In view of the high level of risk, investors naturally demand a very high level of return on their portfolio of venture capital investments.

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1 Submission of Erica Caslin and Caolan O Callaghan in Response to the Public Consultation entitled A new European regime for Venture Capital and Conducted by D. G. Internal Market and Services Introduction This submission is in two parts, Part A and Part B. Part A deals with general points in response to the Public Consultation entitled A new European regime for Venture Capital and Conducted by D. G. Internal Market and Services (the Consultation ) while Part B responds to the questions posed in the fourteen (14) different boxes in the Consultation. Part A Venture Capital Investors Venture capital is a very high risk business compared to investing in well-established companies principally because of the combination of risks that arise from the lack of capital in portfolio companies and the lack of access to capital by portfolio companies, a management team that usually have not worked together before, the absence of a developed marketing and distribution strategy, unproven production or service delivery & quality control and the untested nature of the business idea or technological application. In addition, investments tend to be locked in for a long period of time and there are few opportunities to receive interim payments on the investments by means of dividends. Despite the risk and the painstakingly careful management that early stage investing demands and the lack of liquidity, venture capital investments can potentially be very high return investments when compared to investing in well-established companies. In order to reduce the risk of their portfolio of investments, venture capital investors seek to diversify their investments: (i) across a wide range of business sectors; or (ii) by specialising in one business sector but seeking a very large number of investments in that sector. In view of the high level of risk, investors naturally demand a very high level of return on their portfolio of venture capital investments. Economic Growth If venture capital is widely available, then we believe that the availability of such capital helps to drive innovation as people with good ideas know that they can get funding to commercialise their ideas. Further, the success of others in commercialising their ideas serves as a beacon to budding entrepreneurs. Providing finance to small-&-medium sized enterprises ( SMEs ) in the EU is likely to have a significant positive impact on economic growth, competitiveness and job creation in the EU. Indeed, increasing the supply of venture capital at this time of relatively high unemployment in the EU is particularly timely. The Contribution of Venture Capital to Job Creation According to an article entitled A jobs plan for the Starbucks generation by Andrei Cherny which appeared on the on-line version of the Financial Times on 4 July 2011, Page 1 of 18

2 during the past generation, start-ups less than five years old have accounted for all net job growth in the United States ( U. S. ). Venture Capital is a Global Business The United States and the Middle East are significant sources of venture capital 1. Any discussion about improving the availability of venture capital in the EU must therefore consider the issues faced by venture capital funds, investors and managers based in the United States and the Middle East in making venture capital investments in the EU. Taxation If an investor who is resident in say country X were to invest directly in the unlisted shares of a number of companies seeking venture capital and resident in other countries with whom country X had concluded double taxation agreements, in the vast majority of cases that investor would, after allowing for double taxation relief, only be subject to tax in the investor s country of residence. If that same investor invests in a venture capital fund which in turn invests in the unlisted shares of the same companies, then there is a risk that taxation may be applied: (i) at the level of the fund when the fund realises an investment or receives income; (ii) when the investor receives capital or income from the venture capital fund. Investors in venture capital funds seek tax transparent vehicles where the capital gains and income of the vehicle are treated as that of the vehicle s investors and they are taxed accordingly; no taxation occurs at the level of the vehicle. Put another way, the investors seek: (i) vehicles that the relevant tax authorities look through to the underlying investors to ensure that tax is only imposed in the home state of the investor; or (ii) fund structures that do not result in additional taxes. The limited partnership entity is a popular vehicle for venture capital investment in many but not all EU jurisdictions for a number of reasons including: (i) it provides commercial flexibility in being able to offer each investor (limited partner) different investment terms; and (ii) where it is considered tax transparent in both the investor s country of residence and the countries of residence of the portfolio companies, it does not result in additional taxes for the investors (limited partners). Tax transparency makes cross-border investing significantly easier as the investor need consider only the tax laws of his or her own country. Given the high risk in venture capital investing, investors need to see that investing via a venture capital fund leaves them in at least the same tax position as if they invested directly in the underlying portfolio companies. Taxation leakage from the return stream of venture capital investing which arises from an inappropriate structure for the venture capital fund, investors and manager can lead to very significant costs for cross-border venture capital funds and their investors and this diminishes investment returns which in turn makes high risk investment like venture capital less attractive. 1 Source: European Commission Report of Expert Group on removing tax obstacles to cross-border Venture Capital Investments, page 20. Page 2 of 18

