Submission to Australian Financial Centre Forum
The Australian Private Equity & Venture Capital Association Ltd
Summary
Th...
Discussion
1. About AVCAL
The Australian Private Equity and Venture Capital Association (“AVCAL”) was established in 1992
...
section of the financial services sector. It is also estimated that PE-backed companies
           employ 1 out of 13 jobs...
Figure 1: Resident and non-resident commitments to Australian PE (Source: ABS, 2009)
                             $18
    ...
Specific barriers to Australia becoming a regional centre for PE and VC.

Taxation issues
The Board of Taxation is current...
investing. Such gains should be on capital account and statutory amendments should be
       introduced to confirm this.

...
Appendix 1 – taxation discussion (extract from AVCAL’s submission to the Board of
Taxation review)

1.       As has alread...
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Submission to Australian Financial Centre Forum

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Submission to Australian Financial Centre Forum

  1. 1. Submission to Australian Financial Centre Forum The Australian Private Equity & Venture Capital Association Ltd Summary The Australian Private Equity & Venture Capital Association Limited (AVCAL) is a national association which represents the private equity and venture capital industries. AVCAL's members comprise most of the active private equity and venture capital firms in Australia. These firms provide capital for early stage companies, later stage expansion capital, and capital for management buyouts of established companies. Around the world, private equity is an increasingly important tool in investment policy for pension funds, sovereign wealth funds and other institutional savings pools. Both Australian superannuation pools, which are increasingly seen by foreign countries as examples of global best practice, and their overseas equivalents, use private equity investment as an important element of their investment policy. Global allocations to private equity have steadily grown in the last decade. It is therefore important for Australian tax and regulatory policies to be conducive to embracing what is emerging as a major new force in standard institutional investment practice. Value of private equity Private equity (“PE”) and venture capital (“VC”) are important components of the financial services sector. In their own right they are a significant industry. However it is their investment into Australian companies across all sectors which is the most important aspect of their value to the Australian economy. VC investment enables tomorrow’s industries (primarily in the technology sectors such as biotech, cleantech and ICT) to establish themselves and grow into sustainable entities. Some of Australia’s largest technology companies, particularly those in the life sciences sector, would not be here today without VC funding. The jobs and tax revenues that companies such as Cochlear, ResMed and others bring to Australia are valuable. They are also the ‘smart’ future of Australian industry, capitalising on our intellectual property and growing highly profitable enterprises. PE investment provides much-needed finance to small-to-medium businesses looking to expand and also an exit opportunity for business owners approaching retirement. PE managers work actively with investee companies of all sizes to improve operational performance, leading to an increase in jobs and enterprise value. Recommendations 1. At the forefront of the changes which AVCAL urges you to consider in order to maximise Australia’s ability to attract capital for private equity and venture capital investments are changes to clarify the tax treatment of gains from PE and VC investing. Such gains should be on capital account and statutory amendments should be introduced to confirm this. 2. Establishment of a simple limited partnership vehicle (such as was recently introduced by New Zealand) to enable investment in PE and VC. 3. Removal of the FIF rules would also enhance Australia’s attractiveness as a destination for investment capital. The flow-on effects through the portfolio companies of employment growth and improved operational performance would be of undoubted benefit to Australia’s future. Yours sincerely Dr Katherine Woodthorpe Chief Executive Australian Private Equity & Venture Capital Association Limited Gateway Building,Level 4l, 1 Macquarie Place, Sydney NSW 2000 Telephone +61 02 8243 7000 ABN 84 056 885 708 www.avcal.com.au
