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Venture capital company tax regime under review. Again.

Extension of Section 12J will depend on success in enabling job creation, small business development and economic growth, Treasury says.
Treasury wants to be sure that the tax incentive is achieving its objectives. Image: Shutterstock

National Treasury has proposed that the venture capital company (VCC) tax regime again be reviewed to prevent abuse.

The tax incentive was initially set up in 2009 to encourage job creation, small business development and economic growth.

In 2018, changes were made to the tax regime to prevent the abuse of some aspects of the system.

According to the 2019 Budget Review, it has come to government’s attention that some taxpayers are attempting to undermine other aspects of the regime to benefit from “excessive tax deductions”.

The tax incentive (Section 12J), which allows investors to deduct the full amount invested in VCCs approved by the South African Revenue Service (Sars) from their taxable income in the year they invest, has become increasingly popular following legislative amendments. Wasteful spending in government has also been a selling point for VCCs hoping to lure investors. VCCs use the money raised to invest in small and medium enterprises and junior mining companies.

Over 80% of the tax expenditure related to the incentive accrues to taxpayers who have a taxable income of more than R1 million (before the VCC deduction), the Budget Review states.

“There are a small number of taxpayers in these income brackets due to some very large single investments. The majority of taxpayers benefiting from the incentive are in the lower income tax brackets and they contribute modestly to overall tax expenditure.” 

By August 2018, roughly R4 billion had been invested with VCCs and around R1.7 billion with qualifying companies. Treasury attributes the difference largely to the time it takes to identify the right investments. VCCs have a three-year window to employ the money.

Johan Lamprecht, director for financial sector and international taxation at National Treasury, says unlike the situation in the UK and the US, the Section 12J deduction is unlimited (the full amount invested in a venture capital company can be deducted from a taxpayer’s taxable income). Treasury has found that some taxpayers have benefited from “very, very high single deductions” running into “quite a few million”.

While this doesn’t necessarily mean that something untoward or illegal is happening, Treasury wants to ensure that the fiscus is getting value for the money it forgoes by supporting the incentive. (The cost to the fiscus is partially offset through the capital gains tax taxpayers incur upon exit.)

Evidence of outcomes

“We want to be sure that the tax expenditure that we are incurring – whether it is R10 million or R1 million or whatever the case may be – we want to make sure that it is resulting in job creation, small business development, all those objectives we have for the incentive.”

The proposed review is aimed at determining where the money is going, how many jobs are being created, whether it is diversified and which sectors are being supported.

The VCC regime is subject to a sunset clause that ends in mid-2021.

Lamprecht, who is also responsible for small business at Treasury, says the extension of the incentive will depend on its effectiveness.

“If we find it is very effective and it is meeting its objectives then there is no reason not to extend it, but we need to determine … to what extent is it effective, just like any other incentive.”

South Africa’s largest Section 12J asset manager, Westbrooke Alternative Asset Management, recently led the establishment of an industry body – The Section 12J Association of South Africa – to prove the viability of extending the incentive past June 2021.

“The body … aims to compile the relevant information that National Treasury can use to assist in understanding the success of the incentive and motivating to extend the legislation post the sunset clause,” the Association said in a statement.

Lamprecht says if there are organisations that do research, Treasury will consider it, but it wouldn’t only rely on that – it will gather its own data to do a proper analysis.

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Failing to understand the abuse concern. Taxpayers making a large investment as allowed by law enjoys a significant tax deduction into a VCC company vetted and approved by National Treasury. Who is NT actually investigating, the VCC only or the taxpayer too? And should the VCC, originally vetted by NT, be found not to be playing correctly, what happens to the taxpayers investment? Will the tax deduction be revoked? Venture Capital is high risk and while the immediate 45% return is attractive, NT sure does make one re think ever investing into one

MountainBoy:

OK, so how many of your sub R300k income clients did you put into 12J and what was your commision? Buy some wooded Chardonnay with that commission cheque, lekkerrrr

That table indicates that nearly 4000 persons with income of less than R25k per month were induced to invest on average over 6,000 each into venture capital investments.

Whatever board overseas the scum that sell venture capital products into low income clients needs to lock these advisors up and throw away the keys. VC is completely inappropriate to low income investors! What was the deal : two free lottery tickets with every R10k invested, fractional ownership of crypto, time share in Durban, legal aid insurance?

How many Section 12J VCCs can really look Investors and SARS in the eyes and legitimately claim that they advance small business development and job creation? Looking fwd to the review on outcomes!

A lot of the punters of these VCC schemes conveniently forget to mention the sting in the tail of 12J: They are quick to mention the tax deduction of the capital contributed which is correct. However, all the capital returned on exit will be subject to capital gains tax, even if it is less than the amount that was initially invested. Since the expenditure incurred in acquiring the VCC shares would have been allowed as a deduction against income under section 12J(2), it will be reduced to nil for purposes of determining the base cost of the VCC shares under paragraph 20(3)(a) of the 8th Schedule. Hence the base cost is deemed to be zero when calculating the capital gain.

Now there’s a little detail most people are not aware of

Simon Brown had a very interesting podcast about 12J a week or two ago where I also learned about this. Lots of useful info shared in that podcast – definitely staying far away.

I did not know that – thank you very much

This table is obviously incorrect, 90% of VCCs accept R1m as a min and there are a few with a min of R100k. Shocking that NT released these numbers.

They are getting for a tremendous info.

Very interesting figures. The preponderance of small investors is startling (though I see even the Money Matters woman on TV is punting these things).

A few thought experiments :

Cumulative investment in 12J schemes R4bn. Disclosed management fees of around 3% on that generate R120m pa to cover the payroll for all those accountants and lawyers who run the VCCs, and all their office overhead ? Really ? Even allowing for growth in investment values.

Many (all ?) the VCCs have dilution devices, ranging from differential share classes to management shares the investor pays for, a ratio of 1:4 not being unusual in the latter case (ie 20% of your money goes to the VCC management in addition to the disclosed fee). For someone with taxable income <300k pretty much all the tax incentive goes to VCC management.

So now, if – over eight years ! – only 1.7bn of that 4bn has actually been invested, the first question Treasury should ask is, what are the real management costs ? and how much of the dilution has been monetised by VCC managers, who sign the cheques (and sit nearest the door) ?

End of comments.

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