Relevant to P6 (MYS)
This article is relevant for candidates preparing for the P6 (MYS), Advanced Taxation exam. The article is based on prevailing laws as at 31 March 2017. The article is written to provide an overview of the venture capital industry in Malaysia and the government’s effort in promoting this industry and makes reference to the Public Ruling 2/2016 Venture Capital Tax Incentives.
Venture capital is financial capital provided by investors, which can be from the government, corporations or individuals to high potential and high risk growth start-up companies at the early stages of the project/business. Venture capital investors generally take very high risks when investing in start-up companies, referred to as venture companies (VC). In most cases, a VC provides the investors with a profit share in the form of share equity in the VC.
The Malaysia venture capital industry started in the 1980s with the establishment of the Malaysia Ventures Berhad. Since then, the Malaysian Government continues to play a key role in promoting the development of the industry, being the key contributor to the invested funds for the industry.
The sectors that received the most financing from venture capitalists were the information technology (IT) and communication sector, followed by the manufacturing and life sciences sectors, which includes biotechnology.
The Government recognises the importance of the venture capital industry as a source of financing to emerging high-growth companies and various efforts have been taken to create a favourable environment for venture capital activities in Malaysia. In this regard, the Securities Commission (SC) has been tasked to assess and certify applications for tax incentives for the venture capital industry in Malaysia.
Investments in VCs can be made in several stages of the business life cycle as follows:
- Seed capital phase: During this phase, the business utilising the funds for the purposes of research, assessment and development of an initial concept or prototype, where the VC’s organisational structure has not been formalised
- Start-up phase: During this stage, the VC will undertake product development and initial marketing where the VC is in the process of formalising its organisational structure, or if its organisational structure has been formalised, the VC has not started its commercial sale of its products.
- Early stage phase: At this point, the business is ready for commercialisation. The VC at this stage would look for funding to assist it for initial commercialisation of a technology or product, increase production capacity or for marketing or product development as well as interim financing for the purpose of being listed on the official list of a stock exchange.
A venture capital company (VCC) is a company incorporated under the Companies Act, investing in a VC in the form of seed capital, start-up or early stage financing and that is registered with the SC. On the other hand, a venture capital management corporation (VCMC) manages on behalf of a VCC the investments in securities of a VC in different business stages ie seed capital, start-up or early stage financing.
A VC is a company incorporated under the Companies Act, which is:
- (a) resident in Malaysia for the basis year for a year of assessment (YA), and
- (b) involved in utilising the seed capital, start-up or early stage financing for qualifying activities / products as follows:
(i) products or activities promoted under the Promotion Investments Act, 1986 (PIA) where a VC has been granted tax incentives such as pioneer status or investment tax allowance (ITA)
(ii) technology- based activities listed under the Venture Capital Tax Incentives Guidelines issued by the SC
(iii) products or activities which have been developed under the Industrial Research and Development Grant Scheme, granted by the Ministry of Science, Technology and Innovation (MOSTI), or
(iv) products or activities which have been developed under the MSC Research and Development Grant Scheme granted by the Multimedia Development Corporation.
Tax incentives available
In order to promote investments in high risk business undertaken by the VCs, the Malaysian Government has announced a number of venture capital tax incentives for the industry. The tax incentives can be categorised as follows:
- (a) Tax exemption for a VCC investing in a VC under the Income Tax (Exemption) (No. 11) Order 2005
- (b) Tax deduction incentive for an individual or company investing in a VC under the Income Tax (Deduction for Investment in a Venture Company) Rules 2005, and
- (c) Tax incentive for VCMCs under the Income Tax (Exemption) (No. 12) Order 2005.
It should be noted that a VCC that has applied for tax exemption under (a) is not entitled to apply for the tax deduction incentive under (b) for the whole of its tax exempt period. This is because both the incentives are mutually exclusive.
Tax exemption for a VCC investing in a VC
Under this incentive, a VCC is given full income tax exemption on its statutory income derived from all sources of income excluding interest income arising from savings or fixed deposits and profits from syariah-based deposits. The tax exempt period is for 10 YAs or the life of the fund established for the purpose of investing in a VC, whichever is the shorter.
