The 12J Association of South Africa recently published an analysis of the employment impact of this tax incentive on SMMEs.
We have previously written about the merits and possible red flags of investing in 12J tax incentive schemes. You can access the article by clicking here.
We have summarised some of the main points of the 12J Association’s analysis below.
First of all a reminder. What are Section 12J investments and how do they work?
Section 12J investments were first introduced by the South African Revenue Service, on instruction from National Treasury in 2009. A tax incentive was created through Section 12J of the Income Tax Act 1962 with the purpose of stimulating economic growth and creating jobs.
The tax deduction provided investors with a 100% write off for their investment in the year that they invested, on condition that investments were made into qualifying SMMEs. The rationale of the tax deduction was therefore to stimulate investment in SMME companies, which would hopefully then have a knock-on effect on employment and growth. It has long been recognised around the world that SMME success is a critical component of economic growth, and therefore job creation.
Qualifying section 12J investments offered individuals, trusts and companies resident in South Africa a tax rebate on investments (up to 45% for individuals and trusts and 28% for companies), if made through an approved venture capital company (VCC). The income tax relief under Section 12J was designed to be provisional in nature and only became permanent if investors held their VCC shares for a minimum period of five years.
Despite being launched in 2009, the real interest in Section 12J investments only picked up in 2015 when further amendments to the Income Tax Act were made. As of 2019, limits were imposed on the deduction claimable by taxpayers for the year of assessment. Individual taxpayers and trusts were limited to R2.5 million, while companies were limited to R5 million, per tax year.
Have the 12J investments met their objectives?
Until the report was published there was little in the public domain about the impact of Section 12J investments and/or whether they had contributed to employment opportunities.
The key conclusion of the 12J Association of South Africa’s publication was that the Section 12J incentive has indeed contributed to permanent jobs. In addition, the cost of creating these jobs has been cost-effective relative to other incentives.
It was reported that an estimated 5 250 permanent jobs had been created at a cost of R252 000 each. Over the short term, Section 12J investments had created an additional 5 250 temporary (mostly construction) jobs, and if these were taken into account the total cost per job reduced to R126 000 each. According to the report, these figures should be compared with benchmark data from the Industrial Development Corporation, which shows that other job creation focused incentives allowed for a cost per job of up to R450 000.
The report argued that Section 12J had been an efficient allocator of equity capital to SMMEs, at a time when access to capital had been crucial. In addition, survey respondents believe 76% of the total capital invested by Section 12J into small businesses had been incremental, meaning that if Section 12J opportunities had not been available, an approximate R4.2 billion would never have been invested into local SMMEs.
According to the report, the top three areas of investment, as measured by jobs created included hotel-keeping, operating rentals and technology development. Between 2015 and 2020, R2 billion was invested in the hotel keeping sector in 98 investments. The report noted that tourism remained a key driver of South Africa’s national economy and was a major contributor to job creation.
The report quoted research from consulting firm PricewaterhouseCoopers (PwC) that states that for every R1 invested into tourism an additional R1.26 of GDP activity is generated and for every R1 million invested into the sector seven jobs are created. In addition, according to PwC, the tourism industry has the fourth-highest job multiplier of any industry in South Africa as well as a relatively high tax revenue multiplier (every R1 investment in hotel keeping was expected to yield R0.99 in tax revenue).
The publication reported that the three most popular reasons that investors chose to invest in Section 12 J investments were to gain exposure to SMME investments, to gain exposure to alternative products and to ‘impact invest’.
|Section 12J investments in a nutshell|
|AUM in Section 12J investments||R9.3 billion (Feb 2020)|
|Number of businesses/SMMEs invested in||360|
|Jobs supported/ created (permanent)||5 250|
|Jobs supported/ created (temporary and permanent)||10 500|
|Cost per permanent job (Sec 12J)||R252 000|
|Cost of jobs benchmarked against other job creation programs*||Up to R450 000|
|Number of registered and approved venture capital companies**||180|
|Number of participating investors||5 500|
|Average investment size per investor||R1.7 million|
|Split of investors type [individual, trusts, corporates]||57%, 8%, 35%|
|Estimated cost of Section 12J tax relief to the fiscus (2015 – 2020)||R1.324 billion|
|Rural/ urban investment split||25%/75%|
Source: 12J Association of South Africa
*Benchmark with data from the Industrial Development Corporation
**Data from Sars
Why was the report by the 12J Association of South Africa published?
Section 12J investments were designed with a predetermined lifecycle; at the outset, they were subject to a ‘sunset clause’ effective June 2021.
The purpose of this report was therefore to demonstrate the fact that Section 12J investments have been an effective mechanism to raise five-year lock-up investment capital into SMMEs and to lobby for the extension of the sunset clause currently in place.
100% of the respondents surveyed believed that the Section 12J legislation should be extended beyond the June 2021 sunset clause and that the tax incentive and associated investments into SMMEs should continue, to enable these investments to play a relevant role in the South African economy.
Many of the survey respondents agreed that Section 12J investments had played a part in promoting job creation and stimulating economic growth, as they had encouraged many private investors, not traditionally drawn to the SMME sector to provide funding to businesses that were ‘below the radar’ of banks, governments and other equity investors.
The report proposed that ‘accepted PwC economic multipliers’, indicated that Section 12J investments had the potential to create a further 30 000 jobs if the lifespan of these investments were to be extended. The report, therefore, proposed that the Section 12J incentive should be extended to June 2027.
However, industry respondents bemoaned the lack of policy certainty in Section 12Js and noted that this had negatively impacted (i) the industry’s ability to raise capital from investors, (ii) the industry’s ability to successfully invest this capital in South African SMMEs and (iii) the Section 12J fund managers’ ability to run sustainable business models and invest capital in their businesses.
What is Rosebank Wealth Group’s view on Section 12J’s?
In our view carefully selected Section 12J venture capital investments could have a place in a portfolio of investments for those investors seeking tax-efficient investments and returns uncorrelated with listed entities. It goes without saying that in addition, Section 12J investment opportunities should be attractive in their own right.
We have observed that not all Section 12J investments have fair fee structures or even returns commensurate with their risk and ‘five-year lock-up’ requirements.
We believe we have been successful in assisting clients with appropriate risk profiles to invest in those Section 12J schemes that have delivered performances while providing diversification, non-correlated returns, and of course tax relief. We would caution investors to read the small print carefully before allocating capital.
Disclaimer: Please note that this article should not be construed as a solicitation, advertising or sale in any shape or form. Nor is it advice of any description. It is an information-only article of general interest that aims to outline possible merits and hazards of investing in 12J companies.