Incentive Investment Capital Programs: Part II

PART II (see part I for applicable definitions)

by Alina V. Nikolaeva

Venture Capital Programs

These programs encourage investors to make equity capital investments in BC small businesses that will enhance and diversify the provincial economy.  The government recognizes that creating new small businesses and expanding existing ones will contribute to a healthy economy.  These programs give small business continuous access to early-stage venture capital to help them develop and expand.  Venture Capital programs use the following investment models:

• Portfolio Investment – Venture Capital Corporation (“VCC”); and
• Direct Investment – Eligible Business Corporation (“EBC”) 

Small Business Venture Capital Tax Credit

Corporations or individuals investing in shares of a registered VCC or EBC can claim a Venture Capital Tax Credit established by Income Tax Act of BC (the “VCTC”).  Under this regime investors may claim 30% tax credit in a taxation year equal to the lesser of:

• Amount of the tax credit certificate issued by the Ministry of Small Business, Technology and Economic Development; and
• Provincial income tax otherwise payable.

The VCTC may be applied only to provincial income taxes payable.  The excess may be carried forward up to four years.

 Tax Credits

Tax credits are issued to investors only if the equity capital is raised by VCC or EBC, as the case may be, under a pre-approved authorization from the Investment Capital Branch and is in compliance with the Small Business Venture Capital Act.

 An individual, referred to in section 2(1) of the Income Tax Act of BC, who is resident in BC may claim up to $120,000 in tax credits in one year for after Budget 2019 and the following years.  An individual investor also has the option of claiming a tax credit for the prior taxation year if the shares were purchased in the first 60 days of the year.  The amount claimed is applied toward payment of provincial income tax amounts due with any excess refunded directly to the individual.

A corporation, referred to in section 2(2) of the Income Tax Act of BC, that has a permanent establishment in BC may claim the tax credit to offset BC income tax otherwise payable in a year.  The tax credit issued to a corporate investor is not refundable.

If an individual shareholder resides in BC at the date of the subscription for shares but moves outside the province at year-end, may not be able to claim the tax credit certificate.

Tax Credit Liability

If the VCC, EBC or its investors engage in an ineligible transaction or is in non-compliance with the Small Business Venture Capital Act, the investor may be required to repay the tax credits.  Under section 20(1) of the Small Business Venture Capital Act, the VCC, EBC and its investors must comply with the following:

• no tax credit has been previously allowed or paid for the shares;
• the shares, for which the VCC or EBC applies for tax credits, are not a type of security that entitles its holders to claim a tax credit against tax payable under the Income Tax Act (Canada) for the purchase of the security; and
• the eligible investor shareholders acquire the shares directly from the VCC or EBC.

A tax credit certificate issued under the Venture Capital Programs may be revoked by the administrator of the Small Business Venture Capital Act if the administrator determines that, at the time the tax credit certificate was issued or at a subsequent time, the VCC or EBC was in contravention of the Small Business Venture Capital Act or the Regulations under it.  A tax credit certificate that is revoked by the administrator is deemed never to have been issued.

1. VCC

A VCC is a corporation registered under the programs that have been formed for the sole purpose of investing funds in a number of start-up, emerging and expanding eligible small businesses.  These corporations usually are managed by venture capitalists or angel investors who provide small businesses with the benefit of their expertise, experience and business knowledge.

Registration

A VCC is a newly incorporated BC company registered under the Small Business Venture Capital Act.  BC investors earn a 30% tax credit for purchasing shares in registered VCCs.  These VCCs then use capital raised from investors to make equity investments in qualifying small businesses.

To register as a VCC, an applicant must, amongst other things:

• incorporate under the Business Corporations Act of BC;
• raise at least $25,000 in equity capital;
• never have previously carried on business; and
• have authorized capital of only voting common shares (the shares must be without par value and have no special rights or restrictions except for special rights relating to share redemption).  A VCC is entitled to have more than one class of common shares.

It should be noted that the Small Business Venture Capital Act limits the dollar value of tax credits that may be issued in a calendar year.  There are no guarantees that any applicant will be registered under the Small Business Venture Capital Act.

