Regulatory Landscape for the Purpose Driven Capital funds
This document aims to address the key compliance elements with respect to the regulatory landscape that Purpose Driven Capital will operate.
Purpose Driven Capital’s (PDC’s) new fund, the Sustainable Enterprise Fund, is a tax incentivised investment scheme operating under the Federal Government’s Venture Capital (VC) program as an Early-Stage Venture Capital Limited Partnership (ESVCLP).
Those businesses utilising the Federal Government’s Venture Capital program of tax incentivised investment schemes are jointly administered in Australia by the Department of Industry, Science, Energy and Resources and the Australian Taxation Office (ATO). It is the role of the Innovation Investment Committee (IIC) to administer the various venture capital programs including registration, compliance and interpretations of provisions in the relevant Acts.
The Australian Treasury and Industry Innovation and Science Australia (IISA) also play an important role in monitoring the industry. IISA is an independent statutory board that advise the Australian Government on innovation, research and science.
Meeting Both the Letter and the Spirit of the ESVCLP Program
ESVCLPs have the advantage that their compliant investments are tax exempt for both income and capital gains tax for up to 15 years.
PDC’s funds will operate an enhanced model that differs in certain respects to traditional venture capital funds. This model has the potential to attract a much broader range of early-stage investors and investments to the ESVCLP investment program benefits and because the PDC funds will be the only funds of their kind offering tax exemption to those investors. Accordingly, they have the potential to attract significant investment inflows.
The PDC funds, like all ESVCLP funds, will be Government registered tax Incentivised vehicles. A thorough review is warranted to ensure the enhanced model is watertight with regards to regulatory compliance and not at risk of having tax benefits denied.
Accordingly, both the letter and the spirit of the law need to be met.
Letter of the Law
Most ‘tax avoidance’ schemes operate by making interpretations of vague taxation legislation to create means of circumventing taxation requirements, or spurious claims to entitlements within taxation legislation. They do not operate under specific legislation, nor require Government registration to operate.
ESVCLPs are Government tax incentivised investment schemes that must be registered and then operate under specific legislation solely for this purpose.
PDC’s funds will be registered ESVCLPs, although operating in an enhanced model to other traditional venture capital fund managers, they will at all times act within the bounds of the ESVCLP legislation. The Sustainable Enterprise Fund has gone through a rigorous registration process with IISA which included review and assessment of all documentation and representations of the fund, including this website.
The VC-As-A-Service model of funds is not the first iteration of our enhanced model. The first iteration was questioned by the regulator (see ‘Indirect Regulatory & Judicial Interpretation of Spirit’ below) and went through judicial review, exposing any weakness or flaw.
Incorporating everything learned through this legal process the second iteration was created. To ensure the model of funds were strictly in adherence with the legislation, legal opinion and advice was sought from one of Australia’s leading tax barristers, Mr Lister Harrison KC, after which, two funds under this model went through the fund licensing and registration process with the regulator[2].
Spirit of the Law
It is not always enough that a matter meets the letter of the law. When in dispute it is often important to assess if the matter, dealings or transaction were also within the spirit or intended purpose of the law. For example, in taxation there is Part IVA: the general anti-avoidance rule for income tax (ITAA 1936), which has broad powers to undo a transaction that essentially is not within the ‘spirit of the law’.
Spirit of the law, for the VC Program, can be determined directly from the stated objectives for creating the program and indirectly from the terms, structure and form of the legislation.
Indirect Regulatory & Judicial Interpretation of Spirit
This indirect interpretation of the spirit of the law is first made by the regulator. The regulator is staffed by public servants that often have no commercial, legal, or industry background. They are known to act as gatekeepers so deem anything that appears non-standard to be inappropriate or view with suspicion interpretations or innovations that are even marginally different to their own interpretations.
Ultimately the interpretation of the legal spirit must be made by the judiciary and in the instance of regulatory compliance, by the Administrative Appeals Tribunal (AAT).
When we first introduced the enhanced model of ESVCLP we encountered precisely this issue with the regulator. The presiding AAT Deputy President in considering the spirit of the law did two things:
- Assessed if our fund would meet the objectives of the program (see ‘Program Objectives’ outlined below);
- Assessed if our fund was strictly in accord with the legislation (see ‘Letter of the Law’ above).
It is because of our unique experience in this process that we are capable of avoiding or managing any potential impediments – in a timely manner.
