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SAVCA

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  • 1. AVCA 2005 Conference 6 November – 9 November 2005 Southern African Venture Capital & Private Equity Association 33 Scott Street Waverley, Johannesburg PO Box 1140 Houghton 2041 Tel: +27-11-885-2666 Fax: +27-11-8853640 www.savca.co.za
  • 2. Contents of tax paper submitted to Revenue Authorities <ul><li>Background to Private Equity Industry </li></ul><ul><li>Economic impact of PE on the local economy </li></ul><ul><li>Tax analysis: </li></ul><ul><ul><li>Case law </li></ul></ul><ul><ul><li>Tax treatment of other comparable industries </li></ul></ul><ul><ul><li>International benchmarking </li></ul></ul><ul><li>PE impact on BEE facilitation </li></ul>
  • 3. Background to Private Equity Tax debate <ul><li>Recognised globally for its significant positive contribution to the development of national and regional economies, in both developed and developing countries </li></ul><ul><li>Contribution takes many forms; enterprise creation, development, job creation, new technologies, new forms of competitive advantages and increases in taxation revenues </li></ul><ul><li>Attractor for foreign direct investment, a key component of capital formation </li></ul><ul><li>Asset class receives small allocation of total institutional allocation </li></ul><ul><li>Taxation of gains on PE investments as revenue would have a major Impact on the decision of investors to commit capital to private equity funds, rather than to other competing asset classes </li></ul><ul><li>The very existence of the industry would be in question should all realisation gains be deemed of a revenue nature </li></ul><ul><li>Clarity and consistency of treatment, in a manner that promotes the sustainable growth and development of the private equity industry, to the net benefit of all stakeholders </li></ul>
  • 4. Business case for a capital basis of taxation for PE realisation <ul><li>Is a positive and significant contributor to local economies as indicated by its role in: </li></ul><ul><ul><li>Developing new enterprises </li></ul></ul><ul><ul><li>Improving the performance of established enterprises </li></ul></ul><ul><ul><li>Supporting existing jobs and maintaining the employment base of the economy </li></ul></ul><ul><ul><li>Developing and commercialising new technologies </li></ul></ul><ul><ul><li>Increasing the economy’s revenue base in terms of the sales of products and services </li></ul></ul><ul><ul><li>Increasing the economy’s foreign exchange earnings by increasing exports from investee companies </li></ul></ul><ul><ul><li>Increasing efficiencies in the management of production assets and the use of business resources </li></ul></ul><ul><ul><li>Attracting new investment into the economy by both local and international investors </li></ul></ul><ul><ul><li>Supporting the tax revenue base of the economy on a sustainable basis </li></ul></ul>
  • 5. Economic impact of the private equity industry <ul><li>“ Contribution of the private equity industry to the national economy is linked to a supportive regulatory and tax environment” </li></ul><ul><li>Findings from economic impact studies conducted in the US and the UK </li></ul><ul><li>‘ The Economic Impact of the Private Equity and Venture Capital in the UK’ </li></ul><ul><li>‘ Venture Impact 2004 – Venture Capital Benefits to the US Economy’ </li></ul>
  • 6. Economic impact of the private equity industry <ul><li>The key findings from the 2003 UK study are as follows: </li></ul><ul><li>‘ Private equity backed companies create jobs at a considerably faster rate than other private sector companies’ </li></ul><ul><li>‘ Private equity backed companies boost the UK economy’ </li></ul><ul><li>’ 81% of companies said that without private equity the business would not have existed at all or would have developed less rapidly’ </li></ul><ul><li>‘ Over three quarters of the companies felt that their private equity firms had made a major contribution other than the provision of money’ </li></ul><ul><li>‘ Nearly half the firms said that with private equity backing their level of investment was higher than would have been possible’ </li></ul><ul><li>‘ Private equity backed companies generate total sales of £177 billion and contribute around £26.6 billion in taxes’ </li></ul>
