Ontario to abandon labour-sponsored investment funds?

Moratorium on new LSIFs imposed in first Liberal budget

Toronto - The days may be numbered for labour-sponsored investment funds (LSIFs) - as they now exist in Ontario.

A moratorium on the creation of new labour funds was announced in the province's first Liberal budget this week, and a review of existing funds will be made to determine their future.

The province now offers a 15% annual tax credit for anyone making investments of up to $5,000 in a labour fund dedicated to investing in small business.

Labour-sponsored venture capital funds were pioneered nationally by the now-defunct Canadian Federation of Labour, which was inspired the Solidarity Fund created in Quebec in the 1980s.

After the federal government for former Prime Minister Brian Mulroney endorsed the idea, it later spread to provinces across the country, allowing individuals to make personal investments and claim tax credits at both the federal and provincial level.

Now, in the view of Ontario, there are so many labour-sponsored funds that investment capital is being spread too thinly to be effective.

What the budget says

The following commentary on labour funds was included in budget documents made public by the Finance Minister Greg Sorbara when he tabled his inaugural Ontario budget this week:

Labour Sponsored Investment Funds (LSIFs)

Labour Sponsored Investment Funds (LSIFs) are significant fundraisers and investors in Ontario's venture capital industry. In 2003, LSIFs invested over $220 million in Ontario businesses, representing 34% of the total venture capital investment in the province. This capital is invested in new and emerging small and medium-sized businesses essential to Ontario's economy.

The LSIF program has been operating since 1991 and is now a mature feature of the tax system. As with all tax expenditures, it is important that the government review this program to ensure that it is still an appropriate vehicle for meeting the goal of increasing venture capital investment and that the Province and shareholders are receiving value for their investments. The Province will involve stakeholders in this review.

In the last several sales seasons, a number of newly registered LSIFs have failed to raise sufficient capital to be viable investment companies for the long term. LSIF capital is spread too thinly among too many LSIFs and many of the existing LSIFs are too small to be viable long-term investors.

To ensure the stability and health of the venture capital pool available for Ontario businesses, the Province proposes a moratorium on new LSIF registrations effective May 18, 2004. Applications for registration received by May 18, 2004 will be processed. This would allow existing LSIFs to continue operations and raise capital while the Province works with the federal government and venture capital community to determine appropriate changes to the LSIF program.

A number of amendments will be proposed to the Community Small Business Investment Funds Act that would ensure that the LSIF program continues to operate effectively while the program is under review. These amendments are described in the following pages.

The calculation of investment requirements has created difficulties in two respects. First, the current rules regarding the treatment of realized gains and losses were created when the program was new and did not contemplate older LSIFs with long investment histories. Several LSIFs face increasing investment requirements even if they are capped and have no new capital to invest.

Second, the determination of investment requirements of an LSIF formed from the amalgamation of two LSIFs can result in an unfavourable outcome. This has created a disincentive to amalgamate LSIFs, and resulted in smaller and less successful LSIFs being unable to grow or leave the program through amalgamations.

To remedy these situations, the following changes are proposed:

* introduction of rules allowing the amalgamation of LSIFs through asset purchases; and

* an amendment of the investment requirements such that LSIFs must offset 70% of realized losses deducted from investment requirements with a maximum of 70% of realized gains.

LSIFs are limited in the amount of investment they can make in public companies. In order to ensure that smaller public companies can raise capital, the following changes are proposed:

* the restriction on LSIF investments in companies listed on a stock exchange would be relaxed so that an LSIF could invest up to 25% of its investments in a year in listed companies; and

* to give LSIFs some certainty of their maximum investment limit, LSIFs would be able to determine this limit on the greater of either their current or previous years' investments.

Other technical amendments will be proposed as part of the government's on going evaluation of the Community Small Business Investment Funds Act. Minor amendments would:

* allow LSIFs to control investee companies;

* allow research-oriented investment funds more flexibility when determining their investment requirements by providing them with a choice of August 31 or December 31 as the date on which the requirement would be determined;

* change the calculation of the LSIF tax credit to conform to federal practice, giving investors greater certainty with respect to the amount of their tax credit;

* no longer permit LSIFs to count investments in holding companies against their investment requirements;

* clarify that investments that have been written off without having been disposed of would be deemed to be disposed of; and

* change various provisions to comply with administrative practice.