Program Objectives
The objectives of the Venture Capital Limited Partnership (VCLP), Early-Stage Venture Capital Limited Partnership (ESVCLP) and Australian Fund of Funds (AFOF) programs, as articulated through explanatory memoranda, are outlined below. All three programs have two common objectives.
These common objectives are, to:
1) increase levels of venture capital investment in Australia, and
2) enhance the development of skills and experience of venture capital fund managers.[3][4]
However, the focus of each program differs. The primary focus of the VCLP program is to attract foreign investment to the Australian venture capital sector, while the ESVCLP program is focused on encouraging early-stage investments in start-ups and expanding enterprises with a view to commercialisation of the activity.
Additional broader program objectives have also been outlined in explanatory memoranda, including:
- Fostering a shift towards a culture of innovation and entrepreneurial risk-taking;
- Providing Australia with a world’s best practice investment vehicle for venture capital;
- Making finance more readily available and cheaper for high risk expanding businesses; and
- Improving funding for promising projects across the economy and in industries beyond the
- technology sector.[5]
Common Objectives
Increase levels of venture capital investment in Australia
The term ‘venture capital’ is one that people assume they know, yet, it is rarely defined concisely. The Australian Federal Government, in spite of having a venture capital program providing significant tax concessions to venture capital funds, does not provide a concise definition. Arguably, the lack of a concise definition is not an oversight, but rather, recognition that it is neither appropriate nor constructive to be too precise in the definition, in part because the definition needs to vary from circumstance to circumstance.
While not concise, the Federal Government does provide a lengthy, if indirect, definition of ‘venture capital’ where it matters to the Government, i.e. with regard to investment vehicles offering tax concessions such as the ESVCLP and VCLP programs (for our purposes we will focus on ESVCLP).
ESVCLPs are deemed to make venture capital investments, therefore, any compliant investment made by an ESVCLP must be a venture capital investment for the purpose of the definition applied in the memoranda determining the objectives. As such the definition is determined by combining the relevant legislation (Venture Capital Act 2002 [VC Act], Income Tax Assessment Act 1936 [ITAA36], and Income Tax Assessment Act 1997 [ITAA97]) to determine if an investment is compliant for an ESVCLP.
A simplified reinterpretation of this objective is: To increase the levels of compliant investment made by an ESVCLP in Australia.
PDC’s model aims to attract and channel a large portion of the direct early-stage investment market currently estimated at $2B per annum, to its ESVCLP model. Much of this market is not aware or cognisant of how it can meet the definitions of an early-stage venture capital investment. This will expand the investor and investment base thus contributing towards the achievement of the Federal Government’s program objective of ‘increasing levels of venture capital investment in Australia’. The
more successful PDC is in attracting investment to its funds, the more it fulfills the program objectives.
Enhance the development of skills and experience of venture capital fund managers
“Skills and experience” are not defined, but it is reasonable to assume it means, for the purpose of the ESVCLP program, ‘skills and experience relevant in the development and operation of an ESVCLP and in the investment selection and management of ESVCLP compliant investments’.
There is no useable definition of ‘venture capital fund managers’ but by extending the logic applied to the definition of ‘venture capital’ (above) and taking into account the legal structure required for an ESVCLP, a definition for the purpose of the ESVCLP program, and therefore these objectives, could be, ‘the General Partner/s (GP/s) of the Venture Capital Management Partnership (VCMP) which is/are the GP/s of the ESVCLP’.
As such the ESVCLP specific objective might be better stated as:
Enhance the development of skills and experience relevant in the development and operation of an ESVCLP and in the investment selection and management of ESVCLP compliant investments, of the General Partner/s (GP/s) of the Venture Capital Management Partnership (VCMP) which is/are the GP/s of the ESVCLP.
A GP of the VCMP may be one or more corporate or private individuals. In the case of PDC it is to be a single corporate entity, Purpose Driven Capital Pty Ltd. Thus the “skills and experience” must be those of the corporation, with those in turn being made up of those of the officers and staff of that corporation.
The quantum of “skills and experience” could be either as the number of GPs, whereby for a single corporate GP (as is our case) it is one fund manager, or more pragmatically on the number of persons at the GP level gaining the relevant “skills and experience”.
PDC’s model requires the management of its ESVCLPs to be similar to other fund managers. The development of PDC as a new fund manager means that “skills and experience” will be developed and enhanced inhouse as per any other fund manager, thus fulfilling the objective, at least to the same extent as any other fund manager.
