Elcano Capital LP and Innovation Australia [2010] AATA 679 (8 September 2010)

Last Updated: 9 September 2010

Administrative Appeals Tribunal

DECISION AND REASONS FOR DECISION [2010] AATA 679

ADMINISTRATIVE APPEALS TRIBUNAL )

) No 2010/0186

GENERAL ADMINISTRATIVE DIVISION		)
	Re		ELCANO CAPITAL LP

Applicant

And

INNOVATION AUSTRALIA

Respondent

DECISION

Tribunal

Deputy President P E Hack SC

Date 8 September 2010

Place Brisbane

Decision

The decision under review is affirmed.

...............Signed..................
Deputy President

CATCHWORDS

TAXATION – venture capital investment – conditional registration under Venture Capital Act 2002 (Cth) – structure proposed by applicant contrary to legislative intent of Act – applicant if conditionally registered would not meet registration requirement of appropriate investment plan – not appropriate to conditionally register partnership as ESVCLP – “association of persons” – proposed structure not a limited partnership – decision under review affirmed

Income Tax Assessment Act 1997 (Cth), ss 118-407(4), 118-425, 118-427, 995-1

Venture Capital Act 2002 (Cth), ss 1-10, 3-1, 7-1, 9-3(1), 11-1, 13-1(1A), 13-5(1A), 13-10, 13-20

Kibby v Registrar of Titles [1998] VSC 148; [1999] 1 VR 861

Minister for Aboriginal Affairs v Peko-Wallsend Ltd [1986] HCA 40; (1985) 162 CLR 24

Navy Health Ltd v Commissioner of Taxation (2007) 163 FCR 1; [2007] FCA 931

REASONS FOR DECISION

8 September 2010	Deputy President P E Hack SC
INTRODUCTION

1. The taxation laws of Australia, in particular the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) and the Income Tax Assessment Act 1997 (Cth) (ITAA 1997), provide concessional treatment for income tax and capital gains tax purposes for venture capital investment. The Venture Capital Act 2002 (Cth) “provides for some administrative measures that are needed for the operation of”[1] that concessional treatment. Those measures include the requirement for registration of entities involved in venture capital raising.
2. In these proceedings the applicant, Elcano Capital LP (Elcano), contends that conditional registration under the Venture Capital Act ought to have been given to a limited partnership of which Elcano is the general partner. The respondent, Innovation Australia, is a board established by the Industry Research and Development Act 1986 (Cth). Its functions include the granting of registration under the Venture Capital Act. It refused Elcano’s application for conditional registration and maintains in these proceedings that its decision to refuse ought to be affirmed. It contends that conditional registration was properly refused as a matter of discretion and because the partnership proposed does not answer the statutory description of a limited partnership.

THE LEGISLATION

3. Registration under the Venture Capital Act is dealt with in Part 2 of the Act. Section 7-1 of the Act explains the operation of the Part in this way:

7-1 What this Part is about

Innovation Australia can register limited partnerships as venture capital limited partnerships, early stage venture capital limited partnerships or Australian venture capital funds of funds.

Registration is one of the requirements before investments of venture capital through a limited partnership can attract the operation of:

• the capital gains tax exemption relating to venture capital under Subdivision 118-F of the Income Tax Assessment Act 1997 (and the related provisions about similar income gains and losses); and
• the income tax exemption under section 51-52 of the Income Tax Assessment Act 1997 (if the partnership is an early stage venture capital limited partnership); and
• the “flow-through” treatment, under Division 5 of Part III of the Income Tax Assessment Act 1936, of the income of limited partnerships.

Broadly speaking, Innovation Australia will register a limited partnership under Division 13 if an application meets the requirements of Division 11, unless Innovation Australia is satisfied that the partnership does not meet the applicable registration requirements of Division 9.

Conditional registration is an option if an application does not meet the requirements of Division 11.

Note: Conditional registration becomes important if full registration is achieved. Registration is then backdated at least to the time of conditional registration.

Innovation Australia can revoke a registration under Division 17. Broadly speaking, the grounds for revocation are:

• failure to meet the applicable registration requirements of Division 9; and
• failure to provide information as required under Division 15.
  

4. As appears from s 7-1 there are three types of limited partnerships that are capable of being registered – a venture capital limited partnership, described as a “VCLP” in the legislation[2]; an early stage venture capital limited partnership (ESVCLP); and an Australian venture capital flow of funds (AFOF). The entity in issue here is an ESVCLP. Section 118-407(4) of ITAA 1997 provides:

“(4) A *limited partnership is an early stage venture capital limited partnership at a particular time if, at that time, the partnership’s registration as an early stage venture capital limited partnership under Part 2 of the Venture Capital Act 2002 is, or is taken to have been, in force.

