As an investor, you may already be familiar with Early Stage Venture Capital Limited Partnership (ESVCLP) program. Under this kind of partnership, you receive tax deductions for investing in business’ that are at an early stage in their growth. To be recognised as an ESVCLP, your fund must be structured as a limited partnership and make eligible investments. This article explains what investments are eligible for this program and the tax concessions available to ESVCLPs that are investing in financial technology (fintech).
Tax Incentives for ESVCLPs
The ESVCLP program provides tax incentives for investing in early stage venture capital activities. The law treats ESVCLPs as “flow-through vehicles” for tax purposes. This means that the income of the ESVCLP is treated as the income of the investors.
Therefore, some tax incentives for limited partners of ESVCLPs include:
- having no tax liability on income or capital gains received from the ESVCLP; and
- receiving a non-refundable carry forward tax offset of up to 10% on eligible contributions.
Further, the ESVCLP will hold the general partners’ interests in a capital account rather than revenue account.
Tax incentives are available to ESVCLPs that make eligible venture capital investments (EVCIs). To qualify as having made EVCIs, the investee must satisfy at least two of the three following requirements:
- more than 75% of the assets of the investee are primarily used in activities that are eligible;
- more than 75% of the employees of the investee are primarily engaged in activities that are eligible; and
- more than 75% of the total income of the investee must come from eligible activities.
Ineligible activities include those that are:
- property development;
- land ownership;
- construction; or
- making investments directed at deriving passive income.
ESVCLPs can only invest in businesses which have assets of less than $50 million. It is also a requirement that at least 50% of the businesses’ assets and employees be located within Australia.
ESVCLPs and FinTech
Before now, there was an issue for ESVCLPs in circumstances where the investee was engaging in:
- the provision of capital to others; or
While this would not apply for all fintech start-ups, there was some uncertainty for businesses where it did apply.
In the past, the general rule was that an investee whose technology enabled others to engage in ineligible activities would not itself be considered to be engaging in ineligible activity. However, this was a grey area. There was no law to guide ESVCLPs in assessing whether a fintech startup was an EVCI.
This was especially difficult for ESVCLPs investing in fintech. This is because the eligibility requirements were ongoing.
Therefore, even if the investee met the eligibility requirement when the ESVCLP first made an investment, as the business evolves and ceases to be an EVCI, it may fail the test and be deregulated.
The New FinTech Laws
In March 2016, the government committed to encouraging investment in fintech firms by promising reforms so that the tax concessions available under the ESVCLP included fintech startups.
On 3 October 2018, these fintech reforms came into effect. This change in law ensures that tax concessions for ESVCLPs are available for investments in fintech businesses. The amendments are effective concerning investments made on or after 1 July 2018.
The fintech reforms provide greater certainty for ESVCLPs looking to assess whether a potential fintech investee is an EVCI. The changes ensure that an investee is not ineligible if it is:
- developing technology in relation to finance, insurance or making investments;
- undertaking activities that are necessary or incidental to the activity of developing this; or
- covered by a finding from Innovation and Science Australia that it is a substantially novel application of technology.
While these reforms provide greater certainty for ESVCLPs looking to invest in the fintech sector, they must be taken with caution. There is little guidance about what “developing technology” or a “substantially novel application of technology” mean. These reforms also do not solve the significant issue that the investee may cease to be an EVCI as the business evolves.
Therefore, partners to the ESVCLP should always monitor their investments to ensure that they continue to pass the EVCI test. The reforms directly invite ESVCLPs to invest in fintech, but partners must still closely consider whether the prospective investee is in danger of falling into the ineligible activity category. This could put pressure on partners to dispose of investments at a less than optimal time or in a less than optimal way.
ESVCLPs provide great tax incentives for investing in early stage venture capital activities. In the past, there were issues for ESVCLPs when the investee was engaging in fintech activities. However, recent reforms ensure that investees are not ineligible from ESVCLPs if they are:
- developing fintech;
- undertaking activities that are necessary or incidental to developing fintech; or
- undertaking a substantially novel application of technology.
If you have any more questions on the ESVCLP program, get in touch with LegalVision’s taxation lawyers on 1300 544 755 or fill out the form on this page.
Was this article helpful?
We appreciate your feedback – your submission has been successfully received.