  2. 2. Discussion 1. About AVCAL The Australian Private Equity and Venture Capital Association (“AVCAL”) was established in 1992 as a forum for participants in the private equity and venture capital industry. AVCAL is the central voice of the Australian industry and its membership includes almost all the domestic, regional and global private equity and venture capital firms active in Australia. 2. What is Private Equity? Private equity is investment typically in unquoted companies that are considered to have high growth potential, with the aim of building and improving them over a period of years and then exiting the investment at a higher value. Here, we use the term ‘private equity’ in its broadest sense to encompass both early-stage (venture capital) and later stage investments. Private equity investment is frequently categorised according to the stage of development of the company being invested in. Expansion and buy-out stage investments are often termed ‘private equity’ investment, whereas seed and early stage investments are termed ‘venture capital’ (“VC”) investment. Private equity (“PE”) involves: − equity investment typically over a 3 to 5 year investment period in unquoted companies considered to have significant growth potential; − active involvement by the investor in the governance and management of the investee business; and − consideration, at the time of investment, of the subsequent sale of the investment rather than its indefinite retention. 3. Value to the Australian economy 3.1. Benefiting Australian Businesses And Investors PE provides much-needed finance to small-to-medium businesses looking to expand and also an exit opportunity for business owners approaching retirement. This will be increasingly the case as an entire generation of family businesses stemming from the immigration boom of the 70s to 80s begins to look towards succession planning. PE managers work actively with investee companies to improve operational performance. A study of Australian private equity exits in 2007 found that:1 – Enterprise value in these firms grew by a CAGR of 21%: almost double that of public company benchmarks – EBITDA grew 2.5 times faster than public company benchmarks. The benefits of PE allocations are largely returned to Australian retirees. Although only about 1% of Australian superannuation is invested in PE, domestic superannuation funds accounted for over half of PE drawdowns in FY08. 3.2. Productivity PE is associated with productivity gains. An independent study commissioned in 2004 by AVCAL indicated that the labour productivity of private-equity backed firms increased over a period of two years by a total of 6.3% which was almost double the comparable national figure of 3.4%.2 PE is good for employment and professional development in the financial services sector. Besides the estimated 1,000-odd people employed directly by PE firms, the industry also generates substantial fees, employment and professional development in a significant 1 Source: Ernst and Young, How Do Private Equity Investors Create Value, 2008. Figures exclude two (positive) outliers. 2 Source: Meyrick and Associates, Labour Productivity Study, 2004. 2
  3. 3. section of the financial services sector. It is also estimated that PE-backed companies employ 1 out of 13 jobs in the Australian private sector. PE and VC are vital to the innovation framework and the technological enablers of Australia’s future competitiveness. An independent study commissioned by AVCAL in 2006 found that 72% of PE investee companies launched new products the previous year, compared to only 27% who did so in the year prior to the initial PE investment.3 PE plays an important role in investing in and regenerating those companies which otherwise would continue to be starved of financial/management capital. The vast majority of PE deals involve the acquisition of unwanted or non-core assets. This is irrespective of whether the assets are acquired from public or private companies. An excellent example is Bradken Ltd, acquired by CHAMP Private Equity from ANI Ltd where it was an under-resourced division. Following three years of ownership, restructuring and growth it was re-listed separately as a profitable company in its own right. Since that time it has continued to grow in profits and employment and export earnings. 3.3. Proven Capacity To Be A Regional Centre In Private Equity Australia is a major PE investment centre in the region. In 2008, Australia received the largest amount of PE investment of any country in the Asia-Pacific region, with over US$1.68 billion of deals reported that year. China saw just over US$1.13 billion of deals, none above $200 million in size, with Japan just behind at US$999 million.4 Australia has a well-developed financial services infrastructure for PE relative to other regional markets. In 2008, Australia was the biggest market for M&As in the East Asian region. It accounted for 20% of total deal value for the region, followed by China (17%), HK (16.5%) and Japan (14%).5 Industry data availability, reporting standards and the tax and legal framework re generally reported to be among the most well developed in the region. 