Bills Digest No. 168 2003-04
Tax Laws Amendment
(2004 Measures No. 3) Bill 2004
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
Concluding Comments
Endnotes
Contact Officer & Copyright Details
Passage History
Tax Laws Amendment (2004
Measures No. 3) Bill 2004
Date
Introduced: 27 May
2004
House: House of Representatives
Portfolio: Treasury
Commencement:
Sections 1 to 4 and
Schedule 1: the day the Act receives Royal Assent.
Schedule 2: 1 April
2004.
Schedule 3: the day
the Act receives Royal Assent.
To amend:
-
the Income Tax Assessment Act 1936 (ITAA 1936) and the
Income Tax Assessment Act 1997 (ITAA 1997) to allow an
investment in the holding company of a company or a group of
companies to qualify for the tax exemption if it satisfies certain
requirements
-
the Venture Capital Act 2002 to require the general
partner of a Venture Capital Limited Partnership (VCLP) or
Australian venture capital Fund-of-Funds (AFOF) and eligible
venture capital investor to include a statement in the annual
return as to whether the company met each ongoing eligibility
requirement at all times during the financial year
-
the Fringe Benefits Tax Assessment Act 1986 (FBTAA
1986) to extend the transitional arrangements for the fringe
benefits tax (FBT) exemption by one year beginning on 1 April 2004
for certain contributions to worker entitlement funds, and
-
the ITAA 1936 to make certain technical corrections to the
provisions that allow foreign tax credits.
As there is more than one them to the amendments in the three
Schedules in this Bill, the background to the various measures will
be discussed in the Main Provisions section.
In December 2002, the Parliament enacted legislation to extend
the scope of the tax exemption for venture capital investments. The
object of the legislation was to improve incentives for foreign
investment in the Australian venture capital industry and encourage
the relocation of international venture capital managers to
Australia.
The key features of the legislation were set out in Bills
Digest No. 77 2002-03 and can be summarised as follows:
-
flow-through tax treatment for certain types of limited
partnerships, that is Venture Capital Limited Partnerships (VCLPs),
Australian venture capital Fund-of-Funds (AFOFs) and Venture
Capital Management Partnerships (VCMPs). This enables partners in a
VCLP, AFOF and VCMP to be taxed at the partner level on gains and
losses of the partnership, and brings Australia into line with
international jurisdictions
-
tax exemption on the share of profit or loss made on the
disposal of certain investments for eligible investors. This allows
certain overseas investors including tax-exempt entities such
pension funds to exit from a venture capital investment without
incurring a capital gains tax liability, and
-
taxation of venture capital manager s carried interest as a
capital gain. If the venture capital manger is an individual, and
the partnership agreement under which the carried interest arises
was entered into at least 12 months before the disposal, then a
discount capital gain applies to tax only 50 per cent of the
capital gain.
The Australian Venture Capital Association Limited (AVCAL)
estimates that the new tax changes will attract an additional $1
billion in foreign venture capital investment into Australia over
the next five years.(1) In 2002, Australia attracted 24
per cent of private equity invested in the Asia-Pacific
region.(2)
The first Australian managed VCLPs under the new tax changes
were granted conditional registration by the Pool Development Funds
(PDF) Board in May 2003.(3) The conditional
registrations totalled $575 million in new venture capital:
|
Name of Fund
|
Capital Sought
|
Investment Stage
|
|
Macquarie Investment Partners IV, LP
|
$300 million
|
Expansion and later
|
|
Starfish Technology Fund I, LP
|
$80 - $100 million
|
Technology
|
|
Deutsche Private Equity Fund II, LP
|
$175 million
|
Expansion and later
|
The first foreign managed limited partnership, in this case an
AFOF, was registered with PDF Board in 2004 and the amount invested
is reported to be close to $250 million. However, the market has
drawn attention to structural and administrative hurdles preventing
overseas managed funds from seeking registration:
The VCLP regime, whilst offering significant tax
benefits, has not to date proved to be attractive to foreign
managed funds due to the complexity of the rules on the one hand,
and the lack of market experience by those administering the regime
on the other. The potential for Australian taxation of foreign
manager s carry has also acted as a disincentive to registration.