Where a VCC suffers losses from the disposal of shares in a VC during the tax exempt period, such losses can be carried forward to the post tax exempt period.
In order to qualify for the tax exemption, the VCC shall for each YA during the tax exempt period obtain a certification from the SC confirming that:
- (a) The VCC has invested at least 70% of its invested funds in a VC or where the investment is in the form of seed capital, at least 50% of its invested funds
- (b) The VCC has not invested in a VC which is its related company at the point of the first investment, and
- (c) The VCC has provided early stage financing to a VC which is involved in activities which are not listed as technology based business activities, from seed capital or start up stage, where such early stage financing is provided as:
(i) additional capital expenditure or additional working capital to increase production capacity, marketing or product development, or
(ii) an interim financing for the purpose of being listed on the official list of a stock exchange.
In other words, it is clarified in the Public Ruling 2/2016 that if a VCC provides early stage financing to a VC, which is involved in an activity not listed as technology-based business activities, the VCC would qualify for the tax exemption if it had also provided financing to the VC from the seed capital or start-up stage.
Examples of technology-based activities as provided under the SC’s Venture Capital Tax Incentive Guidelines include advanced electronics and IT, telecommunications, equipment / instrumentation, automaton and flexible manufacturing systems, biotechnology, bioconversion and genetic engineering, healthcare, advanced materials, etc.
ABC Sdn Bhd (ABC) was set up as a VCC in 2015 and has invested 75% of its funds in the form of early stage financing in XYZ Sdn Bhd (XYZ) which undertakes technology-based activities as provided in the Venture Capital Tax Incentives Guidelines. The balance of the funds was temporarily invested in listed portfolio investments as well as fixed deposits.
Both ABC and XYZ are not related companies and closes its accounts to 31 December every year. ABC has obtained a certification from SC confirming that it had invested at least 70% of its invested funds in the VC for the year ending 31 December 2015.
The income derived by the company for the financial year ended 31 December 2015 was as follows:
|Interest income from loan given to XYZ||20,000|
|Dividend income from portfolio share investment listed in Bursa Malaysia||30,000|
|Interest income from fixed deposit||10,000|
As the VCC has obtained certification from the SC that it had invested at least 70% of its invested funds in the VC for the YA 2015, it would qualify for tax exemption in respect of its statutory income from all sources of income excluding interest income arising from savings or fixed deposits and profits from syariah-based deposits. The tax exemption is for a period of 10 YAs beginning from YA 2015 or the life of the fund established for the purpose of investing in a VC, whichever is shorter, subject to the annual certification issued by the SC.
Based on the income stream for YA 2015, dividend income from the portfolio investment listed in Bursa Malaysia is tax exempt under the single tier regime. The interest income received by ABC should avail for the VCC tax exemption, other than the interest income from fixed deposit of RM10,000 which is excluded from the tax exemption.
Tax deduction incentive for an individual or company investing in a VC
The venture capital incentive is not just restricted to special purpose VCCs but also individuals or normal companies which invest in a VC.
The incentive given is in the form of a tax deduction given for an amount equivalent to the value of the investment in shares (cost of investment) in a VC. In order for the individual or company to avail for this incentive, the individual or company must meet the following conditions:
- (a) is resident in Malaysia
- (b) has a business source, and
- (c) invested in a VC at seed capital, start-up and early stage financing for the qualifying products and activities provided in the Venture Capital Tax Incentive Guidelines.
Similar to a VCC, the individual or company must obtain a certification from the SC confirming that:
- (a) The investment was in the form of holding of shares which at the time of acquisition are not listed for quotation in the official list of a stock exchange
- (b) The investment, in relation to a company, was not made in a VC which is its related company at the point of first investment
- (c) The investment was made for seed capital, start-up or early stage financing
- (d) It had provided early stage financing to a VC which is involved in activities which are not listed as technology based activities, from the seed capital or start-up stage, where such early stage financing was provided as:
(i) additional capital expenditure or additional working capital to increase production capacity, marketing or product development, or
(ii) an interim financing for the purpose of being listed on the official list of a stock exchange; and
- (e) The investment was made at least two years prior to the date of its disposal.