PDC’s inhouse funds management requirements will be larger than most other fund managers in the industry when it raises $200M for each ESVCLP. The model takes this into account.
PDC’s model of engaging third party advice and expertise is not unusual. This includes making investment selection and management recommendations. However, PDC will engage a much broader range of advisers in the form of investors to perform investment analysis and make investment recommendations. This is likely to involve a much larger number of people at the GP level enhancing and developing the relevant “skills and experience”.
As such and in view of the potential for the VC-As-A-Service model to both raise much larger ESVCLP funds and as a result engage more GP level staff and advisers, it is highly likely that PDC will not only meet this objective but do so to a significantly greater extent than most other funds managers.
ESVCLP Focus: Encouraging early-stage investment in start-ups and expanding enterprises with a view to commercialisation of the activity
It appears reasonable to assume that because ‘encouraging early-stage investment in start-ups and expanding enterprises with a view to commercialisation of the activity’ is the focus objective of the ESVCLP program then any investment via an ESVCLP that meets all of the prescribed legislative requirements as to be a compliant investment must therefore be an early-stage investment in start-ups and expanding enterprises with a view to commercialisation of the activity.
As such, it stands to reason that in the event the VC-As-A-Service model encourages more ESVCLP compliant investment through its ESVCLP funds then it must be fulfilling this focus objective. Indeed, should the VC-As-A-Service model do so to a larger extent than its competitors it could be concluded that we better achieve this objective than other existing models.
Broader Program Objectives
The broader program objectives are largely Government level objectives to assist it in determining the structure of the program. Many do not directly apply to PDC as fund manager.
Fostering a shift towards a culture of innovation and entrepreneurial risk-taking
A Government level objective – fulfilling this objective would come, in part, from an increase in ESVCLP ‘venture capital’ investment (see above), and the greater PDC’s success in filling ESVCLP funds the greater its contribution towards the Government fulfilling its objective.
World’s best practice investment vehicle
This is a macro level objective for the Government itself and not something deliverable by the fund manager. However, it is worth noting that seeking ‘world’s best practice’ is a limiting statement saying they only want to be as good as the best, but not ahead of the rest.
The Government has selected the current ESVCLP structure as its ‘world’s best practice investment vehicle’ and PDC will be compliantly utilising that vehicle.
Making finance more readily available and cheaper for high risk expanding businesses
In this objective it is ‘finance’, with a much broader general meaning than ‘venture capital’ investment, to be more readily available and cheaper for high risk expanding businesses.
Interestingly, the restrictions to be compliant ESVCLP investments is not so restrictive as to be constrained to only meeting the generally understood narrower meaning of venture capital investment. They allow for a broader range of ‘finance’ capability to ‘expanding businesses’ and in the absence of a specific ESVCLP definition of ‘high risk’ but applying the more complex definition that if it meets the ESVCLP compliant investment requirements, it must also meet the definition of ‘high risk’. Our proposed line of mid-market corporate finance through equity will arguably meet this objective to a far greater extent than more traditional fund managers.
Improving funding for promising projects across the economy and in industries beyond the technology sector
The VC-As-A-Service model of compliantly making ESVCLP investment open to a larger percentage of the investment community is aimed at improving the amount and price of funding for Australian SMEs. Our Sustainable Enterprise Fund is intended to be as generic in nature and open to funding any promising project across the economy and in any complying industry, including all those beyond the technology sector, as permissible by the legislation.
The Sustainable Enterprise Fund does not have a technology sector focus.
Conclusion
The VC-As-A-Service model, enabling Self-Managed VC Funds has been reviewed and undergone legal scrutiny before being confirmed through Government registration.
It is because of this heightened past regulatory and legal scrutiny that the VC-As-A-Service model is so robust.
All of the objectives for the VC program and specific ESVCLP program are targets of what should be done, none are objectives of what should not be done.
As demonstrated above, nothing within the VC-As-A-Service model restricts or limits our ability to fulfill any of the common, focus or even broader program objectives, and in almost every one of these objectives the greater the VC-As-A-Service model’s success the greater our ability to meet these objectives in a manner surpassing many other fund managers.
[2] Elcano Sustainable Investments 1 & 2.
[3] Tax Laws Amendment (2007 Measures No. 2) Bill 2007 Explanatory Memorandum
[4] Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 Explanatory Memorandum
[5] Tax Laws Amendment (2007 Measures No. 2) Bill 2007 Explanatory Memorandum, Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 Explanatory Memorandum