According to the South African Revenue Service (Sars), 724 investors took advantage of the incentive in 2017, which was a substantial increase compared to the 34 and 272 individuals for the 2015 and 2016 tax years respectively.
Section 12J is an initiative by Treasury to mobilise capital towards small and medium-size South African businesses. It entails registering a venture capital company with Sars, and inviting taxpaying investors to take up shares in the company. Investors can deduct 100% of their investment upfront against their taxable income. Section 12J vehicles allow investors access to well-regulated, tax-managed private equity while managing their tax liability during the provisional tax season. Their money is pooled and put to work in specifically identified opportunities. There are currently in excess of 80 such companies registered.
Minimum investments into 12J companies tend to vary, but there is no upper limit to the amount you can claim back from the receiver for a Section 12J investment.
To retain the upfront tax deduction, it is necessary to stay invested for at least five years. During that period, if all goes as planned, investors should receive a commensurate return on their investment. On realisation of an investor’s venture capital shares, this entire amount would then be subject to standard capital gains tax rates.
“For many investors five years can feel like a long time in the current environment of political and economic uncertainty, and can increase their perception of risk,” says Ian Groenewald, CEO of TBI.
“This obviously creates demand for a higher return; however, the tax benefit should contribute towards this, allowing the manager to take more tapered risk exposure while still providing venture capital type returns.”
It’s important to understand how the venture capital company plans to invest your money so that it generates a return. After all, you won’t be able to access your capital for at least five years and the return needs to compensate for that. The Act has listed criteria for suitable investments, referred to as qualifying companies. It is extremely important that the venture capital company has a well-identified, well-researched pipeline of qualifying companies to invest in when it is established.
Given the strong focus on tax, investors should also expect the management of the venture capital company to have a suitable depth of tax knowledge. A failure of the venture capital company to abide by the requirements of 12J would result in stiff penalties, to the ultimate detriment of the investor.
“The 12J initiative is much needed in South Africa, spurring economic growth and job creation. There is also a great deal of pressure on the management teams of venture capital companies to manage both the tax risk and investment risk in these vehicles. Investors are therefore encouraged to do their due diligence before considering an investment,” Groenewald concludes.
