328-8091
© Commonwealth of Australia 2000

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Published by the Department of the Parliamentary Library, 2000.

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