3 Major Barrier to EU Economic Growth At present, the 27 different taxation systems of the European Union are probably a significant barrier to: (i) reducing the tax risk of a portfolio of venture capital investments; (ii) achieving an appropriate net of tax return which reflects the risk taken in a (iii) portfolio of venture capital investments; and attracting venture capital investment from major sources of such finance, namely, the United States and the Middle East; and, in the light of the Financial Times article mentioned on page one of this submission, to the economic growth, competitiveness and employment creation potential of the EU. In view of the typical structure of venture capital funds as outlined on page 10 of the Report of Expert Group on removing tax obstacles to cross-border Venture Capital Investments 2, the risk of double taxation either: (i) where two countries want to tax the same income received by the same taxpayer; or (ii) a company s profit is taxed at the company level and at the shareholder level when dividends are paid out of profits, is a major barrier to investors and venture capital funds seeking to invest throughout the EU. Permanent Establishment Issue The activities of managers of publicly quoted equities are accepted 3 as activities of independent agents and do not risk creating a permanent establishment for the fund or investors in the fund in any country other than the one in which they are based or resident. By contrast, the activities of a manager of a private equity fund in a tax jurisdiction run the risk of the fund and its investors being classified as having a permanent establishment in that tax jurisdiction and having to allocate income to that jurisdiction with possible double taxation 4 consequences for the fund or its investors if the fund is regarded as tax transparent. In the absence of taxation and other constraints, a venture capital manager investing across EU borders would seek to gain local knowledge in the host Member States and would identify potential investments and draft terms, conditions and prices in relation to those investments and ultimately decide whether to invest or not. Then following any investment the venture capital manager would probably be closely involved with the portfolio company. The idea of a permanent establishment is designed to ensure that tax authorities in a country are not deprived of taxation from businesses carried on in that country by persons outside that country who have not established a local entity in that country. The OECD definition and commentary on the permanent establishment concept is quite wide and regards a person who is acting on behalf of an enterprise and who has and habitually exercises in a country an authority to conclude contracts in the name of the enterprise as having a permanent establishment in that country. If a venture 2 Available at obstacles_venture_capital_en.pdf on 16 July Source: EU Commission Report of Expert Group on removing tax obstacles to cross-border Venture Capital Investments, pages 1 and Double taxation may arise because of taxation at the level of the deemed permanent establishment and at the level of the investors. Page 3 of 18

4 capital manager is an agent of independent status in the host Member State and is acting in the ordinary course of business, it will not be regarded as having a permanent establishment in the host Member State. The difficulty for venture capital managers is whether they are regarded as an independent or a dependent agent of the venture capital fund or its investors. Different approaches by tax authorities in different Member States create uncertainty as to whether activities of the venture capital manager carried out in the Member State of a portfolio company would be considered to constitute a permanent establishment of the venture capital fund or its investors in that Member State. While it is a question of fact based on what a venture capital fund manager does in the jurisdiction of residence of a portfolio company whether the venture capital fund manager establishes a permanent establishment in that jurisdiction, artificially restricting its activities 5 to avoid additional tax at the management level reduces the effectiveness of venture capital investing in the EU. Venture capital fund managers ought to be viewed as independent agents acting in the ordinary course of their business in the same way as managers of funds of public equities are regarded as agents independent of the fund and its investors. Classification of Tax Status of Venture Capital Fund in Home & Host Member States The classification for tax purposes of a venture capital fund in the Member State in which it is established i.e. as between transparent or non-transparent, trading or nontrading, resident or non-resident, subject to tax or not subject to tax, may not be generally acceptable throughout the EU. The differences in the classification of a venture capital fund between different Member States may, in the absence of inefficient, costly and complex structures, give rise to double taxation for the fund or the investors or in some cases no taxation for either the fund or the investors. For example, if a venture capital fund is treated as tax transparent in its home Member State and non tax transparent in a host Member State, the fund will be taxed in the host Member State because the fund vehicle is non tax transparent and the investors will be taxed in their home Member State where the same fund vehicle is regarded as tax transparent giving rise to double taxation. An EU directive setting out a common classification for tax purposes of venture capital funds would be a major step forward in resolving this issue. Principal Recommendation The nature of the global venture capital industry is that funds consist of investors from many countries and invest in more than one country. Where there is significant uncertainty surrounding the tax treatment of investments in venture capital funds, investors appetites for participation in cross-border venture capital funds are diminished which reduces the assets available for cross-border venture capital funds. 5 In order for the venture capital fund manager to avoid creating a permanent establishment in a jurisdiction, the venture capital fund manager typically has to limit its activities in that jurisdiction to the mere provision of advice. The advice is usually provided by one or more separate advisory companies which analyse the market in that jurisdiction, identify and evaluate potential venture capital investments and prepare investment proposals but do not carry out management functions. In order to avoid the risk of permanent establishment for the venture capital fund or its investors, such advisory companies are subject to frequent and detailed reporting in regard to their participation in negotiation with potential portfolio companies and are not granted authority to conclude contracts on behalf of the venture capital fund. This is highly inefficient, costly and complex while not completely eliminating the risk of the venture capital fund manager being deemed to have established a permanent establishment in the jurisdiction. Page 4 of 18

