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Problems persist with the VCC tax initiative

Stakeholders have requested a ‘review and redesign’ of the VCC regime to meet its initial objectives.
Picture: Moneyweb

Preliminary results from a study into the design of the Venture Capital Company (VCC) regime in South Africa show that despite several improvements obstacles remain which prevent these companies from making notable inroads in the funding of small businesses.

The CIMA Research Centre of Excellence, a UK-based professional body, is funding a study by North West University scholars to find ways around the obstacles.

Associate professor Pieter van der Zwan and lecturer Lehanri Mulder at the university’s School of Accounting Sciences aim to make recommendations for change at the end of the year. The regime was introduced in June 2009 and is subject to a 12-year sunset clause that ends on June 30 2021.

The objective of the Venture Capital Company (VCC) regime is to encourage equity funders to invest in small businesses.

The main attraction of the regime is a full tax deduction of the amount taxpayers invest in a VCC. The VCC will then use the funds raised to buy shares in small companies with big potential.

An investor who invests R5 million in a VCC will get the full amount as a deduction on his taxable income, however the money must remain invested for five years. If not the tax benefit will be recouped.

The company in which the VCC invests must hold assets with a book value of not more than R500 million in any junior mining company, or R50 million in any other qualifying company. If these thresholds are exceeded, it no longer qualifies in terms of the VCC regime.

A qualifying company must be a South African entity, trading mainly inside the country. Companies which trade in immovable property, except to trade as a hotel keeper, offer financial or advisory services, gambling or are involved in the manufacturing, buying or selling of liquor, tobacco products or arms and ammunition do not qualify.

Treasury acknowledged concerns about finding initial investors to provide seed funding for the Venture Capital Company (VCC) without breaching requirements in the legislation.

A connected person includes someone who holds more than 20% of the VCC shares without another majority shareholder.

In terms of the change the connected person test will be delayed for three years after the first shares are issued by the VCC. Only after the three-year period will it be done at the end of every year of assessment.

Van der Zwan says if one investor invests R50 million in the VCC, the company will have to raise at least R250 million to avoid the risk that one investor holds 20% of the shares.

VCC fund managers have expressed the need for one “core” investor to get the capital raising started.

“However, as soon as the first investor takes a large share in the VCC the fund is at risk that it may fall foul of the rules if it is unable to raise sufficient further investments,” says Van der Zwan, member of the business tax work group of the South African Institute of Tax Professionals (Sait).

Another obstacle identified by fund managers participating in the study is the potential of double taxation on growth.

Sait has previously requested a “review and redesign” of the VCC regime to meet its initial objectives. Erika de Villiers, head of tax policy at Sait, asked that the multiple levels of taxation be addressed.  

Sait suggested exempting the VCC from capital gains tax on the disposal of their investments in the small businesses.

The VCC is taxed on the capital gain of the proceeds from selling its shares in the small business at 22.4%. The dividends distributed to the investors (in the VCC) attract a 20% withholding tax.

Van der Zwan says fund managers are also finding it difficult to find the right companies to invest in. The challenge is to make an investment in a company that is not too risky, and which offers good prospects of a return on investments.

Many companies fitting these criteria exceed the R50 million threshold.

Guy Harris, a social entrepreneur, says the original focus was small- and medium-sized businesses. However, if research finds that most jobs are created by companies above that threshold, then the thresholds may need a review.

Harris says it should not be used for “abusive” low job creating structures such as game farms, front Airbnb properties and for capital equipment financing.

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There are plenty of investable small and medium startups around. Most actually just need a bit of advice plus asset finance and growth working capital but our banks won’t help unless they have cash security.

The problem with these structures is that real venture / angel investors would not entrust a penny to the people that run these south acrican VC funds. Look overseas, VC advisory boards are populated with people with actual startup experience that co-invest and that take active or at least helping hand role in the investments.

Here we have mba desk jockeys taking a break from mismanaging retirement funds.

I don’t understand the prohibition in section 12J against “impermissible trades” which includes any trade carried on in respect legal/tax services of financial or advisory services, management consulting services, auditing or accounting services. This is especially the areas in which a lot of black professionals want to practice with huge scope for government work. What 12 J wants to do is help the junior mining companies and those who start factories. The whole mining industry is in turbulence and gone are the days when people started factories- too many labour problems.

“a lot of black professionals want to practice with huge scope for government work”

Therein lies the rub. Instead of entering the production space and creating new wealth, they want to resdistribute it. We are starting to see how this backfires, spectacularly and tragically in the case of the victims of the Life Esidimeni massacre where the objective was to take the outsourcing from WMC to black-owned for-profit NGOs. Another case is Eskom, where the report into Corruptheid by Werksmans, one of SA’s pre-eminent commercial firms was not good enough and a second legal firm was appointed, whose sole merit is that it does not employ a single white.

If white privilege — the presumption (prejudice?) that white professionals are more competent — black professionals must be seen to be competing and succeeding without reverse apartheid or quotas.

jnrb

We are NOT going to get near full employment with VC funds invested into more mba-type advisory services consulting startups!!!!! FFS, if you start a consulting business you need to carry your minimal overhead (start in coffee shops not R400/square offices with pretty reception and IT) for a few months and not pay yourself till you get clients, whether you are pink or blue or black

What we need in SA is employment, which is manufacturing, which is equipment and working capital finance.

Advisory services are not supposed to have long cash burns. Advisory entrepeneurs are not supposed to pencil in R100,000pm salaries in THAT spreadsheet.

IMO we should be doing billions in agri-processing and mining benefication investment for example. Zero chinese/vietnamese advantage. Big unskilled labor supply chain.

It is also worth pointing out that CGT is calculated with a zero base cost; not the initial capital invested in the VCC. This is a major disincentive to invest in Sec 12J VCC’s as it erodes returns by a further 18% on an already extremely risky investment with massive liquidity constraints.

End of comments.

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