Accordingly, while registration offers certainty that qualifying
investments will not be subjected to Australian capital gains tax,
structural and administrative hurdles have to date prevented funds
from seeking registration.(4)
The tax exemptions were originally only granted to certain
eligible non-residents on the gains made on eligible venture
capital investments. The amendments in Schedule 1
extend the tax exemption to eligible investments made in a holding
company of a corporate group as announced by the Minister for
Revenue and Assistant Treasurer in
Press Release No. C027/04 of 6 May 2004.
The rationale for the extension of the tax exemption is given in
the
Explanatory Memorandum to the Bill:
1.7 The existing law provides than an eligible
venture capital investment can only be made into a company whose
total assets, together with those of any connected entities, are
valued at not more than $250 million immediately before the
investment is made. The effect of this test (the permitted entity
value test) is that where a company is being disposed of by a
corporate group or institution whose assets are valued at more than
$250 million, the investment is not eligible for the exemption.
This is the case even if the company will not be connected to the
group after the investment has been made and the value of its
assets, together with that of the entities that will continue to be
connected after the investment is made, will not be more than $250
million.
1.8 The amendments will allow an eligible
investment to be made into a company if the value of its assets and
those of its connected entities, but excluding entities that will
not be connected after the investment is made, is not more than
$250 million. Integrity rules will ensure that treating each
investee company as an independent entity will not allow otherwise
ineligible investments in companies that are members of a large
corporate group to qualify for the exemption by splitting into
smaller entities.(5)
The amendments in the Bill impose numerous conditions to obtain
the favourable tax treatment including the 'predominant activity'
test that will be determined by the Pool Development Funds (PDF)
Board. The amendments also impose reporting obligations in respect
of the ongoing eligibility requirements for an eligible venture
capital investment. The amendments will take effect from 1 July
2002, the date the venture capital tax changes came into operation
(Part 3 of Schedule 1).
The amendments to the Venture Capital Act 2002 will
require the general partner of a venture capital investment and
eligible investor to include, among other things, in reports to the
PDF Board, a statement as to whether the company met each ongoing
requirement at all times during the financial year.
The significant amendments in Schedule 1 are
considered below.
Subdivision 118-F of the ITAA 1997 deals with the capital gains
exemptions for venture capital and section 118-425 provides a
meaning of venture capital investment.
Proposed subsection 118-425 (11) to be inserted
into section 118-425 of the ITAA 1997 by item 11
of Schedule 1 provides that an acquisition of
shares or options by a VCLP, AFOF or eligible investor in a company
that is formed solely for the purpose of investing in another
company, including the holding company of a group, will be an
eligible venture capital investment if:
- within 6 months of the investment being made the holding
company uses the money to acquire shares or options in the other
company, or to pay administrative expenses associated with the
investment in the other company, or provides loans to the other
company, and
- the company in which the new holding company invests meets the
requirements to be an eligible venture capital investment within
that 6 month period and after the end of that period.
Item 7 of Schedule 1 repeals
subsection 118-425(3) which deals with primary activity and
substitutes proposed subsection 118-425(3) which
provides a predominant activity test.
Proposed subsection 118-425(3) provides that a
company satisfies the predominant activity test if it satisfies at
least 2 of the following requirements:
-
more than 75 per cent of its assets are used primarily in
activities that are not ineligible activities
-
more than 75 percent of its employees are engaged primarily in
activities that are not ineligible activities
-
more than 75 per cent of its total assessable income is derived
from activities that are not ineligible activities.