3.4. Scope For Growth Despite its positive role for the economy, PE in Australia is still relatively small compared to other forms of business financing. The value of businesses purchased by PE in Australia in 2007 was less than 0.4% of the value of all businesses listed on the ASX. The total value of funds raised by PE firms in the 9-year period to 2007 is still under 2% of ASX market capitalisation: less than the market capitalisation of the 10th largest ASX stock alone. Foreign investment into Australian PE funds has remained low although local investor commitments have risen over threefold since 2000 (thanks in a large part to strong growth in local superannuation funds over this period). The absolute value of foreign investment is today at approximately the same level it was at 2000, but as a proportion of total PE commitments it has halved over the last nine years from 22% to 11% (see Figure 1). Given the natural limits to sourcing further funding from the domestic pool of funds, it is vital that Australian PE and VC firms should to be able to successfully tap foreign funds to ensure that Australian innovations and businesses can continue to grow and thrive. 3 Source: PricewaterhouseCoopers, Economic Impact of Private Equity and Venture Capital in Australia, 2006. 4 Source: AVCJ KPMG Asian Private Equity Quarterly Investment Report, Feb 2009. 5 Source: mergermarket Monthly M&A Report, Dec 2008. 3
  4. 4. Figure 1: Resident and non-resident commitments to Australian PE (Source: ABS, 2009) $18 $16 Non-resident commitments ) $14 b D Resident commitments U $12 A ( s t $10 n e $8 m t i m $6 m o $4 C $2 $- 0 1 2 3 4 5 6 7 8 0 0 - 0 - 0 - 0 - 0 - 0 - 0 - 0 - 0 0 1 2 3 4 5 6 7 2 - 0 0 0 0 0 0 0 0 9 0 0 0 0 0 0 0 0 9 2 2 2 2 2 2 2 2 9 1 4. Regional Cooperation AVCAL has taken the initiative to build links with equivalent industry associations in Asia Pacific. The Australian association mentors its NZ counterpart and has led regional discussions on issues such as valuation guidelines. AVCAL is seen as the most professional and comprehensive association in Asia Pacific. It is the association to which others turn to for advice. A longer term initiative is to build a pan-Asia industry group which will cover broader issues such as standards and education, in a similar manner to the European Venture Capital Association. 4
  5. 5. Specific barriers to Australia becoming a regional centre for PE and VC. Taxation issues The Board of Taxation is currently examining the impact of the current confusing tax regime regarding the tax treatment of gains arising from the investing activities of managed investment trusts (MITs) such as PE and VC funds. The current regime is largely based on case law and is subject to differing interpretations. In addition, the ATO has prepared (but not released) a draft determination which seeks to treat gains made from the investments of MITs as being on revenue, rather than capital, account. This issue has a direct impact on the attractiveness of Australia as a location for both locally-grown and overseas PE and VC funds. Regional competitors for the sector such as Singapore, Hong Kong and even New Zealand have simpler and more attractive tax regimes for fund managers. Investors such as superannuation funds are discouraged from investing in PE and VC when the tax treatment of gains is unclear and differs depending on whether the super fund invests directly or via a MIT. AVCAL and almost all other submissions to the Board of Taxation Review have argued that the gains from Managed Investment Trusts should be treated as capital gains and that there should be legislative clarity around this. AVCAL’s full submission can be found at: http://www.taxboard.gov.au/content/managed_investment_trusts_review/Submissions/05_Australia n_Private_Equity_And_Venture_Capital_Association_Limited.PDF. An extract from the submission is appended to this document. It would be an enormous disruption to the industry and its investors for there to be differing taxation treatments of gains derived directly and gains derived via managed funds. Specifically, if a superannuation fund invests in securities directly and attracts a clear statutory taxation treatment of gains via section 295-85 of the Income Tax Assessment Act of 1997, it is inappropriate to treat the gain as being on revenue account if derived via a managed fund. The superannuation fund will lose the benefit of an explicit policy setting if this happens. It would be disastrous if superannuation funds decided to withdraw their investment support for Australian fund managers as a result, and chose to invest in overseas markets where the tax regime clearly identifies such investing as being on the capital account (such as the UK and the US). If gains from managed investment trusts become taxable as revenue it would be totally counterproductive to the Government’s policy aims. An approach to clarify matters would be to establish a limited partnership (“LP”) vehicle similar to the one introduced by New Zealand in 2007. More details can be found at: http://www.nzsecurities.com/limited_partnership.htm. It is clean and simple with no caveats to complicate