5 In addition to the proposals in the Consultation which we welcome, we would urge the European Commission to redouble its efforts to get a group of at least ten Member States to co-operate in the area of the taxation of venture capital. In particular, (a) the contrasting tax treatment of: (i) managers of publicly quoted companies; and (ii) managers of private equity investments in relation to the issue of deemed permanent establishment; and (b) the need for a common classification for tax purposes of venture capital funds as between transparent or non-transparent, trading or nontrading, resident or non-resident, subject to tax or not subject to tax, may well be suitable starting points to begin the discussion with Member States. This group of ten should ideally consist of a number of Members States that have strong and developed venture capital investment skills and a number of Member States where innovation is part of the culture and venture capital investment would be likely to provide the finance to commercialise the innovation opportunities. The United Kingdom, Finland and Luxembourg appear to be three countries with which to start the negotiations as they seem 6 to have the appropriate structures in place that meet the needs of private equity managers and the investors in their funds. If such a group of ten Member States ( VC-10 Group ) could be successfully established, their mutual attractiveness from the points of view of venture capital investors and start-up SMEs would likely drive a majority of the remaining 17 Member States into joining the VC-10 Group. We strongly believe that it is likely that the changes to the tax regimes of the VC-10 Group would demonstrate to the remaining 17 Member States that the rising economic growth actually increases tax revenues in VC-10 Group Member States when compared with the likely possible loss of tax revenues from making the necessary changes in tax law to join the VC-10 Group. Summary Double taxation makes investing in venture capital funds uneconomic for investors. It is difficult for venture capital funds to achieve economies of scale without investing across borders. Improving economies of scale may encourage new entrants into the venture capital market. The uncertainty surrounding double taxation for venture capital investors investing across EU borders must be removed to stimulate venture capital funds to invest across EU borders. 6 Private Equity Fund Structures in Europe An EVCA Tax and Legal Committee Special Paper June Page 5 of 18

6 Part B Box 1 a) Do you think that encouraging Member States to a process of mutual recognition of venture capital funds, based on the direct enforcement of the Treaty freedoms, could facilitate the cross-border activity of these funds? Yes b) Do you believe that the main impediment preventing cross-border venture capital fundraising and investments is the absence of a passport for activities under the AIFMD thresholds; or the fact that the AIFMD is not tailored to venture capital in general? Neither of the alternatives is the main impediment preventing cross-border venture capital investing and raising funds. The main impediment is the risk of double taxation arising from the permanent establishment rules and the different classification of a venture capital fund under taxation legislation in the 27 different EU Member States. Venture capital is inherently a very high risk business so it is really important to understand just how significant the additional risk of double taxation is to the return stream which rewards venture capital risk taking. A passport system for venture capital funds where that concept is clearly defined in an EU directive would be a first step towards assisting in eliminating the differential treatment of a public equity fund and a private equity fund in relation to the permanent establishment rules and may lead to agreement among a minimum number of Member States in forming the VC-10 Group described in Part A of this submission. c) Is a targeted modification of AIFMD rules for venture capital or a standalone initiative in this area the more appropriate tool to increase venture capital activities? Please specify. In the light of the research 7 showing that during the past generation, start-ups less than five years old have accounted for all net job growth in the U. S., we believe that a standalone initiative would be the preferable option in order to have an immediate effect on job creation. d) From your experience, could you provide concrete examples where you encounter additional administrative or regulatory hurdles when raising or investing funds across the EU? The two main hurdles are tax related: (i) differential tax treatment of a public equity fund and a private equity fund in relation to the permanent establishment rules; and (ii) the different classification of a venture capital fund under taxation legislation in the 27 different EU Member States. e) Do you believe that an initiative on cross-border operations of venture capital could contribute to eliminating the cross-border tax problems encountered and if so, how? 7 Quoted in the Financial Times on-line on 4 July 2011 in an article entitled A jobs plan for the Starbucks generation by Andrei Cherny. Page 6 of 18

