This is how Section 12J projects benefit SMEs

And explains why there are calls for the tax incentive to be extended to 2027.
Dino Zuccollo, chair of the 12J Association of SA. Image: Supplied

Financial advisors were quick to recognise the benefits of the attractiveness of Section 12J investments, but they are also proving quite beneficial for small and medium-sized enterprises (SMEs) – and not just in metropolitan areas.

This is according to the 2020 Section 12J industry report, which demonstrates that the tax incentive has not only managed to create jobs, but it has done so more economically than other government-backed job creation incentives.

The report states that since its inception in 2015, the Section 12J industry has “raised a significant” amount of incremental investor capital, at a time when most South African high-net-worth investor capital is being invested offshore.

Read: The ‘fund’amentals of Section 12J investing

Which is why Dino Zuccollo, chair of the 12J Association of South Africa, says it should be extended until at least 2027.

“In only five years, it has grown into a mature and successful incentive. As at February 2020, Section 12J has total assets under management exceeding R9 billion, the bulk of which has been invested by SA’s high-net-worth individuals [57% of total investment] for a minimum of five years,” Zuccollo says.

He highlights this as particularly significant in the wake of the devastation caused by the Covid-19 pandemic, “at a time when the majority of high net worth investor capital is being invested offshore”.

The graph below displays the significant growth achieved by the industry. The dip in February 2020 is attributable to the 12J investment cap, which was implemented in 2020, and which had a marked negative impact in the ability of the industry to continue growing on the trajectory achieved historically. The median size of a Section 12J manager is approximately R140 million.

Source: 12J Association of South Africa

The report also indicates that 25% of all industry investments have been made outside of major metropolitan areas, thereby assisting the job creation and economic growth initiatives in rural communities.

Individuals raising capital

12J was established to assist qualifying small, medium and micro enterprises (SMMEs) to gain access to equity funding by providing investors with a 100% tax deduction for making investments where the capital will ultimately be allocated to these businesses.

A survey indicated that approximately 57% of total Section 12J capital has been raised from individuals.

“Many of these individuals comprise successful business people and entrepreneurs who become key role players in the growth and development of their investments,” says Zuccollo.

The report states that based on the survey finding, 82% of Section 12J capital raised is incremental.

“It can be concluded that many, if not most, of these business people and entrepreneurs, would not otherwise have invested into local SMEs had it not been for the Section 12J incentive,” Zuccollo says.

The ability of Section 12J to introduce young SMEs to experienced business people is fundamental to the growth of these businesses, with the mentorship and guidance that is provided being invaluable contributors to their ultimate success.

The survey indicated that 74% of the jobs created have gone to previously disadvantaged individuals and 25% of industry investments have been made outside of major metropolitan areas.

Based on the association’s calculations, the Section 12J incentive has been cost-effective for the South African government, at an average cost of about R126 000 per job already created.

This is in stark contrast to other job-creation focused incentives in South Africa, which cost up to R450 000 for each job created, the association notes.

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Mmmmm… one thing the punters of these VCC schemes conveniently forgets to mention is the sting in the tail of section 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. Please remember that.

Do agree, and being able to get out may also prove to be a thing… many of these ‘funds’ haven’t considered the secondary market – I haven’t checked the legislation to see how it is covered, if at all – and the exit plans after the individuals 5 year lock up is over…

The CGT for a natural individual is a maximum of 18%. If you get (as a maximum tax payer) a 45% deduction upfront that is still a nice tax benefit.

Wow the least we ever consider ..exhaustive tax technical detail before submitting a comprehensive advice pack to would be investors..

Well to be honest, most investors that do invest in 12J, are HNWI – meaning they usually care enough about various tax incentives / structures before investing (or get tax advice before investing).

From my quick calculations, if you invest e.g. R1mil into a 12J fund (assuming you are at the 45% tax bracket), you get back R450k of your R1mil investment, therefore, money outflow of R550k. In 5 years’ time, you get back your R1mil investment (assuming no capital growth), however, net of CGT with effective 18% CGT, you get R820k (calculated on R0 base cost). Taking time value of money into account, that equates to c. 8.32% annual growth of your money – not too bad considering the average returns out there (in SA that is), and you are also positively contributing to creating jobs and helping to stimulate the economy.

However, the above is assuming the fund you invest with, give you back your money and do not lose a significant amount of your capital etc etc.

Locking up capital in South Africa for 5 yrs is a big big ask, irrespective of any tax benefits. I’ll gladly pass this ‘opportunity’

End of comments.

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