The potential approval of a new tax credit for venture capital in Ontario could create a much needed boost for the VC sector in the province. If passed, the measure also could provide an alternative for taxpayers who invest in labour-sponsored investment funds; investors in LSIFs will be losing the existing provincial tax credit for those funds by 2013.

The innovation and productivity tax credit for Ontario, proposed by the Toronto-based National Angel Capital Organization, is a refundable tax credit modelled on a provision available to taxpayers in British Columbia. The B.C. provision offers a refundable tax credit of 30% for amounts the taxpayer has invested in a startup business in any sector.

NACO, the umbrella group for about 30 regionally based clusters of angel investors in Canada who collectively invest more than $3 billion annually, has been pushing for the new provision in Ontario since 2003. NACO chairman Andrew Wilkes says his group is hoping the Ontario government will approve the new tax credit at its budget meeting this February. While it’s not clear why Ontario seems more interested in the IPTC concept this year, a post-recession job push in the province may be part of the reason. Ontario has long stated its wish to add high-quality jobs in knowledge sectors such as high-tech. Says Wilkes: “This is the first year we know they will be taking a serious look at the credit program.”

While NACO’s proposed IPTC is similar to past government initiatives aimed at increasing VC funding — such as the LSIF program — it represents a departure from past programs. The 30% credit proposed by NACO for the IPTC is double the 15% credit for LSIFs and allows for much higher contributions — $250,000 for the IPTC vs $7,500 for LSIFs. (The limit in B.C. for IPTCs is $200,000.)

The purpose of the IPTC proposed for Ontario, says John Ruffolo, chair of the tax committee for Toronto-based Canada’s Venture Capital & Private Equity Association, is to provide support for individual companies that require between $500,000 and $2 million in start-up capital. Says Ruffolo: “At that stage of funding, startups have typically exhausted the resources of family and friends, but don’t give bigger institutions the returns they are looking for.”@page_break@There are some limitations to the proposed IPTC. To get the full tax credit, investors must keep their money in the startup firm for at least five years. If the start-up is successful and is bought before the five-year period expires and the investor is repaid all or part of his or her capital, that taxpayer must repay, on a pro-rated basis, the amount received as a result of the tax credit.

Ruffolo believes this type of enhanced tax credit could be crucial to the health of the long under-funded Canadian VC sector: “Angel investors are becoming a more and more critical source of capital for funding at the early stages.”

At the moment, LSIFs make up about 40% of VC funding in Canada, but these investment vehicles are being phased out as a result of poor or negative returns for most of the program’s existence. Of all the companies LSIFs have invested in since the 1990s, Waterloo, Ont.-based Research In Motion Ltd. has been the biggest success story.

The B.C. program shows signs of greater success than the LSIF program. B.C. firms that received seed money through an IPTC typically go on to receive seven or eight times more funding down the road, Wilkes says: “Once they receive the initial seed money, they can launch more quickly and, assuming the company starts growing, it attracts more capital later.”

These types of tax incentives are most helpful for technology and life sciences startups, Ruffolo says, because this type of funding reduces the debt such startups may have to take on to develop untried technologies.

Before a technology company can sell its product, it often needs to spend millions to assess whether developing the product is feasible. Says Ruffolo: “Most angel investors are sophisticated enough to assess business risk — but not the technology risk — and may refrain from taking chances on these businesses.”

And they can lead to major successes, he adds: “Without these tax incentives to get [startups] over the hump, we may lose out on the next RIM.” IE