Treasury (through multiple amendments to Section 12J of the Income Tax Act) is incentivising South African taxpayers to invest in the local economy, via a tax deduction on the investment amount, provided the investment is made into an approved Section 12J Venture Capital Company (Section 12J VCC).
The benefit to the investor for making the investment in a Section 12J VCC, is a return on the investor’s full investment and a tax deduction on the amount invested.
By way of illustration, if an investor (an individual in the highest tax bracket) invests R1 million in a Section 12J VCC, the investor will receive a tax credit of up to R450 000 at the end of his/her financial year. What this means is that an investor will receive a return on 100% of their investment but only have exposure on 55% of their original investment amount.
|Initial investment||R 1 000 000||R 1 000 000|
|Tax relief (in the tax year of initial investment)||(R450 000)*||(R280 000)|
|Net investment (risk capital)||R550 000||R720 000|
*assumes individual is in the highest marginal tax bracket
The tax relief can be carried over where the investor is a company, and in circumstances where the investor is an individual or trust, the tax relief (in most instances) is limited to the tax year of investment and can therefore not be carried over.
What is a Section 12J VCC?
A Section 12J VCC is a company which has been registered as Financial Service Provider (FSP) with the Financial Sector Conduct Authority (FSCA) and been approved by the South African Revenue Service as a Venture Capital Company. The sole objective of the Section 12J VCC is to manage investments in qualifying companies, which should stimulate local investment in small to medium enterprises (SMEs) and address unemployment in South Africa. This is done by providing the investor (South African taxpayers) with a tax incentive for investing in a Section 12J VCC.
There are two types of Section 12J VCCs into which an investor can invest, namely:
1. Third Party Section 12J VCC
Third Party Section 12J VCCs are managed by fund managers who raise third-party finance for the Section 12J VCC and identify the investment opportunities. Third Party Section 12J VCCs offer various levels of returns based on the risk profile of the underlying asset class. Examples of Third Party Section 12J VCCs can be found at www.12Jmarketplace.co.za
2. Ring Fenced Section 12J VCCs
Ring Fenced Section 12J VCCs allow South African taxpayers to indirectly invest in qualifying investments which they have identified and benefit from the tax deduction associated with Section 12J, whilst having exposure only to their specific investment through a specific class of share.
A Ring Fenced Section 12J VCC, therefore, allows angel investors, seed investors and/or entrepreneurs with a higher risk appetite to invest in qualifying investments which they understand and which in many cases would not be of interest to other investors.
What investments can a Section 12J VCC invest in?
A Section 12J VCC can invest in most sectors, however, the legislation outlines which sectors are prohibited. Accordingly, a Section 12J VCC would need to determine whether any of the following elements exist and if so, the Section 12J VCC would be prohibited from investing:
- The gross asset value of the target company exceeds R50 million on the date of the investment (R500 million in the case of a junior mining company) from the Section 12J VCC;
- The target company earns more than 20% of its income from investments (for example, an investment in an investment holding company would not be permissible);
- The target company operates with a majority of its trade outside of South Africa;
- The target company carries on one of the following “Impermissible Trades”:
- any trade carried in respect of immovable property, other than a trade carried on as a hotel keeper (i.e. an investment in hotels, serviced apartments, and student residences may very well comply);
- any trade in the financial services sector (for example, banking, insurance, money lending, hire-purchase arrangements, however, this does not prevent a Section 12J VCC from investing in technology within this sector);
- any trade carried on in respect of financial or advisory services, including trade in respect of legal services, tax advisory services, stock broking services, management consulting services, auditing or accounting services; and
- any trade carried on in respect of gambling, liquor, tobacco, arms or ammunition.
On the premise that an investment does not fall into one of the categories above, there is an opportunity to make use of the Section 12J associated tax benefit.
Taking the above into account, Section 12J VCCs can invest in most businesses with a gross asset value of less than R50 million (R500 million in the case of mining companies), examples of qualifying businesses include (but are not limited to):
- mining and contract mining businesses;
- agriculture businesses;
- hotel, lodge, student residences and B&Bs;
- renewable energy businesses; and
- general SMEs.
What are the limitations associated with Section 12J?
From an investors perspective, there are two main limitations:
- In order to retain the tax deduction, an investor must hold the shares in the Section 12J VCC for a minimum period of 5 years. If the investor disposes of these shares prior to the 5-year period, the investor would be required to pay back the full tax deduction with no interest or penalties incurred.
- When an investor exits the Section 12J VCC, the investor’s base cost for capital gains tax (CGT) purposes will be reduced to zero. This means the investor will pay CGT on their investment amount as well as any growth on the investment. By way of example, if the initial investment amount is R1 million and the investment fails to increase in value, the investor will incur CGT on the R1 million.