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Changes to venture capital incentive ‘misdirected’

If a proposal to limit the tax deduction goes through it will be effective from July 21 – again making the scheme less attractive.

National Treasury has proposed changes that will reintroduce a limit to the tax benefit for taxpayers investing in venture capital companies (VCCs).

Treasury believes that despite efforts to curb abuse of the VCC tax incentive, there are still attempts to undermine the objectives of the regime to benefit from “excessive tax deductions”.

The proposed change in the Draft Taxation Laws Amendment Bill is to limit the tax deduction for investments in VCC shares to R2.5 million per VCC shareholder – and if the proposal goes through it will be effective from July 21 this year.

Industry players have expressed concerns about the constant changes to the incentive, saying the latest proposal is misdirected and creates difficulty for venture capital companies to meet certain compliance criteria.

The VCC tax incentive scheme was introduced into the Income Tax Act – as Section 12J – in 2008 and has seen several changes in order to “tighten up” perceived abusive behaviour.

The aim of the incentive is to raise equity funding for small businesses that would otherwise not have access to funding either because of their size or the inherent risk associated with the company.

It offers investors (angel investors; individuals but seldom companies) a 100% tax deduction on the amount invested into a VCC, which in turn will be invested into qualifying companies.

Read: There’s more to Section 12J than ‘45% immediate tax relief’

When it was introduced there was a limit of R750 000 per tax year and a lifetime limit of R2.25 million. However, this limit was removed around 2011 in order to make the incentive more attractive.

Recent changes have made it once again less attractive and the proposed change is no different, says the 12J Industry Association of South Africa. The industry body was formed earlier this year.

“Since major amendments were made to Section 12J in 2018, industry players have found it challenging to continually modify their business models to remain compliant with the periodic changes in legislation and would benefit from policy certainty and stability going forward. These constant changes impact confidence among Section 12J investors, who invest five-year lock-up capital into SMEs [Small and medium-sized enterprises] across the country.”

Duane Newman, joint MD of Cova Advisory, believes the proposal is misdirected.

There has been a lot of marketing activity around the incentive – promoting it to prospective investors – and Treasury now wants to limit the amount of tax it is losing at the top level.

It is targeting investors by placing the investment limit of R2.5 million on them. “I think that is the wrong place to focus on,” says Newman.

“One does not want to limit capital going into venture capital ventures. You should not be doing that.”

He believes the right focus would be to limit what the venture capital company can do with the investments it receives.

Newman, who is chair of the business incentive committee of the South African Institute of Tax Professionals, says from available data it appears that most of the investments from VCCs have been in property.

“Property is not what the venture capital regime was designed for. I think that market is well structured and well capitalised and can get access to funding.”

Fundamental purpose

Newman believes Treasury needs to tighten up the investments made by the VCCs. “The fundamental purpose of Section 12J is to invest in high risk ventures,” he says.

The 12J Association says it is in the process of obtaining statistics from members regarding the quantum of capital raised, capital invested, as well as the nature and success of the underlying investments that VCCs have made into the SA economy.

The association says an incentive that can raise money from high net worth individuals and institutions for investment in SMEs should be a key focus area for government.

South Africa has the highest unemployment rate compared to its peers. One would expect policy certainty for companies that can gain from an incentive that enables investments aimed at economic growth and job creation.

The 12J Association notes that the incentive is subject to a sunset clause and will only be available to investors until June 2021, unless extended by government.

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I believe the purpose of section 12J is not intended to be a tax haven. Maybe a complete report would include and highlight the committed investments vs the money raised to date?

This is very tricky. High risk VC will attract little capital due to its risk. Hence the funds keep being invested in lower risk assets that enhance yield for an investor through the tax break, or to reduce cost of capital for corporates again through a tax break. It’s still stimulating demand in the economy if you’re reducing corporates cost of capital through a super tax break…

The problem has always been with the VCCs as middlemen, the lion’s share of the tax incentive goes to VCC management in many cases. Both the type of business invested in and the rewards to VCCs should be regulated.

Cheetah58:

100%

Look at the track records and see how many of the fee-jockeys have personally started anything that succeeded – other than the fee engine VCC.

If people want risk exposure in their portfolio, virtually all communities have jockeys in need of funding. They can not (for a variety of reasons) get funding from banks or investment firms. Most often their need is to small for an investment firm as they want more in fees than their dd costs them in suits. Second most likely reason is they have no security – if they had they would not need funding. Third most likely is the bank Basel scoring committee fell off their chairs laughing. Then there are our uniquely South African reasons that I won’t delve into, but they range from race to the big boys stealing your pie.

So, look around you for a good jockey with a great idea. At least you can see your project close up – and understand why it turns out like does, good or bad. You might even be able to help in ways other than an EFF-for-tax-reasons

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