Note 1: For when the registration is, or is taken to have been, in force, see section 13-10 of the Venture Capital Act 2002.

Note 2: In this Act and the Venture Capital Act 2002, the term ‘early stage venture capital limited partnership’ is usually abbreviated to ‘ESVCLP’”.

5. The requirements of registration for an ESVCLP are set out in s 9-3(1) of the Venture Capital Act in these terms:

“(1) The registration requirements of an ESVCLP, in relation to a *limited partnership, are that:

(a) the partnership was established by or under a law in force in, or in any part of:

(i) Australia; or

(ii) a foreign country in respect of which a double tax agreement (as defined in Part X of the Income Tax Assessment Act 1936) is in force that is an agreement of a kind referred to in subparagraph (b)(i), (ia), (ii), (iii), (iv) or (v) of that definition; and

(b) all of the partners who are *general partners are residents of a country referred to in paragraph (a); and

(c) under the partnership agreement the partnership is to remain in existence for a period of not less than 5 years and not more than 15 years; and

(d) the partnership’s *committed capital:

(i) is at least $10 million; and

(ii) does not exceed $100 million; and

(e) none of the partners has *committed capital in the partnership that, taken together with the sum of the amounts of committed capital in the partnership of any of that partner’s *associates (other than associates to whom subsection (5) applies), exceeds 30% of the partnership’s committed capital; and

(f) each investment that the partnership holds is:

(i) an *eligible venture capital investment; or

(ii) an investment in a company, in which the partnership owns one or more eligible venture capital investments, that would have been an eligible venture capital investment but for subsections 118-425(2) and (6) of the Income Tax Assessment Act 1997; or

(iii) an investment in a unit trust, in which the partnership owns one or more eligible venture capital investments, that would have been an eligible venture capital investment but for subsections 118-427(3) and (7) of the Income Tax Assessment Act 1997; and

(g) each investment that the partnership holds is in accordance with the partnership’s *approved investment plan; and

(h) the partnership acts in accordance with the partnership’s approved investment plan; and

(i) the partnership does not hold any investment that breaches subsection (6); and

(j) the partnership only carries on activities that are related to making eligible venture capital investments, investments to which subparagraph (f)(ii) applies or investments to which subparagraph (f)(iii) applies; and

(k) every *debt interest that the partnership owns is, and continues to be, a *permitted loan.”

6. Innovation Australia places particular reliance upon the requirements,
   • that the committed capital not exceed $100m;
   • that no single partner (together with associates) may ordinarily hold in excess of 30% of the capital.
7. The process of registration is dealt with in Div 13 of the Venture Capital Act. By virtue of s 13-1(1A) of that Act, Innovation Australia must register a partnership as an ESVCLP if:

“(a) a *general partner has applied for registration as an ESVCLP; and

(b) the application meets the requirements under section 11-1; and

(c) Innovation Australia is satisfied that the partnership’s investment plan (as set out in the application or that plan as since approved by Innovation Australia is appropriate; and

Note: Section 13-20 deals with deciding whether an investment plan is appropriate.

(d) Innovation Australia is satisfied that the partnership has access to the skills and resources necessary to implement, and is reasonably likely to be able to implement, its investment plan; and

(e) any further information requested under section 11-10 has been provided; and

(f) a general partner has notified Innovation Australia that the ESVCLP has sufficient funds to begin its investment program;

unless Innovation Australia is satisfied that the partnership:

(g) does not meet the *registration requirements of an ESVCLP; or

(h) has had a previous registration revoked under Division 17.”

Additionally, and by virtue of s 13-5(1A) of the Venture Capital Act, Innovation Australia may conditionally register a partnership as an *ESVCLP if:

“(a) a *general partner has applied for registration as an ESVCLP; and

(b) either:

(i) the application for registration does not meet the requirements under section 11-1; or

(ii) any further information requested under section 11-10 has not been provided;

unless Innovation Australia is satisfied that the partnership:

(c) would not, if it was conditionally registered, meet the *registration requirements of an ESVCLP within the period specified under subsection 13-10(3); or

(d) has had a previous registration revoked under Division 17.”

8. Where, before registration, conditional registration was granted, the effect of s 13-10 of the Venture Capital Act is that registration has relation back, for the purposes of the ITAA 1936 and the ITAA 1997, to the date of conditional registration.
9. Finally it is necessary to have regard to the definition of “limited partnership” set out in s 995-1 of the ITAA 1997 as meaning:

“(a) an association of persons (other than a company) carrying on business as partners or in receipt of *ordinary income or *statutory income jointly, where the liability of at least one of those persons is limited; or

(b) an association of persons (other than one referred to in paragraph (a)) with legal personality separate from those persons that was formed solely for the purpose of becoming a *VCLP, an *ESVCLP, an *AFOF or a *VCMP and to carry on activities that are carried on by a body of that kind.”