7 Yes; incorporating a definition of a venture capital fund and manager in an EU directive may help in making progress on getting a small group of Member States to co-operate in relation to the taxation problems as there would be a common understanding throughout the 27 Member States of what a venture capital fund is and how a venture capital manager operates. We believe that such an initiative on cross-border operations of venture capital would make it easier to get the VC-10 Group of Member States to co-operate on eliminating the major tax barriers to EU-wide venture capital funds. While tax authorities are primarily concerned about whether they gain or lose revenue in the wake of changes, we believe that an EU directive defining a venture capital fund and manager would give EU tax authorities: (i) a much higher level of comfort about the structures and the operations of managers of EU-wide registered venture capital funds; and (ii) lead to: (a) a resolution of the permanent establishment issue in favour of treating venture capital managers as independent agents acting in the ordinary course of business; and (b) a common classification of venture capital funds for tax purposes across the EU. f) How could a possible passport for venture capital operators facilitate targeted tax incentives in favour of cross-border venture capital investments? Please see the response to e) above. Box 2 a) Do you agree with this approach? If not, what alternative approach would you suggest? Could you then briefly outline the pros and cons of such an alternative? Yes; we agree with the European Registration approach. We would very much favour registration with the European Securities and Markets Authority ( ESMA ) as this would lead to a single database of venture capital funds and managers operating across the EU. By contrast, where a venture capital manager registers with the competent authority of its own Member State and that Member State notifies the other 26 Member States, information on the contribution of venture capital funds and managers operating under a European Registration to the EU s economic growth would be fragmented and would require significant effort to collect data each time an EU view of venture capital operating under the European Registration is required. A European Registration system centralised at ESMA would, in our view, give tax authorities in the 27 Member States greater confidence concerning venture capital entities operating across the EU. As we suggested in Part A, tax authorities in the 27 Member States or at least in 10 Member States might be asked to come to a common understanding on rules on permanent establishment and the classification of venture capital funds for the purpose of double taxation conventions. Under the approach suggested in Section 2 of the Consultation, there is clearly defined information in ESMA European Registration database in relation to identification, domicile, structure, resources, identify of persons conducting venture capital business, objectives, investment policy, geographical area of activity and the Page 7 of 18

8 identity of significant shareholders all of which ought to give tax authorities greater comfort on venture capital funds and managers operating in their individual jurisdictions. b) Do you consider such a voluntary regime to have any major cost implications for the key stakeholders? (Investors, competent authorities, venture capital business). Please specify. As outlined in Section 2, 1) of the Consultation, the approach suggests that managers provide ESMA with certain basic information. We believe that this is a small cost compared with the potential benefits of an EU-wide passport and the comfort it may give taxation authorities in the 27 Member States in coming to a common understanding in relation to the issues of permanent establishment and classification of venture capital funds, managers and investors. Centralising the European Registration at ESMA reduces industry fragmentation and lowers costs for competent authorities. c) Based on your experience, could you provide qualitative and/or quantitative assessment of potential cost savings that the European 'Passport' would bring about? Speaking qualitatively, a European Passport would eliminate the need for registration in the individual Member States and thereby eliminate the professional fees and management time involved in registering in a number of Member States. d) What information should the manager provide to the competent authority? The manager might reasonably provide basic information on itself and the funds it wishes to passport throughout the EU including for the manager and each fund the following information: 1. Identification 2. Domicile 3. Structure including tax classification of each fund vehicle in its relevant country of domicile 4. Resources 5. Identity of the persons conducting the business 6. Investment policy and objectives 7. Identity of significant shareholders The answer to this question might usefully be partly determined by a survey of taxation authorities in the 27 Member States. The purpose of the survey would be to determine the information the tax authority in each Member State might reasonably require in relation to venture capital funds and their manager who are established outside the tax authority s jurisdiction. Such a survey may also highlight the problems of double taxation in relation to venture capital funds and their managers to tax authorities and Member States. At the same time, there is an opportunity for the Commission in conducting such a survey to point out the potential tax revenue benefits of the availability of venture capital to fund new start-ups and provide expansion capital for SMEs in their Member State. Page 8 of 18

