- What is venture capital?
- Why are tax credits needed to encourage investors to put their money into these ventures?
- Why is the focus on “small business”?
- What is the Direct Equity Tax Credit program?
- What is the area referred to as the North East Avalon?
- Who will be eligible for a Direct Equity Tax Credit?
- What criteria must be met for a business to be considered an eligible business under the program?
- What kinds of business activities must a company be engaged in to qualify under the program?
- What kind of shares issuance could be considered to be eligible investments?
- Do shares issued under this program still have to comply with the Securities Commission of Newfoundland?
- Are there any restrictions on how the investment funds can be used by an eligible company?
- How can government monitor this program for compliance?
- What is the rationale for excluding certain businesses and business activities from the program?
- Are there any fund-raising limits or caps under the programs for the eligible businesses?
- What is the application process under the Direct Equity Tax Credit program for an eligible business?
- How does an investor or arm’s length corporation under the Direct Equity Tax Credit program actually receive the tax credit?
- How much tax credit can an investor receive?
- What requirements are there in terms of the shares after issuance?
- Is it fair to assume that companies made eligible under this government tax credit program should be safe investments?
- Has the program been successful so far?
- What are the new enhancements to the Direct Equity Tax Credit Program?
- How do people obtain more information on the Direct Equity Tax Credit program?
Venture capital, also known as risk capital, is money put up by investors to fund a new company or an expansion of an established company. The investor’s money is used as equity by the company to grow the business and eventually to provide a return or profit to the investor. Venture capital is usually very “patient” money where investors are prepared to leave it in the company for a considerable period of time to give the company a chance to grow and succeed.
The start up of a new business or an expansion of an existing one is very risky, especially for small businesses in new emerging areas of the economy. Entrepreneurs often have difficulty finding the capital they need to get their businesses up and running or expand them as they start to grow. Tax credits reduce the financial risk to investors and thereby provide an incentive for them to put their money into companies that are in need of start up or expansion funds.
Small businesses are a vital part of our economy – they make up about 95 per cent of all business enterprises that exist in Newfoundland and Labrador and create more jobs each year in Canada than any other sector of the economy. Targeting the small business sector for support has the potential to make a real difference in virtually all areas of the Province.
The Direct Equity Tax Credit program became effective October 30, 2000. This program provides a provincial income tax credit equal to 20 per cent of the investment made directly in eligible businesses located in the North East Avalon area, and a 35 per cent tax credit to investors who make a direct investment in eligible businesses in the remainder of the Province. Effective April 1, 2004, the Direct Equity Tax Credit Program has been expanded to include investments made by an arm’s length corporation into an eligible business.
The North East Avalon includes Bauline, Conception Bay South, Flatrock, Logy Bay-Middle Cove-Outer Cove, Paradise, Petty Harbour, Portugal Cove-St Philip’s, Pouch Cove, Torbay, Mount Pearl and St. John’s. The location of the investor is not a consideration in determining the tax credit rate. Where qualifying activities are undertaken both inside and outside the North East Avalon, a reasonable pro-ration of the 20% and 35% tax credit rates would apply.
The credit is available to individuals 19 years of age or older who invest in an eligible business and who are residents of Newfoundland and Labrador or otherwise paying income tax to the Province.Effective April 1, 2004, the program has been expanded to include investments made by arm’s length corporations operating in Newfoundland and Labrador and otherwise subject to Newfoundland and Labrador corporate income tax.
7. What criteria must be met for a business to be considered an eligible business under the program?
In order to qualify as an eligible business, a corporation must:
- be a Canadian controlled corporation and not a publicly traded corporation
- have a permanent establishment in Newfoundland and Labrador
- have less than $20 million in assets, including associated corporations
- utilize in the Province all of the capital raised from the specified issuance
- have no more than 50 full time equivalent positions
- have at least $25,000 of either or both of shareholder equity and shareholder loans before applying for certification
- must be engaged in, and will utilize funds for, qualifying activities
The programs are designed to support small businesses in growing areas of the economy, such as:
- research and development
- forestry and agrifoods
- manufacturing and processing
- export / import replacement businesses
- cultural industries
Considerable flexibility will be adopted to ensure that legitimate proposals are considered if they meet this fundamental test. However, businesses engaged in the following areas will not be eligible:
- food and beverage services
- personal services, business services, professional practices and trades
- real estate marketing and development
- oil and gas development and production
- mineral resource exploration
- financial services
- fish harvesting and primary fish processing (except processing of underutilized species as designated by the Minister)
- any other activity which in the opinion of the Minister is not in keeping with the spirit and intent of this program
The proposed share offering must be new common voting shares issued after October 30, 2000. They must be non-redeemable, non-convertible and unrestricted in profit sharing or participation upon dissolution. Other than the RRSP program, they may not be eligible for any other credits or deductions. The shares can not be paid for in kind. They must be fully paid for in cash.In addition, shares are not eligible if the individual investor disposed of any shares of the eligible business at any time after March 22, 2000 and before the specified issue of shares. Shares purchased by a corporate investor are not eligible if that investor disposed of any shares of the eligible business at any time after March 27, 2003. The specified issue of shares refers to those shares that are specified in the business’s application for a Certificate of Registration as an eligible business.
