Implications from the Venture Capital Tax Concessions Review

In July 2021 the Treasury Department of the federal government released the Terms of Reference for the Venture Capital Tax Concessions Review.

The purpose of this review is indicated on the relevant Treasury webpage, https://iisa-consult.industry.gov.au/vc-review. “As part of the 2016 National Innovation and Science Agenda, the Government implemented reforms to enhance the concessional treatment of the Early-Stage Venture Capital Limited Partnership (ESVCLP) program to target this concession towards ventures at the early stages of the lifecycle of a developing start-up. Five years on, now is the appropriate time to evaluate the impact of these tax concessions.”

As such it seems the target is ESVCLPs, which is reasonable given it offers the largest tax concessions, and the impetus is a five-year check-up.

Nothing in the supporting release material gives any indication of an interest or intent to dismantle or reduce the benefits of the ESVCLP program.  Rather, it seems from the opening statement on the Treasury site “The venture capital sector is a strong part of the Australian economy. Recent trends demonstrate a growing Australian venture capital industry with a record $1.3 billion raised in 2020, compared to $200 million in 2013” that the federal government are going to claim that the ESVCLP program has been responsible for this growth.  This ignores the fact that venture capital investment is cyclical and is in a very upside of investment globally.

The Terms of Reference direct a lot of questions to the issue of foreign investment and investors.  It is reasonable to want to attract foreign investment capital.  Nothing in the legislation or this review limits the ability for domestic investors to enjoy the tax concessions.

The review called on submissions until September 2021 with the intent to deliver the report to the Treasurer by the end of 2021.  At the date of writing, 9^th March 2022, there is no indication that the report has been delivered.

Submissions

Nineteen submissions were received:

1. Anonymous
2. Crowd Funding Institute of Australia
3. The Tax Institute
4. Australian Investment Council
5. KPMG Australia
6. David McKeague
7. Square Peg
8. Anonymous
9. Gilbert + Tobin
10. Seed Space Venture Capital
11. Tech Council of Australia
12. Charlie Day and Michael Molinari
13. Brandon Capital Partners
14. Ernst & Young
15. Sydney Angels
16. Blackbird
17. FinTech Australia
18. Jelix Ventures
19. Tidal Ventures Group

Two are confidential and not publicly available, 13 are from the venture capital industry, 4 from industry associations.

I have assumed that the venture capital companies will praise the current system in an effort to avoid the government reducing the tax concessions and as such paid little attention to their submissions.  Of greatest interest are the negative submissions that may recommend either the reduction or dismantling of tax concessions, however, in the absence of the two confidential submissions, there do not appear to be any.  The key submissions are reviewed below.

The Tax Institute

The Tax Institute is of the view that the programs have had a positive impact on the growth of Australian venture capital and have played a significant part in creating a vibrant start-up environment in Australia.  The substantial impact of the programs on the Australian market could not have been anticipated at the time of their inception.

We recommend that IISA and Treasury continue to work together alongside industry stakeholders and take a more holistic approach in creating a favourable environment for the venture capital sector to thrive.  This will ensure that the economy and community may benefit from increased levels of innovation and economic activity.

Australian Investment Council

What was AVCAL (Australian Private Equity and Venture Capital Association Limited), as such their submission is self-congratulatory while also strongly in support of the current concessions.

It does include the following interesting detail:

EY Modelling 9 The programs have contributed a significant share of investments in the Australian venture capital sector. EY’s modelling found in 2014/2015 33% of VC investment by value was registered under the ESVCLP and VCLP programs compared to 80% in 2018/2019.

The number of annual VC investments is growing. 256 investments have been made through the VCLP and ESCVLP programs since 2014/2015, 112 in ESVCLP and 144 in VCLP.

In my opinion this data demonstrates that the program has been underutilised for genuine early-stage investment with only 112 ESVCLP investments in a six-year period.

There are no recommendations to reduce or increase the tax concessions.

Day & Molinari

This is a private submission that seeks to have the ESIC scheme aligned into the ESVCLP program, but as the submission itself points out, this is outside the scope of this review.  I doubt this submission will be viewed seriously or the recommendation followed.

Sydney Angels

Effectively another venture capital manager but with a model that ties to the angel investor network it operates.  There focus is on very small venture capital funds (as they are) and calls for lowering the minimum requirements to open the field to more very small managers.

Ernst & Young

From my review this is the most impactful of submissions with real calls for adjustment and action, though not the reduction or dismantling of the tax concessions.

EY supports the VCLP, ESVCLP and AFOF programs and the positive impacts on increasing investment into the ecosystem which the incentives are intended to achieve. While the VC landscape has benefited greatly from these programs, improvements and clarity to the programs are needed to address uncertainty with elements of how the rules are drafted and administrated.

The regimes have facilitated increased investment into early stage and expansion stage venture capital businesses in Australia as demonstrated by the following:

• The expansion of the number of registered ESVCLPs, VCLPs, committed capital and the proportion of capital coming from international investors.
• The primary source of capital is now international institutional investors.

The ESVCLP regime overall has the right design features to facilitate domestic and foreign investment into venture capital and develop skilled venture capital managers.

The main complaint in this submission is directly pointed at the regulator, IISA.

On numerous occasions, members of the private capital industry have sought clarification on a list of outstanding issues / matters, and we are yet to have any traction or receive a response on such matters.

Further, the administration of these programs needs to be efficient and consistent.

• We have seen a number of cases where fund documents that have been previously accepted by the IISA and used for a second or third fundraise have been questioned and required to be amended. This causes a lot of uncertainty and angst amongst fund managers especially where the investors in the second fund were the same as the original fund – this creates a view that the Australian tax landscape is uncertain and can detract foreign investment.
• The Fintech amendments, while on the face of the law and the explanatory memorandum is clear, we have seen instances where the IISA has taken a different view which has caused issues for our clients and the industry more broadly. Once an investment is made (upon receiving appropriate legal and or tax advice), it is not an easy process to transfer the ‘non-compliant’ investment into another vehicle without adverse consequences including an impact on reputation with investors.
• Recently foreign investors have raised concerns that the public can have access to information relating to the investors in a limited partnership. Whilst this is a state registration issue, many foreign investors are institutional investors who are wary of such information being made public and/or linked to an investee company. This is another example of how the administration of these programs do not reflect market standard and may affect the levels of investment into the ecosystem.

Conclusion

Not one viewable submission was negative towards ESVCLPs or called for the reduction or dismantling of those programs, or for any consequential structure changes.

It is worth remembering that the ESVCLP program is currently only utilised under the traditional VC model, i.e., only open to institutional, corporate investors and extremely high net wealth individuals and under the standard fee structure of 2% management fees and 20% carried interest fees.  This standard carried interest fee means that the majority of tax exemption benefit is consumed in those fees.  Furthermore, the investments under existing ESVCLPs are likely to be highly speculative, rarely pay dividends and still in the pre-exit stage of investment.

As such, it is likely that the actual tax revenue impact of the ESVCLP program has been negligible at best to date.

Furthermore, as highlighted by Ernst & Young the majority of ESVCLP investment and investors are foreign, a major government focus.

Government policy around innovation, SMEs and economic development indicate that it would be detrimental to those policies to dismantle or reduce ESVCLP tax concessions.

On this basis it appears highly unlikely that the review will recommend the dismantling or reduction of ESVCLP tax concessions, or any consequential structure changes.

As such, the implication for Purpose Driven Capital funds is positive as the conclusion of this review is likely to mean that there will be no political will to review the ESVCLP tax concessions for another five years, as per our prior expectations.