9 e) What option would you favour: registration with the national authority or with ESMA? Alternatively, ESMA could hold a European register of venture capital managers and funds with the information provided by national authorities. Would you favour this solution? In order to monitor the contribution of venture capital funds and managers to economic growth and job creation, venture capital funds and managers ought to be registered with ESMA. ESMA registration of venture capital funds has the advantage of introducing some competition into the regulatory landscape. ESMA might provide competent authorities and tax authorities in the Member States with access to an on-line portal with all the relevant information on venture capital funds and managers holding an EU passport. Box 3 a) Do you agree with this approach? If not, what alternative approach would you suggest? We have suggested that the registration of venture capital funds and their managers for the purposes of gaining an EU passport should be centralised with ESMA who might offer access to its register to competent authorities in the EU via a secure web portal. ESMA could provide notification to the competent authorities of all 27 Member States once a new venture capital fund and its manager have registered with it so that the competent authorities could view the registration on ESMA s secure web portal. b) What should be the content and timeframe of the notification? If venture capital funds and managers are registered with ESMA, then notification to the competent authorities of the 27 member states might reasonably take place within five business days of registration. Should the notification cover both, the places where the manager intends to invest in SMEs and the places where it intends to raise funds? No; this perpetuates fragmentation of the venture capital industry. Once a manager and its venture capital funds are registered with ESMA, competent authorities might reasonably be notified of each registration. Once notified, competent authorities would then be able to access all the information available to ESMA. c) Do you consider such a procedure to have any major cost implications for the key stakeholders? (Investors, competent authorities, venture capital business). Please specify. Such procedures are unnecessary where ESMA acts as the central register of EU-wide venture capital funds and their managers and competent authorities may access ESMA web portal for such information once they receive the initial notification of registration from ESMA. Box 4 Page 9 of 18

10 a) Do you agree with this approach? If not, and in case you believe venture capital should be accessible to retail investors, what kind of measures would you recommend to ensure their protection? In the same way that the AIFMD restricts the European passport to marketing to professional investors, we agree that venture capital funds covered by the European passport should be restricted in their marketing to professional investors. If a venture capital fund and its manager wish to target retail investors as a potential source of capital, then the manager should comply with the MiFID Directive to ensure that retail clients obtain the benefits of disclosure obligations and investor protection. b) What are the restrictions (if any) on participation of retail investors in your country within the fund structures used for venture capital investments? Venture capital funds structured as non-ucits investment funds may be sold to Irish investors who are prepared to subscribe a minimum investment of EUR12,500. However, for such a non-ucits fund to be authorised, the manager must be authorised under MiFID so that the manager is subject to the disclosure and investor protection obligations of the MiFID directive as implemented in Ireland. In Ireland, to our knowledge, there is no legislation prohibiting the participation of retail investors in venture capital funds structured as unregulated limited partnerships under the Limited Partnership Act Box 5 a) Do you agree with this approach? If not, what alternative approach would you suggest? Yes; however we would add that in order to facilitate EU-wide comparisons of the performance of and uniformity of disclosure in relation to venture capital funds by both investors and competent authorities, the Commission might consider making it a requirement of the receipt of a European Registration for venture capital funds and managers that they draw up their annual report and audited financial statements under International Accounting Standards. b) Do you agree with the need to require an annual report for each fund? Yes c) Do you agree that the annual report should reflect the annual financial accounts and a report of the activities of the financial year? Yes; EU-wide venture capital funds registered with ESMA might reasonably be required to report under international accounting standards so that their reports may be interpreted using a common set of accounting policies throughout the EU. d) Do you agree with the obligation to audit the financial information of the annual report? Yes e) What reporting requirements/obligations exist within the fund structures used in your country for the purpose of venture capital investments? Page 10 of 18

11 Irish venture capital funds structured as unregulated limited partnerships under the Limited Partnership Act, 1907 must register with the Companies Registration Office providing such details as the name of the firm, the general nature of the business, the principal place of business, the partners or the name of any partner, the term or character of the partnership, the sum contributed by any limited partner and the liability of any partner by reason of his becoming a limited instead of a general partner or a general instead of a limited partner. The Companies Registration Office must be updated promptly following any changes in such details. Irish venture capital funds structured as investment funds or investment limited partnerships are regulated by the Central Bank of Ireland and have half-yearly and yearly reporting requirements. Such reports are publicly available and include balance sheet information, number of units in issue, net asset value per unit, list of investments and their proportion of net assets, a report on the development of portfolio companies, the profit or loss on the sales of portfolio companies, statement of changes in portfolio composition, details of significant (>10% of assets) deposits, description of any material changes to the prospectus, list of exchange rates used, a statement of the developments concerning the assets of the scheme during the period under review, a comparative table covering the last three financial years and including for each financial year, at the end of the financial year, the total net asset value and the net asset value per unit, reports on the activities of the financial year, trustee s report and a report on transactions entered into with related parties. Would you consider that the proposed information requirements would constitute a significant administrative burden? Please specify. We believe that the information requirements set out in paragraph 2, 1) of the Consultation would not constitute a significant administrative burden relative to the benefit of an EU passport. f) Do you think that more information requirements should be imposed on venture capital managers? If so, please specify Venture capital managers and funds raising investment capital from retail investors ought to comply with the equivalent information disclosure requirements of MiFID. Box 6 Do you think there is a need to specify any operating condition for venture capital entities? Yes; however, our answer would differ as between venture capital companies targeting professional investors as opposed to retail investors in seeking to raise funds. Professional Investors For venture capital entities seeking to raise funds from professional investors, we do not believe that there is any need for operating conditions beyond a requirement that funds and their managers observe high standards of commercial honour and just and equitable principles of trade in the conduct of their venture capital business. Retail Investors Page 11 of 18