  • 7. Economic impact of the private equity industry <ul><li>Some of the key quantitative findings from the UK study indicated that, ‘over the five-year period from 1997/8 to 2002/3, venture backed companies have achieved: </li></ul><ul><li>‘ Average turnover growth of 21% per annum, and PBT growth of 26% per annum’ </li></ul><ul><li>Average growth of 11% per annum in value of exports, compared with 3.3% nationally’ </li></ul><ul><li>An average annual rate of growth equal to 27% for R&D expenditure and 19% for UK employment; employment growth nationally currently stands at 0.5% per annum’ </li></ul><ul><li>Levels for corporate investment in venture-backed businesses of 21% versus the comparable figure for the UK economy as a whole (gross fixed capital formation) pf 5.4%’ </li></ul><ul><li>‘ private equity backed companies provided a substantial impetus to the economic performance and global competitiveness of the UK’ </li></ul>
  • 8. Economic impact of the private equity industry <ul><li>The key findings from the 2004 US study were as follows: </li></ul><ul><li>‘ Venture capital back companies employed more than 10 million American workers and generated $1.8 trillion in sales in 2003’ </li></ul><ul><li>‘ Venture capital backed companies outperformed their nonventured counterparts in job creation and sales growth between 2000 and 2003. Employment in venture backed companies jumped 6.5%, while national private sector employment shrank by 2.3%. Venture backed company sales grew by nearly 12%, compared to a n overall rise in US company sales of 6.5%’ </li></ul><ul><li>Venture backed ‘breeder’ industries with a heavy emphasis on research and development, like biotechnology and healthcare products, have made great employment gains since 2000’ </li></ul><ul><li>‘ Venture backed firms are the national leaders in R&D . The mix of US R&D is shifting toward smaller firms in the leading-edge biotechnology, medical research, and high-technology industries’ </li></ul>
  • 9. Economic impact of the private equity industry <ul><li>SAVCA, together with Monitor conducted a pilot study into the economic impact of PE on the SA economy </li></ul><ul><li>Qualitative output suggests findings similar to those in the UK & US </li></ul><ul><li>For many investees Private equity (PE) was the only funding option </li></ul><ul><li>PE enabled higher gearing and therefore the introduction of significant management / BEE stakes </li></ul><ul><li>Increased R&D facilitated greater product development </li></ul><ul><li>Improved managerial effectiveness </li></ul>
  • 10. Tax, legal and regulatory analysis <ul><li>Scope </li></ul><ul><li>excluded the taxation of fund managers and/or general partners </li></ul><ul><li>Capital vs. Revenue </li></ul><ul><li>Taxpayer is engaged in a scheme of profit-making </li></ul><ul><li>The intention of the purchaser of the property in acquiring the property </li></ul><ul><li>Whether or not the property (including shares) in question may be considered to be the stock-in-trade of the taxpayer </li></ul><ul><li>The presumption of an intention towards long term investment may be argued in the case of investors, who are contractually committed to an investment period between 3 and 7 years </li></ul><ul><li>Investment participation of the fund manager is seen as that of a limited partner in the fund and therefore has no different status as that of any limited partner </li></ul>
  • 11. Tax, legal and regulatory analysis <ul><li>Income tax treatment of private equity funds and comparable industries </li></ul><ul><li>Collective investment schemes include unit trusts </li></ul><ul><ul><li>Any gain or loss realised by the CIS is not taxed </li></ul></ul><ul><ul><li>The tax event is only triggered when the investor realises his/her investment in the CIS in securities </li></ul></ul><ul><li>Long term insurers - capital nature </li></ul><ul><li>Pension funds are not subject to income tax or capital gains tax </li></ul><ul><li>Most private equity funds are fiscally transparent entities </li></ul><ul><li>The realisation proceeds generated by the fund accrue directly to the investors </li></ul><ul><li>If the intention of the investors was relevant, the fact that the investors in a private equity fund have no choice but to be passive investors, would mean that the nature of the proceeds would not be of a speculative nature, i.e. capital nature </li></ul><ul><li>No clear practice of the SARS in the case of private equity funds </li></ul><ul><li>Lack of a level playing field for investors in private equity </li></ul><ul><li>It is suggested to treat the private equity industry in a similar manner to CIS in securities </li></ul>