As mentioned above one of the requirements in proposed
subsection 118-525(3) is that more than 75 per cent of the
activities of the company or group must not relate to ineligible
activities. Proposed subsection 118-425 (13) lists
these ineligible activities which include property development or
land ownership, finance, insurance, construction and investments
generating interest, dividends, royalties or lease payments.
The amendments to the ITAA 1997 contained in Part
1 of Schedule 1 of the Bill impose a
number of ongoing eligibility requirements for an investment to be
eligible for the tax exemption. These ongoing requirements are the
predominant activity test (proposed subsection
118-425(3)), the restriction on investing in other
companies (subsection
118-425(4)), the company s auditors to be
registered (proposed subsection 118-425(5)), and
the requirement of a company into which a holding company was
formed to invest to meet the eligibility requirements
(proposed paragraph 118-425(11) (d)).
Amendments proposed to the Venture Capital Act 2002 in
Part 2 of Schedule 1 will require information
relating to ongoing eligibility requirements to be included in
reports to PDF Board. This will include a statement in the annual
return as to whether the company met each ongoing eligibility
requirement at all times during the financial year.
Schedule 2
Worker entitlement funds FBT exemption
Worker entitlement funds are funds which provide for employee
entitlements such as leave payments or payments when an employee
ceases employment. From 1 April 2003, certain contributions to
approved worker entitlement funds are exempt from FBT under section
58PA of the FBTAA 1986. The exemption was designed to ensure that
these contributions are not taxed twice, once as a fringe benefit
when paid into the fund and again as income when paid out of the
fund.
As a transitional arrangement, the
FBT exemption also applied to certain contributions made to
existing worker entitlement funds during the FBT year beginning on
1 April 2003. A fund is an existing worker entitlement fund if it
accepted contributions during the FBT year beginning on 1 April
2002 for the purposes of meeting obligations in relation to leave
payments or payments when an employee ceases employment.
On 1 April 2004 the Minister for
Revenue and Assistant Treasurer announced in
Press Release No. C019/04 that employers will have until 31
March 2005 to comply with the FBT exemption for payments made into
worker entitlement funds. The Minister added that the one year
extension to transitional arrangements is intended to address
concerns that the emerging interpretation of the law would deny
many employers access to the FBT exemption.
Item 2 of Schedule 2 extends
the FBT exemption to contributions made to an existing worker
entitlement fund or an approved worker entitlement fund during the
FBT year beginning on 1 April 2003 or 1 April 2004.
Schedule 3
Technical corrections to foreign tax credit
provisions
Division 18 of the ITAA 1936 deals with credits in respect of
foreign tax. Schedule 3 to the bill contains minor
amendments to sections 160AFCD and 160 AFCJ of Division 18 to
ensure that provisions for allowing foreign tax credits to arise in
particular circumstances will continue to operate properly
following changes to the foreign tax credit provisions that were
made as a result of the Timor Sea Treaty.
The Australian venture capital industry is supportive of the
amendments in the Bill to extend the tax exemption. The Chief
Executive of AVCAL has stated that the Bill represents the
culmination of 18 months negotiation with the Commonwealth
Government to encourage new foreign venture capital investment and
to further develop the venture capital industry.(6)
-
Australian Venture Capital Journal, 'Parliament Passes VCLP
Bills',
February 2003 Year 12 No 117, p. 15.
-
See Axiss Australia,
Venture Capital and Private Equity in Australia, Data File
Series 2004.
-
See Australian Venture Capital Association Limited, Press
Release, 'Venture
Capital Limited Partnerships off to a flying start', 8 May
2003.
-
Australian Venture Capital Journal, 'Offshore investor comes in
with Australian Venture Capital Fund of Funds', May
2004 Year 13 No 131, p. 15.
-
Explanatory Memorandum, Tax Laws Amendment (2004
Measures No. 3) Bill 2004, p. 6.
-
Australian Venture Capital Association Limited,
News Letter, 27 May 2004.
Michael Priestley and Bernard Pulle
21 June 2004
Bills Digest Service
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ISSN 1328-8091
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