12 For venture capital entities seeking to raise funds from retail investors, we believe that the manager should be MiFID authorised and regulated and that the fund should be authorised and regulated and have independent, valuation, custody, administration and accounting service providers. This necessarily raises the costs for retail investors investing in venture capital funds as the price of investor protection. If yes, what would you consider as sufficient EU level framework for venture capital managers in this area and what level of compliance cost would this entail? See the response to the previous question. Do you think that it should be specified that venture capital entities should comply with rules of conduct when dealing with their investors? If yes, to what extend? See the response to the first question of Box 6. Do you think that it should be specified that venture capital entities should comply with specific organisational requirements? Yes but only in the case of venture capital funds seeking to raise capital from retail investors. The requirements are outlined in the response to the first question of Box 6. If yes, to what extent? See the response to the first question of Box 6. Do you think that it should be specified that the persons effectively conducting the business should have good repute and experience? If yes, to what extent? In order to give investors and portfolio companies in host Member States of the venture capital fund and its manager, it might be best that some form of good repute test be carried out as part of ESMA registration. In addition, a survey of taxation authorities in the 27 Member States might reasonably inform the response to this question given that the elimination of double taxation without the need to create artificial structure is probably the single biggest barrier to venture capital funds and managers operating with lower tax risks across the EU. Do you think that it should be specified that the significant shareholders should be suitable? If yes, to what extent? For the purpose of anti-money laundering and countering terrorist financing, it may be appropriate that all significant shareholders be identified and evidence of their identity retained. In addition, a survey of taxation authorities in the 27 Member States might reasonably inform the response to this question given that the elimination of double taxation without the need to create inefficient, costly and complex structures is probably the single biggest barrier to venture capital funds and managers operating with lower tax risks across the EU. Box 7 a) Do you agree with this approach? If not, what alternative approach would you suggest? Page 12 of 18

13 Yes; however, it might be useful to survey the taxation authorities in the 27 Member States to see if any common ground can be reached among a majority of tax authorities as to entities that would receive the same tax classification in as many Member States as possible. b) Is it convenient to specify in the legislative proposal the legal forms that the venture capital funds might adopt? Yes; it is an essential step in achieving a resolution to the differential tax classification of the same venture capital fund by two different tax authorities. c) Is there any other aspect relating to the legal form of the venture capital entities that the proposal should take into account? A survey of taxation authorities in the 27 Member States might reasonably inform the response to this question given that the elimination of double taxation without the need to create inefficient, costly and complex structures is probably the single biggest barrier to venture capital funds and managers operating seamlessly across the EU. Box 8 a) What, if any, investment criteria determine your existing national fund structures used for purposes of venture capital investments? For funds structured as unregulated limited partnerships there are no investment criteria required by legislation. For funds structured as non-ucits and open to retail investors, the fund must observe the principle of risk spreading and specifically cannot invest more than 20% of that portion of net assets which it intended to be invested in venture or development capital investments in any one company or group of companies. Subject to certain conditions, the fund may derogate from the restriction for one year following its launch. b) Do you think it is worth specifying any investment rules for venture capital funds? If yes: Venture capital funds granted a European passport might be restricted to investments in cash, quasi-cash instruments and investments in SMEs. c) Do you think there is a need to define a compulsory investment percentage of assets that the venture capital fund should invest in SMEs? If yes, what compulsory investment percentage would you propose and how should it be calculated? Apart from cash or quasi-cash holdings, venture capital funds are likely to hold the remainder of their investments in SMEs. We don t believe it is necessary to define a compulsory investment percentage of assets that venture capital funds should hold in SMEs. d) Do you agree with the need to envisage a flexible application of the principle described? Yes Box 9 Page 13 of 18

