Amendments to Section 12J under the Income Tax Act welcomed by VCs

Complex legal or financial regulations are all too often cited as South Africa’s main obstacles for flourishing entrepreneurial activity. First introoduced in 2009, Section 12J under the South African Income Tax Act has come as a welcome step in venture capital activity. Now, new amendments to Section 12J will take effect in January 2015, with the aim of boosting investment in entrepreneurial businesses.

Erika van der Merwe from Southern African Venture Capital and Private Equity Association (SAVCA), which represents about R160-billion in assets, elaborates:

We believe that these more attractive tax incentives have the potential to boost greater levels of investment into entrepreneurial businesses in South Africa, many of which cannot easily access finance. More investment into high-potential smaller businesses should translate into much-needed job creation.

The first key amendment is that the total asset limit for qualifying investee companies (being the businesses in which the Venture Capital Company or VCC may invest) has been increased from R20-million to R50-million. For junior mining companies, this limit has been increased from R300-million to R500-million.

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Jeff Miller of Grovest, a S12J VCC, believes that the increasing of the asset thresholds means VCCs can now invest in larger companies that have an extensive asset base. “This amendment changes the entire VCC landscape.” Businesses across the spectrum should benefit from improved investment, ranging from small manufacturing, to hardware-based IT businesses, education, healthcare and renewable energy.

SAVCA notes that the second S12J amendment relates to the tax deduction available to an investor who subscribes for shares in a VCC. Since its inception, this deduction was immediate and for the full amount of the investment made — however, it would be recouped and become taxable if the investor sold the VCC shares at any time. SARS will now allow the investment deduction to be permanent, as long as that investment is held for a five-year period.

Grovest’s Miller explains that without the five-year rule, investors were taking on extensive risk. “Previously there was no real incentive to invest in VCCs. With the investment deduction now becoming permanent after a five-year holding period, this tax relief means that VCC investors will be getting a proper risk-adjusted return.”

While exceptionally pleased with these two amendments, Miller says there is still work to be done to make the VCC tax regime more investor-friendly. “We would like to see tax benefit being passed on to secondary investors who acquire their interests from the original subscribers. We will also be working with government to address capital gains tax and dividend withholding tax, and ideally obtain similar tax treatments as seen in the traditional private equity fund structures.”