As you would appreciate from the above, the tax deduction benefit is given at the time when the investment is disposed of as certified by the SC and not at the time when the investment is made.
DEF Sdn Bhd (DEF), a manufacturing company made an investment in Bio Sdn Bhd (Bio) which was set up to undertake a high risk new business venture in biotechnology research. DEF provided early stage financing to this company. The initial investment made by the company on 1 February 2015 was in the form of 10% ordinary share capital in Bio for an amount of RM3 million and shareholders advance of RM2 million.
DEF subsequently disposed of the share investment in Bio in March 2017 for an amount of RM4 million when Bio was listed on the Bursa Malaysia, resulting in a gain of RM1 million. DEF has obtained a certification from SC that it qualifies for venture capital tax incentives.
The tax information of DEF for the relevant YAs is as follows:
Financial year ended 31 December / YA
|Adjusted income (without considering investment in Bio)||2,000||3,000||4,000|
Based on the above, DEF would be eligible for the tax deduction equivalent to the share investment made by the company of RM3 million as it has held the investment for more than two years and the SC certification has been obtained. It should be noted that the shareholders’ advance given by DEF is not eligible for the tax deduction. The tax deduction would only be given upon the disposal of the investment in YA 2017 even though the investment was made in YA 2015.
DEF’s tax computations for the relevant YAs are as follows:
|Less: Tax deduction on share investment in a VC||(3,000)|
|Add: Gain on disposal of investment (Note 1)||Nil|
|Less: Capital allowance||(300)||(300)||(300)|
|Aggregate income / Chargeable income||2,200||3,100||900|
Note 1: The gain can be treated as a capital gain if DEF is not involved in share dealing activities.
In addition to DEF, Ali, a retiree also invested in Bio on 1 February 2015. Ali took up a 5% ordinary share investment worth RM1.5 million in Bio. Upon the listing of Bio in March 2017, he disposed of all of his investment in Bio for RM2 million. Ali has no other income or investments other than his pension income.
As Ali does not have a business source, he will not be eligible for the tax deduction under the venture capital tax incentive. Upon the disposal of the shares in March 2017, Ali made a gain of RM500,000. The question then is whether the gains arising from the investment is capital or revenue in nature. On the basis that Ali has no other investment, this would indicate that the investment in Bio is a one-off and, therefore, can be argued to be a capital gain. In this case, the gain of RM500,000 should not be taxable.
PQR Sdn Bhd (PQR) also made an investment of 15% ordinary share capital in Bio for an amount of RM4.5 million on 1 February 2015. PQR increased its investment in Bio on 3 October 2015 in the form of early stage financing for an amount of RM1 million. In March 2017, PQR disposed of its entire investment in Bio. PQR obtained certification from SC confirming its investment in Bio qualifies for the venture capital tax incentive.
Based on the above facts, PQR will be eligible for a tax deduction on the share investment made in Bio for an amount of RM4.5 million on 1 February 2015 as it has held the investment for more than two years. However, the additional investment made by PQR on 3 October 2015 is not eligible for the tax deduction as the investment was held for less than two years.
Following on from Example 1, ABC also made an investment of 5% ordinary share capital in Bio for an amount of RM1.5 million on 1 February 2015.
On the basis that ABC has been granted the VCC tax exemption, it would not be eligible for the tax deduction based on the value of the investments made in Bio when it subsequently disposed of its shares in Bio. This is because the VCC tax exemption and tax deduction incentives are mutually exclusive.
However, any taxable income made from the investments in Bio will be eligible for the income tax exemption at statutory income level during its tax exempt period.
Tax incentive for VCMC
A registered VCMC with SC is eligible for an income tax exemption in respect of the statutory income from the share of profits received by it from a VCC on any investment made by the VCC as stipulated in the agreement entered into between the VCMC and VCC. The VCC must have obtained certification from the SC for tax exemption under the Income Tax (Exemption) (No. 11) Order 2005 or deduction under the Income Tax (Deduction for Investment in a Venture Company) Rules 2005.
Written by a member of the P6 (MYS) examining team