14 a) How do your national rules capture (if at all) the definition of venture capital funds? We are not aware of any national rules that define a venture capital fund. b) Should the temporary nature of the venture capital investment activity in SMEs constitute a criterion that should be reflected? No; specifying limits on the time horizon of investments may give rise to forced disposals with adverse tax or timing consequences. c) Do you think it should be specified any temporal limit (minimum and maximum) to the participation of the venture capital fund in the capital of the SME (i.e., from at least 2 to 10 years)? No d) Are there any other means of finance that venture capital funds provide to SMEs that should be reflected (e.g. loans)? As part of a provision of venture capital, loans should not be outlawed or excluded by any definition of venture capital. Some venture capital funds provide finance for portfolio companies by means of a combination of equity and high-yield debt. A venture capital fund may provide a portfolio company with a contingent loan which might be repayable at a premium if the portfolio company were successful but might not be repayable if the company failed to reach certain targets. Further, some venture capital funds provide bridging finance in the form of a simple loan or a convertible security to portfolio companies. e) Do you think that there is a need to specify that the manager should be actively involved in the development, growth and success of the SME? No; given the commitment of the venture capital fund s capital to the SME, it is highly likely that the manager will be actively involved in the development, growth and success of the SME. Further, specifying active involvement would require a definition and give rise to measurement issues so that the manager could demonstrate compliance with the definition. This would only lead to unnecessary additional costs. Or should the passive investment in an SME also be considered by the proposal as venture capital investment? Yes; if the venture capital manager has a high level of confidence in the portfolio company s management team for whatever reason and does not wish to have an active role in managing the investment in the portfolio company, that business model should not be ruled out. Both of the questions in e) may raise important issues for tax authorities in the 27 Member States in reaching an agreement in relation to the permanent establishment concept and in relation to the classification of a fund for tax purposes. It might be useful to survey the tax authorities in the 27 Member States on this point as it may have adverse tax consequences for venture capital funds operating under an EU passport. f) What other criteria would you consider appropriate to capture the venture capital activity? Page 14 of 18

15 We would define a venture capital fund as one that provides finance exclusively for: (i) the Seed stage of a business idea to an individual or group of individuals or an SME; or (ii) SMEs at the Start up stage or the Expansion stage. All three terms in italics are as defined in the State Aid Guidelines and EVCA glossary and the term SME is defined in Commission Recommendation of 6 May In addition, the SME in receipt of the financing must not be publicly traded or controlled by a publicly traded company, it must not borrow or issue debt obligations (other than borrowing from the venture capital fund or issuing debt obligations to the venture capital fund) directly or indirectly, in connection with the fund s investment in the SME, it must not redeem, exchange or repurchase any securities of the SME, or distribute to pre-existing security holders cash or other assets of the SME, directly or indirectly, in connection with the fund s investment in such company and it must not itself be a fund. Box 10 a) To what extent does your national regime capture the above definitions of typical venture capital strategies? To our knowledge, there is no definition of a venture capital fund in Ireland. b) Do you agree that the special rules on venture capital should only apply when funds invest in the seed, start-up and expansion stages of SMEs? Yes; research 8 has shown that during the past generation, start-ups less than five years old have accounted for all net job growth in the U. S.. If not, do you believe that SMEs in a restructuring phase should also benefit from venture capital? Not applicable. What other alternative approaches would you suggest? Not applicable. c) Would you propose other definitions to define the permitted portfolio of venture capital funds? We would define a venture capital fund as one that provides finance exclusively for: (i) the Seed stage of a business idea to an individual or group of individuals or an SME; or (ii) SMEs at the Start up stage or the Expansion stage. All three terms in italics are as defined in the State Aid Guidelines and EVCA glossary and the term SME is defined in Commission Recommendation of 6 May In addition, the SME in receipt of the financing must not be publicly traded or controlled by a publicly traded company, it must not borrow or issue debt obligations (other than borrowing from the venture capital fund or issuing debt obligations to the venture capital fund) directly or indirectly, in connection with the fund s investment in the SME, it must not redeem, exchange or repurchase any securities of the SME, or distribute to pre-existing security holders cash or other assets of the SME, directly or 8 Quoted in the Financial Times on-line on 4 July 2011 in an article entitled A jobs plan for the Starbucks generation by Andrei Cherny. Page 15 of 18

