The Section 12J tax dispensation is finally attracting investors, after several years of being a wallflower. According to SARS, for the tax year ending 28 February 2017, 724 investors took advantage of the incentive. This was a substantial increase compared to the 34 and 272 individuals for the 2015 and 2016 tax years respectively. Based on current trends the expectation is that further significant growth will be seen for the tax year ending 28 February 2018.
Section 12J is an initiative by Treasury to mobilise capital towards small and medium-size South African businesses. It entails registering a venture capital company with SARS, and inviting taxpaying investors to take up shares in the company. Investors can deduct 100% of their investment upfront against their taxable income. 12J vehicles allow investors access to well-regulated, tax-managed private equity while managing their tax liability during the provisional tax season. Their money is pooled and put to work in specifically identified opportunities. There are currently in excess of 80 such companies registered.
Minimum investments into 12J companies tend to vary, but there is no upper limit to the amount you can claim back from the Receiver for a Section 12J investment. One provider, 670 Ventures, which is offered by alternative investment manager TBI, requires a minimum investment of R250,000 while other companies will have higher, or lower, minimums.
To retain the upfront tax deduction, it is necessary to stay invested for at least five years. During that period, if all goes as planned, investors should receive a commensurate return on their investment. On realisation of an investor’s venture capital shares, this entire amount would then be subject to standard Capital Gains Tax rates.
“For many investors five years can feel like a long time in the current environment of political and economic uncertainty, and can increase their perception of risk,” says Ian Groenewald, CEO of TBI. “This obviously creates demand for a higher return; however, the tax benefit should contribute towards this, allowing the Manager to take more tapered risk exposure while still providing venture capital type returns.”
The investor or his adviser, however, needs to make sure that the Manager is not only capable of sourcing, managing and realising a return in the underlying investments, but is also able to ensure that the investor retains his tax benefit, by ensuring that the vehicle remains compliant with the requirements of Section 12J throughout the investment term.
“This tax skill is very rare in our market which is mainly focused on pre-tax investment returns,” Groenewald says.
It’s important to understand how the venture capital company plans to invest your money so that it generates a return. After all, you won’t be able to access your capital for at least five years and the return needs to compensate for that. The Act has listed criteria for suitable investments, referred to as Qualifying Companies. It is extremely important that the venture capital company has a well-identified, well-researched pipeline of Qualifying Companies to invest in when it is established.
Given the strong focus on tax, investors should also expect the management of the venture capital company to have a suitable depth of tax knowledge. A failure of the venture capital company to abide by the requirements of 12J would result in stiff penalties, to the ultimate detriment of the investor.
“The 12J initiative is much needed in South Africa, spurring economic growth and job creation. And it is clear from the above that there is a great deal of pressure on the management teams of venture capital companies to manage both the tax risk and investment risk in these vehicles. Investors are therefore encouraged to do their due diligence before considering an investment,” Groenewald says.