10. Do shares issued under this program still have to comply with the Securities Commission of Newfoundland?
Yes, the Direct Equity Tax Credit program in no way affects or changes the responsibilities of issuing companies to comply with the Securities Commission of Newfoundland. Those who are issuing shares under the Direct Equity Tax Credit program have to ensure that they are in complete compliance with the Commission, as normal.
Yes. The tax credits are intended to finance the start up, modernization, expansion or growth of an eligible small business. They will not be permitted to go toward activities that do not meet these objectives, such as simply retiring old debt in a company or to refinance or purchase an existing company or to pay out existing shareholders of a company. The tax credits must create new wealth and activity in a business.
Eligible businesses shall supply financial statements, corporate tax returns and schedules, as required by the Minister. These statements must include an independent auditor’s statement that the corporation is in good standing and that the specified share issuance meets all the requirements of the Direct Equity Tax Credit program. Upon request, eligible businesses shall supply information confirming the use or disposition of capital raised under the Direct Equity Tax Credit program, to ensure compliance with requirements such as qualifying business activities and prohibited uses of funds. Eligible businesses shall also provide a detailed status report of shareholdings for five years after specified share issuances.Also, the provincial Department of Finance will be conducting routine on-site audits. There are significant penalties for those who knowingly and willingly fail to comply with the requirements of the Direct Equity Tax Credit Regulations under the Income Tax Act.
13. What is the rationale for excluding certain businesses and business activities from the program?
The purpose of the program is to encourage incremental business activity in key sectors of the economy. Targeting the program to growth sectors and to those businesses with the greatest capital-raising challenges enables the Province to get the biggest return for its tax dollars.
Yes. There is a fund-raising cap of $3,000,000 per eligible company in the Direct Equity Tax Credit program. This limit is designed to ensure the benefits of the program are available to as many companies as possible without compromising the needs of the small business community. Based on the consultations held, the cap is high enough to meet the needs of most start up and expanding small businesses in the Province.
15. What is the application process under the Direct Equity Tax Credit program for an eligible business?
An eligible business must make application to the provincial Department of Finance to obtain certification. A simple application form will need to be filled out. Approval of most applications can be expected within two weeks, provided the requested information in the application form is complete. Certification will then authorize the business to go out and raise the approved amount of investment capital within three months of being made eligible, with the benefit of the provincial tax credit as an incentive.
16. How does an investor or arm’s length corporation under the Direct Equity Tax Credit program actually receive the tax credit?
Tax credit receipts to investors, including arm’s length corporate investors, will be issued by the provincial Department of Finance upon receiving investor documentation from the eligible business that has certification. The tax credit receipt must then be submitted with the taxpayer’s T1 Income Tax return or T2 return, as appropriate, for the applicable tax year.
The maximum annual tax credit per investor is $50,000. For eligible individual investment the tax credit may be claimed in the year in which the eligible shares are purchased, or if purchased within 60 days of a calendar year, may be claimed in the previous year. For eligible corporate investors, the tax credit would be claimed in the fiscal year in which the investor purchased the eligible shares. The credit is not refundable but may be carried forward for seven years or carried back three years, however, corporate investors can not carry back in fiscal years ending prior to April 1, 2004 and individuals can not carry back the credit prior to the 2000 taxation year. The $50,000 maximum credit includes any carry forward (or back) amounts used in a given year.
Eligible businesses are not allowed to redeem eligible shares for 5 years after issuance. If shares are redeemed then the eligible business shall pay to the Minister a penalty equal to the tax credit allowed with respect to the shares plus interest. This five year period is intended to ensure that the investment funds have a chance to work for the benefit of the company.
19. Is it fair to assume that companies made eligible under this government tax credit program should be safe investments?
No. The Province of Newfoundland and Labrador in no way guarantees the value of any shares issued by an eligible business nor does it in any way express an opinion as to the financial condition of the issuing company or the merits of an investment in shares of the issuing company.
Yes, the program has been very successful, with numerous applications to date and many companies made eligible. Many of these eligible companies have already raised significant amounts of capital under the program. Recent changes that allow arm’s length corporate investors should further improve the program.
Effective April 1, 2004, the program has been expanded to include investments made by arm’s length corporations in an eligible business. Under the enhanced program,corporations would be eligible for a tax credit respecting the purchase of newly issued non restricted common voting shares of an eligible business. The corporation acquiring the shares would not be entitled to the tax credit in respect of shares purchased from a corporation with which it does not deal at arm’s length. Arm’s length has the same meaning as section 251 of the federal Income Tax Act.
The Direct Equity Tax Credit Regulations under the Income Tax Act may be found through the House of Assembly website. Additional information, including application forms, may be obtained by contacting:Department of Finance Fiscal and Economic Policy Branch