16 indirectly, in connection with the fund s investment in such company and it must not itself be a fund. d) Do you agree that venture capital funds do not/should not use leverage? We do not believe that leverage restrictions should be applied to venture capital funds. Box 11 a) Do you agree with the list of entities described as not being proper investment targets for venture capital funds? Yes we agree that publicly traded SMEs and SMEs controlled by publicly traded companies are not proper targets for venture capital funds. In this regard, care may need to be taken where the venture capital fund is itself publicly quoted. b) If not, what types of companies would you specify as eligible investment targets? Not applicable. c) Do you think that the EU should draw inspiration from the criteria set by the SEC to define the target companies of the venture capital funds? The SEC definition may be too narrow in that it focuses largely on the issue of public quotation, borrowing, distributions and redemption/exchange/repurchase of securities. It may however form part of a more comprehensive EU definition of a qualifying portfolio company. The restrictive focus of the SEC definition may be of assistance in making progress on the tax obstacles faced by venture capital firms. In an EU context, the definition may need to be widened to include the provision of finance exclusively to SMEs 9 for Seed stage, Start up stage or Expansion stage finance as those terms in italics are defined in the State Aid Guidelines and EVCA glossary. Box 12 What could be an appropriate regime for third country venture capital funds? We have considered two options that might be appropriate: 1. Require the third country venture capital to register with ESMA and grant it an EU Passport if it is capable reaching ESMA registration provisions. 2. Mutual recognition by the EU and the third country of the concept of a venture capital fund and its manager without the need for registration in the EU other than for statistical purpose to evaluate the effectiveness of third country venture capital funds and managers at job creation and contribution to EU growth. World Trade Organisation s General Agreement on Trade in Services may also be relevant in constructing an appropriate regime. Given that the Middle East and the U. S. are very significant sources of venture capital, understanding the issues for venture capital investors, managers and funds of such countries and concluding agreements with such third countries might be a priority for the Commission. 9 As that term is defined in Commission Recommendation of 6 May Page 16 of 18

17 Box 13 a) Do you agree with this approach? Yes. b) Would you support the first (exemption for entities below the AIFMD threshold) or the second option (exemption independently from the threshold)? We would support the second option. Venture capital is so important to the GDP and employment growth of the EU that it needs a separate venture capital regime for all those entities providing venture capital to SMEs regardless of the size of the entity. Would you suggest an alternative approach? Not applicable c) Are there any particular elements from the AIFMD that in your view should also apply to the venture capital managers? We believe that the Commission might be well served by consulting the taxation authorities in the 27 Member States to determine what particular regulatory features of a venture capital fund and manager from outside their jurisdiction would give them comfort in relation to co-operating on the elimination of double taxation hurdles in the area of permanent establishment and the classification of the venture capital fund for taxation purposes. Venture capital funds and managers seeking to raise money from retail investors ought to be subject to the investor protection and disclosure rules as set out in MiFID. Box 14 a) Do you agree with this approach? If no, what alternative approach would you suggest? Light obligations might perhaps be matched by powers to sanction venture capital funds and managers for breaches of the rather light obligations. The legislation should also provide for the Commission to sanction competent authorities for failing to effectively implement the European passport for venture capital. b) What supervisory powers should be granted to the competent authorities for the supervision of venture capital funds and managers? We have suggested that ESMA ought to be the competent authority for venture capital funds and managers under the proposed European passport arrangement. ESMA should be given the following supervisory powers: Powers to sanction venture capital managers and investors for providing false or misleading information to the ESMA as part of the initial registration process and failures to keep that information up to date; Powers to require disinvestment by unsuitable significant shareholders; Powers to remove managers who are not of good repute; Page 17 of 18

18 Powers to sanction venture capital funds and managers for failure to observe high standards of commercial honour and just and equitable principles of trade in the conduct of their venture capital business; and Powers to investigate complaints from investors, portfolio companies and members of the public. For venture capital funds raising capital from retail investors, the powers outlined above would be in addition to the sanctions provided for in the MiFID Directive and implemented in each Member State. c) What type of sanctions should be envisaged? Sanctions might range from: (i) a reprimand to; (ii) fines related to the managers fee income and to the capital value of venture capital funds deferring where necessary the payment of a fine on a venture capital fund until the sale of one or more portfolio companies so as not the harm the prospects of portfolio companies; to (iii) removal of the European passport. Erica Caslin, Muckross Park College, Donnybrook, Dublin 4. Caolan O Callaghan, Actuarial & Financial Studies Student, UCD, Belfield, Dublin August 2011 Page 18 of 18