After incorporation, the new company must raise at least $25,000 in cash (up to a maximum of $50,000).  After issuing shares to one or more shareholders in exchange for the minimum $25,000 investment, the company may apply for registration by completing the Registration Application and all attachments to it.

Upon registration, all VCCs are automatically approved to raise $50,000 of equity capital.  If the VCC wishes to raise more than $50,000, it must file an Additional Equity Application.  Approvals to raise additional equity may be restricted by the Small Business Venture Capital Act’s limited tax credit budget.

The VCC cannot make any investments until it has been registered.

Eligible Investment

Section 10 of the Small Business Venture Capital Act lists the criteria for an investment transaction to be considered an eligible investment.  For an investment in a small business to qualify as an “eligible investment”, a number of requirements set out in the Small Business Venture Capital Act must be met.  These requirements include the following:

• a business must qualify as an “eligible small business”;
• the VCC must purchase treasury shares directly from the small business for cash;
• the VCC may purchase the shares of a small business indirectly through the conversion of convertible debt that is prescribed under regulation (prior Administrator approval is required);
• the investment must be at risk and at arm’s length;
• the VCC together with related parties and other VCCs must not control the small business;
• the shares held by the VCC must not carry prescribed rights and restrictions
• the maximum a VCC can invest in a small business (and any affiliates of the small business) is $10 million;
• the maximum all VCCs can invest in a small business (and any affiliates of the small business) is $10 million every two years. 

1. EBC

Under the ‘direct’ investment approach, a small business registers as an eligible business corporation under the venture capital programs.  This allows a small business to accept equity capital directly from investors without having to set up a venture capital corporation or VCC.  This investment structure is ideal for an investor planning to be actively involved in the growth of the small business.

Registration

Registration under the program by the Administrator confirms that at the time of registration the small business qualifies as an Eligible Business Corporation (EBC) under section 28.2, and as an eligible investment pursuant to section 10 of the Small Business Venture Capital Act; also, that the description of the business operations meet the prescribed activity requirements under the Regulation.

Eligibility Requirements

The requirements for registration as an EBC include the following:

• The EBC must be a corporation incorporated under B.C.’s Business Corporations Act, or Canada’s Business Corporations Act;
• The EBC must be substantially engaged (50%+) in BC in one or more of the 5 qualifying activities;
• The EBC, together with any affiliates, cannot have more than 100 employees at the time of an initial investment by an investor under the program.
• If the EBC’s employment grows beyond 100 the EBC may raise additional equity capital from the same VCC or EBC investors.
• The EBC must pay at least 75% of its wages and salaries to employees who regularly report to work at operations located in B.C.
• The 75% threshold drops to 50% for EBCs primarily engaged in the export of goods or services outside BC;
• The EBC must maintain a permanent establishment in B.C.
• The EBC must maintain at least 80% of its assets in B.C.
• The EBC must have equity capital of at least $25,000 (not eligible for tax credits) prior to registration;
• The funds invested in an EBC under the program must be used to finance its start-up, expansion or growth.  An EBC must not use, directly or indirectly, any funds raised under the program for prohibited purposes, defined under section 11(2) of the Small Business Venture Capital Act Regulation. 

Duration of Eligibility Requirements

The EBC must maintain these eligibility requirements while it is registered in the program. Registration requirements end 5 years following the date of the EBC’s most recent issue of shares for which tax credits were issued.

Failure to maintain these requirements may result in the EBC’s registration in the program being suspended or revoked. Also, failure to correct the action that caused the suspension or revocation may result in the government demanding repayment of tax credits previously issued. 

Equity Authorization

The maximum equity capital that an EBC can raise under the Venture Capital Program is $10 million for after Budget 2019 and the following years.  Upon registration the EBC will receive an equity authorization specifying the amount of equity it can raise under the program for the current tax budget year. The equity authorization will also specify a commencement and an expiry date. The maximum duration of an equity authorization is 12 months. Between the two dates specified in the equity authorization the EBC can raise equity capital for which investors are eligible to receive tax credits.