THE DECISION

10. Some uncontroversial matters about the decision-making processes need be noticed. On 3 June 2009, Lellco Capital, LP, was formed and registered as an incorporated limited partnership pursuant to Chapter 4 of the Partnership Act 1891 (Qld). Lellco Investments Pty Ltd was described as the general partner and Mr Darren Lelliott as the limited partner. On the same day Lellco ESI 1, LP was formed and registered as an incorporated limited partnership under the same provisions. On 6 September 2009, Lellco ESI 1, LP, made application to Innovation Australia for registration as an ESVCLP. That application was refused on 27 November 2009. The refusal decision was affirmed on internal review on 22 December 2009. Application to review the refusal decision was lodged in the Tribunal on 13 January 2010.
11. In the course of the Tribunal’s pre-hearing processes the material relied on by Elcano was significantly amended with a view, it was hoped, to overcome the objections of Innovation Australia. As a result, the parties consented to the making of an order, made on 19 May 2010 pursuant to s 42D of the Administrative Appeals Tribunal Act 1975 (Cth), remitting the matter to Innovation Australia for re-consideration. On 4 June 2010, Innovation Australia affirmed the decision with the consequence that the proceedings resumed [see para 24 of exhibit 1].
12. I should also say that despite Mr Lelliott’s unhappiness with the processes and reasoning of Innovation Australia, those matters are not germane to the present proceedings given the Tribunal’s task of merits review.

ELCANO’S PROPOSAL

13. Elcano’s proposal appears from three documents – an Investment Plan, the proposed Partnership Agreement and an Information Memorandum. The key feature of the proposed model, and that which Innovation Australia contends warrants refusal of conditional registration, is that proposed partners participate in what is described as “a ‘unitised’ venture capital model”. That model, according to the material, allows investors to isolate their investment in a particular “Elcano Capital approved Investee company or venture” rather than, as in a conventional partnership, partners sharing in the profits and losses of the entirety of the business of the partnership. The information memorandum describes the result of adopting this model in these terms:

“5. If your selected Investee is a stellar performer, becoming the next Google for example, you will only share the income and gains with those Limited Partners who also invested in that Investee;

6. If other Limited Partners have invested in poorer performing Investees the returns on their Class of Partnership Units are not aggregated or averaged with your Investment returns thereby avoiding the dilution of your returns or even the loss of your investment capital; ...”
14. This notion of quarantining investments is given effect to in the partnership deed which contemplates that the beneficial interest in the partnership would be divided into units and that there should be different classes of partnership units. The number of units to be issued for each class of units is to depend upon the capital contribution required for the particular investment. The partnership deed does not, so far as I can tell, preclude a single investor from holding more than 30% of the units in a particular class nor, for that matter, from holding all of the units of a particular class. The partnership agreement admits of the possibility of an investor approaching the partnership to make an investment of the investee’s choosing, even on a sole investor basis, subject to the approval of the general partner.
15. The proposed structure ensures that the interests of the limited partners are not in the partnership itself as a whole but are confined to the class of units to which the investor has subscribed. Thus, funds are not mixed between classes of investments, financial reporting is undertaken on a class basis, voting at partners’ meetings is undertaken on a class basis, the general partner’s fees are calculated by reference to classes and the general partner has recourse for reimbursement from the class rather that from the partnership as a whole.

THE PARTIES’ CASES

16. The case for Innovation Australia is put on either or both of two bases:

(a) that the discretion to grant conditional registration ought not be exercised where the proposed structure is inconsistent with the legislative design of the ESVCLP scheme;

(b) that the applicant is not a limited partnership as that term is used in the ITAA 97 (and thus the Venture Capital Act)because the element in that definition of “association of persons” is absent.