it. Australia’s attempt at a an LP structure (the Venture Capital Limited Partnership or “VCLP”) and the subsequent Early Stage VCLP are so complex and trammelled with caveats that they become unworkable and fund managers are reluctant to use them. Rules such as the degree to which they can own foreign assets make managing a VC investment extremely difficult, if the entity wishes to set up overseas operations that can be deemed to change the domicile of the company. In VC backed businesses the reality is that they are the ‘born globals’, who inevitably have to venture overseas to be successful. Other rules regarding the size of the investment, particularly after a period of ownership and growth effectively punish a successful investor for growing the investee company. Recommendations 1. AVCAL urges you to consider in order to maximise Australia’s ability to attract capital for PE and VC investments are changes to clarify the tax treatment of gains from PE and VC 5
  6. 6. investing. Such gains should be on capital account and statutory amendments should be introduced to confirm this. 2. Establishment of a simple limited partnership vehicle (such as was recently introduced by New Zealand) to enable investment in PE and VC. FIF Rules From inception, the FIF rules have been seen to overreach their primary purpose of dealing with the tax deferral opportunities for Australian investors in roll up funds located in tax havens. In the result, when the provisions were introduced, they contained numerous complex provisions and exclusions and presented difficult interactions with other parts of the tax law. Moreover, since introduction, qualifying US FIFs have been removed from the scope of the provisions and, as well, Australian superannuation funds and PSTs etc have been given exemption from the application of the FIF rules. This leaves a complex set of rules which, due to a myriad of exemptions and exclusions, in all probability raises little revenue but causes substantial compliance costs to the commercial community. Rationalising the FIF rules or dispensing with them altogether would have a positive impact on the attractiveness of Australia as a location to establish managed funds. Recommendation 3. Removal of the FIF rules would also enhance Australia’s attractiveness as a destination for investment capital. The flow-on effects through the portfolio companies of employment growth and improved operational performance would be of undoubted benefit to Australia’s future. 6
  7. 7. Appendix 1 – taxation discussion (extract from AVCAL’s submission to the Board of Taxation review) 1. As has already been noted, AVCAL represents the PE and VC sector. A typical PE or VC fund is an unregulated, managed investment scheme. The principal reason such funds are unregulated is that such funds' investors are large, regulated superannuation funds, registered managed investment schemes and other sophisticated and professional investors, with the largest proportion being regulated superannuation funds. 2. Presently, the great majority of PE and VC funds treat their gains and losses as being on capital account. This provides consistent treatment with the treatment of Australian regulated superannuation funds, which entities make up a considerable proportion of investors in PE and VC funds. 3. If the Board of Taxation review were to exclude unregulated funds whose investors were large regulated superannuation funds and managed investment trusts the review, in AVCAL's opinion, would not realise the opportunity for significant reform in this sector and would potentially create even greater complexity and uncertainty. Moreover, if the scope of the review is extended in the way AVCAL suggests, but the outcome of the deliberations on Chapter 7 is to treat gains as being on revenue account, the outcome will be also regrettable. Specifically, this outcome would result in indirect investment by regulated superannuation funds being taxed differently than direct investment and increase their tax burden on such gains by 50%. Put simply, it would be disastrous for the industry and for the Government’s efforts to promote Australia as the financial services hub of the region were such superannuation funds to withdraw their investment support for local PE and VC fund managers. We are aware that numerous other organisations, including the Taxation Institute of Australia, the Property Council of Australia and the Investment and Financial Services Association have made detailed submissions on these points. All the submissions, in one form or another, recommend that gains by managed investment trusts should be on capital account and that a statutory amendment should be introduced to confirm this. AVCAL clearly supports such a legislative confirmation of the current treatment and it commends that such legislative confirmation extend to wholesale trusts in the form discussed earlier. 7

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