Section 12J Venture Capital Companies incentive now more attractive than ever

Over the last years, a lot of attention has been focused on the support for SME-sized companies. Most believe, government included, that the key to unlocking economic growth is within small business. But how can government incentivise the wealthy to assist in providing the funding needed to grow these businesses given the relative risk of direct investment in young companies?

Enter Section 12J Venture Capital Companies.

The goal of this section of the Tax Act is to create a pooling mechanism for investors to channel funds into small private companies. And the good news for everyone in the 41% and newly formed 45% tax bracket is that since January 2017, one more big stumbling block of this tax structure has been removed.

Firstly, what is a Venture Capital Company ? Subject to a few requirements, it is basically a SARS approved investment holding company that spreads its investments among five or more qualifying private companies (start-ups and SMEs with a net asset value smaller than R50 million with certain industries excluded).

S12J then allows a taxpayer a deduction of 100% of the cost of shares issued to them by a Venture Capital Company (VCC). That means that for every R1 million a taxpayer in the highest income bracket invests in a VCC, they will receive an effective tax benefit of R450,000! They only actually risk 55% of the amount that they invest. Magic!

Another exciting characteristic of an investment in a Section 12J VCC is that if the investment in the VCC is held for at least 5 years, the taxbenefit will be permanent. There will be no recoupment of the tax benefit when you sell your investment.

Lastly, one big hurdle has been removed that hindered investment in S12J companies. In order to prevent misuse of these vehicles, the section was set up with the intention that no investor may own more than 20% of the fund. Previously, if an investor put in more than 20% of the capital of the fund they would not be allowed their deduction at all. Ouch.

This hindered many groups that could find two or three or four big investors for their fund from launching as they were not able to spread the share pool in such a way that all investors invested less than 20% of the total. From January 2017, a window has been created which could change the game. S12J funds are now allowed 36 months in order to raise additional capital to ensure that by the end of that period, all investors hold less than 20% of the fund. The onus is now also on the fund itself, not the investors, to ensure that this diversified shareholder target is reached. If they are unsuccessful in achieving it, the fund will be taxed on 1.25 times the amount that investors saved when investing in the fund.

This will allow more and more groups of angel investors to pool their funds into formalised investment vehicles, adding to the sophistication of these angel and seed funders in our market. It will also make it easier for new funds to launch, as they no longer require five or more big investors begin investing.

With this amount of encouragement, we expect to see a lot more private sector investments flowing towards venture capital and will be watching all local VCCs closely as Venture Capital becomes the new asset class of the wealthy.

 

Footnote: Louw Barnardt CA(SA) is the co-founder and MD of Outsourced CFO, a financial management firm that renders post-investment financial management services to private companies. He is a director of Oaktree VCC, part of the management team of Carbide VCC and a shareholder in Grovest VCC.