17. Elcano contends to the contrary.

THE DISCRETION TO REGISTER

18. In Minister for Aboriginal Affairs v Peko-Wallsend Ltd[3] Mason J said:

“What factors a decision-maker is bound to consider in making the decision is determined by construction of the statute conferring the discretion. If the statute expressly states the considerations to be taken into account, it will often be necessary for the court to decide whether those enumerated factors are exhaustive or merely inclusive. If the relevant factors – and in this context I use this expression to refer to the factors which the decision-maker is bound to consider – are not expressly stated, they must be determined by implication from the subject-matter, scope and purpose of the Act. In the context of judicial review on the ground of taking into account irrelevant considerations, this Court has held that, where a statute confers a discretion which in its terms is unconfined, the factors that may be taken into account in the exercise of the discretion are similarly unconfined, except in so far as there may be found in the subject-matter, scope and purpose of the statute some implied limitation on the factors to which the decision-maker may legitimately have regard”. [citations omitted]

19. The discretion conferred by s 13-5(1A) is, in terms, unconfined once the matters in paragraphs (a) and (b) of the sub-section are met and provided the matters in paragraph (c) and (d) are not made out. Innovation Australia says that it is relevant to have regard to the structure of the Venture Capital Act, and to its history, in determining whether to grant conditional registration. In particular, it points to s 13-5(1A)(c) of the Act as a basis for refusing conditional registration. The Tribunal should be satisfied, so it is said, that the registration requirements of an ESVCLP would not be met within 24 months of conditional registration.
20. It is as well to start with the history. The Venture Capital Bill was introduced into the Parliament in 2002. The Explanatory Memorandum for the Venture Capital Bill 2002 and the related Taxation Laws Amendment (Venture Capital) Bill 2002 referred to the Bills as facilitating,

“non-resident investment in the Australian venture capital industry by providing incentives for increased investment which will support patient equity capital investments in relatively high-risk start-up and expanding businesses that would otherwise have difficulty in attracting investment through normal commercial means.”

The effect of the Act, when enacted, was that the taxation concessions were not available to Australian residents although some concessional treatment was available to Australian residents under the provisions of the Pooled Development Funds Act 1992 (Cth).

21. The concept of an ESVCLP was introduced to the Venture Capital Act by amendments made in 2007 by the Tax Laws Amendment (2007 Measures No. 2) Act 2007[4]. That Act amended the venture capital regime by,

“· relaxing the eligibility requirements for concessional taxation treatment for foreign residents investing in venture capital limited partnerships (VCLP’s) and Australian venture capital funds of funds (AFOF’s); and

· providing taxation concessions for Australian residents and foreign residents investing in early stage venture capital activities through a new investment vehicle called an early stage venture capital limited partnership (ESVCLP).”

The amendments also closed the pooled development fund scheme under the Pooled Development Funds Act to new applications as a result of the introduction of ESVCLP’s.

22. The effect of the amendments was to extend tax concessions to ESVCLP’s with the result that an ESVCLP is treated as a general partnership. Thus its taxable income flows through to its partners, rather than, as in the case of limited partnerships, the partnership being taxed as an entity. Capital gains and losses by partners of ESVCLP’s are disregarded. However, only eligible venture capital investments in either companies or unit trusts attract the tax concessions. Sections

118-425 and 118-427 of the ITAA 1997 set out extensive criteria for eligible venture capital investments. Importantly for present purposes, the ITAA 1997 has the effect that not more than 30% of a partnership’s committed capital may be invested in a single company or unit trust.

23. On the argument of Innovation Australia, the structure proposed by Elcano does not accord with the requirements of the Venture Capital Act or the ITAA 1997 for four reasons:
    • it undermines the 30% limits in both Acts;
    • it gives rise to a direct investment model, which is contrary to the legislative intent evident from the replacement of the pooled development funds model with the ESVCLP scheme;
    • it undermines the development of the venture capital industry;
    • Elcano is not a limited partnership for the purposes of the ITAA 1997.

If the last point is good, it seems to me that it goes to power, not discretion. That is, if the application is made on behalf of an entity that is not a limited partnership then one of the requirements of s 11-1 of the Venture Capital Act is not met with the result, as it seems to me, that there is no valid application that has been made. Thus, I will consider the argument separately rather than under the general rubric of discretion.

