Registered users can save articles to their personal articles list. Login here or sign up here

10 years on: Is the venture capital tax incentive (still) living up to the hype?

The regime is better regulated and healthier than ever in its short history.

The Venture Capital Company (VCC) regime was introduced to the Income Tax Act 10 years ago. But has the hype surrounding this tax incentive lived up to its promises? The incentive was introduced by National Treasury to direct passive retail capital into targeted areas of the economy (like SMEs and tourism) to generate jobs and stimulate economic growth. In its most simple form, investors (individuals, trusts or companies) can claim a full deduction of their investment in Sars-approved ‘VCC funds’ against their taxable income in the year of investment, which deduction becomes permanent if the investor remains invested for five years.

Although the incentive was always extremely lucrative, it had a slow start. Not only were the requirements and tax consequences linked to Section 12J investments initially onerous, but the market also indicated that it was commercially unrealistic. Investor sentiment changed markedly in 2015 when significant relaxations to the regime were introduced. Most notably, the recoupment of the initial tax deduction was removed if the investor remained invested in the VCC for at least five years. As a result of this and many other legislative changes, the incentive gained significant traction with the subsequent establishment of a raft of new Section 12J VCCs.

Source: Sars

Initially, many thought the incentive would not last until its review date in 2021. Yet the venture capital company market is thriving, as shown on the chart above.

In June 2018, Treasury reinforced the regime by introducing new anti-abuse provisions, which were widely interpreted as a vote of confidence in the sustainability of the incentive. VCCs, which therefore still take on new investments, present a unique opportunity: not only do they allow for investors to qualify for the tax benefits that Treasury seeks to encourage through Section 12J, but those VCCs unaffected by the new anti-abuse rules were obviously also structured in such a way to present genuine benefits to both the South African economy and investors alike. After the latest amendments, they are truly ‘genuine’ VCCs meeting the policy objectives envisaged by Treasury.

The simple example by which to explain the tax relief afforded by Section 12J is that of a salaried employee (earning income at the highest marginal tax rate of 45%). Assume that our employee has R100 000 of investable capital left in February at the end of their tax year. If they invested this amount into a suitable Section 12J fund, this amount would be deducted from their taxable income and they would be eligible for a cash refund from Sars of 45% of the investment, or R45 000. Their assets would now amount to R145 000 (being a R100 000 Section 12J investment and a cash refund of R45 000). If they decided to exit the investment after five years at zero percent growth (which is assumed for simplicity, although realistically, the investment itself may also have grown since), the tax deduction will become permanent and the CGT (capital gains tax) due on the investment made would amount to R18 000. And government encourages this: instead of investing in passive capital, government would have achieved an incremental R100 000 directed towards SMEs and tourism, with concomitant job creation (and an increased tax base!) to boot.

Elegant rebalancing mechanism

In light of the above, compliant VCCs also provide an elegant rebalancing mechanism for investors with investments over-concentrated in a single asset class. Many taxpayers may feel overly exposed to a certain asset class (certain listed shares, for example), yet are wary to exit those investments for fear of the significant CGT consequence that would arise as a result. The VCC model presents an excellent solution to this problem for these prospective investors: CGT consequences arising from a sale of investments will be more than offset if the proceeds from sale of those assets are invested in a registered VCC. Not only will the investors have rebalanced their asset class risk exposure, they will also have achieved a tax deduction over and above the CGT cost neutralised. Investors should seriously consider this type of a rebalancing of asset class exposure where such a latent CGT exposure is present, especially in a fiscal environment where a further increase in CGT inclusion rates in the February budget 2019 is not unexpected.

Assessing the potential of the underlying assets of the VCC is obviously even more important. It is accordingly notable that Treasury is explicitly promoting much needed capacity-building in the employment-hungry tourism sector through Section 12J investments. Conservative investors can accordingly benefit by gaining exposure to growth assets with a fixed property underpin (such as ‘bed and breakfast’ establishments), while creating employment and filling the fiscal coffers from foreign tourism spend.

Ten years on, is the Section 12J VCC tax incentive still living up to the hype? Considering that the regime is better regulated and healthier than ever in its short history, the answer must be ‘yes’. The industry is still nascent with less than R5 billion (market estimates; Sars does not disclose these numbers) invested into Section 12J VCCs over the last 10 years, and the use of the incentive equates to less than 0.1% of all direct taxes collected over the same period.

Given the low base and significant benefits to both the investor and the economy, the robust growth in the number of regulated VCC funds and investment rates comes as no surprise.

 Albertus Marais is director of AJM tax consultants and an independent director of 12Cape Ltd, a registered VCC.

Get access to Moneyweb's financial intelligence and support quality journalism for only
R63/month or R630/year.
Sign up here, cancel at any time.

COMMENTS   5

To comment, you must be registered and logged in.

LOGIN HERE

Don't have an account?
Sign up for FREE

Is R100k a realistic investment amount that a VCC would accept? I suppose each would have their own rules.

What would the picture look like for those at a lower, eg. 25% marginal tax rate? I guess you would need to have enough taxable income to offset in the first place.

Many VCC accept R100k

At 25% tax rate you do need to have enough to write off. Big question is can you afford to put away the R100k.

Good tool to manage CGT

Provided you select a VCC that invests in solid asset classes you almost cannot go wrong with the 12J investment as you basically get half of your investment back immediately. So I would think the crux is to look at the underlying assets that the VCC invests in, if the assets are fairly low risk (property for example), even with small or level growth in the investment, you have already got 45% back in year 1. You have me sold.

So government considers your tax refund as capital growth on your investment, on which you have to pay CGT? Correct me if I’m wrong Pls, but that does change the picture quite a bit!

Do these investments have a Value at Risk for R100000? Can anybody answer this?

Load All 5 Comments
End of comments.

LATEST CURRENCIES  

USD / ZAR
GBP / ZAR
EUR / ZAR

Podcasts

SHOP NEWSLETTERS TRENDING CPD HUB

Follow us:

Search Articles:Advanced Search
Click a Company:
server: 172.17.0.2