  • 12. Tax, legal and regulatory analysis <ul><li>International benchmarking on the taxation of the private equity industry </li></ul><ul><li>Developed countries </li></ul><ul><ul><li>USA (Deloitte) </li></ul></ul><ul><ul><li>UK (SHG) </li></ul></ul><ul><ul><li>Australia (SHG) </li></ul></ul><ul><ul><li>Germany (SHG) </li></ul></ul><ul><li>Developing countries </li></ul><ul><ul><li>Chile (Deloitte) </li></ul></ul><ul><ul><li>India (Deloitte) </li></ul></ul><ul><li>In all countries, the profits from the disposal of shares in private equity benefited from tax concessions. In general, such gains are treated as capital gains after a holding period which varies from 12 months to three years </li></ul><ul><li>In each country considered, the tax regimes are dependent on the holding period of the investment </li></ul>
  • 13. Tax, legal and regulatory analysis <ul><li>International benchmarking on the taxation of the private equity industry </li></ul><ul><li>Tax concessions to private equity granted on the basis that it is beneficial for the economy to stimulate economic activity at the smaller company level </li></ul><ul><li>Chile and India, a minimum holding period of one year qualifies the proceeds as being of a capital nature </li></ul><ul><li>United States of America allows the taxpayer to exclude 50% of the capital gain from CGT where the unlisted share has been held for a minim period of five years </li></ul><ul><li>The Deloitte study concluded greater clarity and certainty is imperative for businesses and investment to be attracted </li></ul>
  • 14. Tax, legal and regulatory analysis <ul><li>International benchmarking on the taxation of the private equity industry </li></ul><ul><li>‘ international best practice’ with respect to the taxation of investors in private equity funds would include the following key principals: </li></ul><ul><ul><li>Government recognition of the importance of the private equity industry to national economic development </li></ul></ul><ul><ul><li>Clarity of tax policies applicable to the private equity industry, in particular certainty as to when the gains would be capital or revenue in nature </li></ul></ul><ul><ul><li>Taxation of investors in private equity funds (and unlisted investments more generally) in a manner that encourages, rather than that deters, investment into the industry </li></ul></ul>
  • 15. Contributors to the report <ul><li>These organisational contributors, and their areas of contribution, are as follows: </li></ul><ul><li>Contributors to the analysis on the economic impact of the private equity industry (Section 4) </li></ul><ul><ul><li>Monitor Company (project sponsor) – represented by Christoph Andrykowsky </li></ul></ul><ul><ul><li>Graduate School of Business (GSB) at the University of Cape Town (project sponsor) – represented by Evan Gilbert </li></ul></ul><ul><ul><li>Business Partners Limited – represented by Ben Bierman </li></ul></ul><ul><li>Contributors to the tax, legal and regulatory analysis (Section 5) </li></ul><ul><ul><li>Sonnenberg Hoffman & Galombik (project sponsor) – represented by Ana-Celia Mendes, Wally Horak, and Alwina Brand </li></ul></ul><ul><ul><li>Deloitte and Touche (SAVCA sponsor) – represented by Nithia Naliah </li></ul></ul><ul><li>Contributors to the analysis on the BEE impact of the private equity industry (Section 6) </li></ul><ul><ul><li>Business Map Foundation – represented by Karen Heese </li></ul></ul><ul><li>SAVCA wishes to express its appreciation to these organisations, most of whom have assisted the association free of charge on a sponsorship basis, as indicated above. </li></ul>

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