24. The structure proposed by Elcano would permit a single investor to hold in excess of 30% of the units in a particular class. That, says Innovation Australia, is contrary to the legislative intention that there must be at least four investors, the consequence of the requirement of s 9-3(1)(e) of the Venture Capital Act that none of the partners of an ESVCLP has more than 30% of the partnership’s committed capital.
25. That requirement is indicative of a legislative desire that there be a diversity of investors rather than, as Elcano’s model permits, a single investor in a project. And there is a legislative desire for diversity of objects of investment. That is evident from the requirement in ss 118-425 (1)(d) and 118-427 (1)(d) of the ITAA 1997 that no more than 30% of a partnership’s capital be invested in a single company or unit trust.
26. In these ways it is evident that the legislature intended that an ESVCLP have a spread of investors, a minimum of four, and a spread of investments, again, a minimum of four. Elcano’s model is quite to the contrary. It would allow a single investor to invest in a single project.
27. Conditional registration may not be granted if Innovation Australia is satisfied that the applicant, if conditionally registered, would not meet the registration requirements in the Venture Capital Act. One of the matters of which Innovation Australia needs to be satisfied before registration is that the investment plan is appropriate. The matters that must be taken into account in considering whether an investment plan is appropriate are set out in s 13-20(1) of the Venture Capital Act. But s 13-20(3) makes it plain that the section does not limit the matters that may be taken into account in making a decision under s 13-1(1A)(c) about the appropriateness of an investment plan.
28. That being so, I regard it as a relevant consideration for the purposes of s 13-1(1A)(c) of the Venture Capital Act that the structure proposed by the applicant here is contrary to the apparent legislative intent of the Venture Capital Act and would permit direct investment contrary to the evident intention of the Venture Capital Act. The applicant bases its proposal on the “unitised” model. It does not propose to alter the structure were conditional registration to be given. Thus, I am satisfied that the applicant would not, if conditionally registered, meet the registration requirement of having an investment plan that would be appropriate.
29. In those circumstances it is not appropriate to conditionally register the partnership as an ESVCLP. Accordingly, the decision under review ought be affirmed.

AN ASSOCIATION OF PERSONS

30. Given my earlier conclusion, it is not strictly necessary to consider this argument however I propose to address it briefly.
31. The proposed partnership has satisfied the test of the Queensland legislation for a limited partnership however the ITAA 1997 poses its own tests. Thus, relevantly[5] there must be “an association of persons ... with legal personality separate from those persons that was formed solely for the purpose of becoming an ESVCLP ... and to carry on activities that are carried on by a body of that kind.” Innovation Australia refers to the discussion of what is meant by “association” in Kibby v Registrar of Titles[6] and in Navy Health Ltd v Commissioner of Taxation[7].
32. In Kibby, Mandie J was concerned with the statutory definition of “association” in the Associations Incorporation Act 1981 (Vic) however his Honour made the following, pertinent, observations[8] about the ordinary meaning to be attributed to the word “association”.

”In the light of the judicial statements to which I have referred and the ordinary meaning of the words contained in the said definition, I consider that the essence of an ’association’ may be described as some form of combination of persons (with a common interest or purpose) with a degree of organisation and continuity at least sufficient to distinguish the combination from an amorphous or fluctuating group of individuals and with some clear criteria or method for the identification of its members.”

33. To similar effect the observations of Jessup J in Navy Health[9]

“On any natural reading of the word, ‘association’ denotes a grouping, or coming together, of two or more persons. Relevantly for present purposes, the dictionary meaning of the word is ‘a body of persons who have combined to execute a common purpose or advance a common cause ...’ (Oxford English Dictionary (2nd ed)). Unless required to decide otherwise by authority, I consider that the proposition that a single person, whether or not incorporated, might constitute an ‘association’ is quite at odds with the natural meaning of the word, and with normal, everyday, usage.”

34. These statements highlight a feature which is absent from the structure proposed by the applicant, the common purpose or common cause. That element is the key feature in a partnership under the general law. The common purpose of the partners is the carrying on together of the business of the partnership with a view to making a profit. A limited partnership, for the purposes of the ITAA 1997 must be “an association of persons ... “. Where the key feature of the proposed structure is the “unitised” model it is my view that the element of association is absent. There will be no common purpose or common cause between the partners except between the partners within a single “unit”.
35. It follows that I am not satisfied that the proposed structure is a limited partnership as defined and thus I would affirm the decision on that basis as well.
    

I certify that the 35 preceding paragraphs are a true copy of the reasons for the decision herein of Deputy President P E Hack SC

Signed: ............Signed..........................................................

Associate

Date of Hearing 13 July 2010

Date of Decision 8 September 2010

The Applicant self represented by its director Mr D Lelliott

Counsel for the Respondent Mr D O’Donovan

Solicitor for the Respondent Australian Government Solicitor

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[1] Venture Capital Act, s 3-1.

[2] The various terms are defined in s 995-1 of the ITAA 1997. Section 1-10 of the Venture Capital Act incorporates the definitions of the ITAA 1997 into the Venture Capital Act.

[3] [1986] HCA 40; (1985) 162 CLR 24 at 39-40.

[4] No 78, 2007.

[5] Only para (b) and not (a) seems relevant.

[6] [1998] VSC 148; [1999] 1 VR 861.

[7] (2007) 163 FCR 1; [2007] FCA 931.

[8] [1998] VSC 148; [1999] 1 VR 861, 872 at [50].

[9] [2007] FCA 931; (2007) 163 FCR 1 at [77].