Understanding S12J and investing in disruptive technology [Sponsored]

In 2009, the South African government identified small and medium-sized entities (SMEs) as a potential major contributor to future economic growth. 

Kalon Venture Partners provides insight into all you need to know about Section 12J

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One of the main challenges to the sector, however, was the limited access of SMEs to equity finance. So, to incentivise investment, and assist these sectors with equity finance, the South African government implemented a tax incentive for investors in these enterprises, through a Venture Capital Company (VCC) regime known as Section 12J.

What is Section 12J?

Section 12J of the Income Tax Act incentivises taxpayers to invest in the economy via an approved Section 12J Venture Capital Company (Section 12J VCC). 

It allows an investor a 100% deduction against taxable income in the year of investment if that investment is for at least five years. The deduction is set to a maximum investment of R 2 500 000 for individuals and trusts, and R 5 000 000 for companies.

So, by way of illustration, let us say an investor invests R 1-million into a Section 12J VCC. The investor will receive a tax credit of R 450 000 on the submission of their tax return for the year in which the investment is made, or the equivalent depending on their tax bracket. Companies will receive a R280 000 tax credit.

And this incentive appears to be working.

Since its inception, S12J Investments have increased by over 5 X. With the total value of 1230 VC deals in 2019 exceeding R1-billion.

However, this amazing opportunity is subject to a sunset clause which is terminating on 30 June 2021, making this opportunity for the 2019 – 2020 tax year, your last opportunity to invest.

What exactly are you investing in?

A qualifying S12J investee company must be a South African entity, trading mainly inside the country and may not operate in certain economic sectors. 

For an investment to qualify under the S12J benefit, it may not involve companies that: trade in immovable property, except to trade as a hotel keeper (includes bed and breakfast establishments); offer financial service activities such as banking, insurance, money-lending, and hire-purchase financing; provide financial or advisory services, including legal, tax advisory, stockbroking, management consulting, auditing, or accounting; are gambling operations including casinos or other games of chance; or are involved in manufacturing, buying or selling of liquor, tobacco products or arms & ammunition.

Section 12J VCC qualifying businesses are the following technology companies, manufacturers, student residences, renewable energy companies, and general SMMEs. In other words, most cutting edge, disruptive technologies.

As mentioned above, to take advantage of Section 12J taxpayers need to invest via an approved Section 12J Venture Capital Company (Section 12J VCC). 

Well known and established Venture Capital firm, Kalon Venture Capital specialises in investing in disruptive technology. 

Kalon’s Section 12J disruptive technology fund invests in entrepreneurs solving African problems with the potential to scale into global markets. They focus on providing smart capital, as well as on delivering smart returns using most of their capital in support of entrepreneurs who are disrupting traditional industries. 

Kalon seeks out companies with high margins and unique intellectual property (IP) to invest in using a “high-touch” methodology and approach to assist these companies through hands-on involvement to help build the businesses into assets of value.

Kalon Portfolio Highlights in 2020 include:

– Ozow hit the ZAR1 billion in GMV (Gross Merchant Value) in one month, a first for the company;

– Finchatbot raised a round of capital for their European expansion;

– Sendmarc exceeded 100 paying clients in less than a year;

– Mobiz grew revenue at a remarkable 300% in FY20;

– Flow has seen 30% MOM revenue growth during the last few months; and 

– Carscan has closed numerous Proof Of Concepts, including one for a European insurance company and we are excited about the pipeline of opportunities going into 2021.

 

How can you get involved?

• Kalon is hosting a free webinar [link to form] on Wednesday 27 January where they will take attendees through the details and answer any questions.
• As a taxpaying entity, an individual or a company needs to approach a VCC such as Kalon with your investment amount. The VCC would then invest this sum within their own company and issue you with a certificate for the investment.
• This certificate allows you to deduct the full value of your investment from your taxable income in that tax year, essentially offering the taxpayer a tax-free investment opportunity.
• When investors are paid out dividends, they are then taxed for capital gains or they pay dividends withholding tax. It is also vital to note that, when the S12J investment reaches maturity after five years and the investor withdraws from the VCC portfolio, the base for capital gain will be zero due to the initial benefit of 100% tax-deductibility.

It is important to understand that Section 12J investments are considered medium to long term investment vehicles, and it is not advisable to invest a Section 12J VCC unless you can commit to a minimum of a five-year investment. An investment will not reach its full potential in less than five years and investors will not qualify for tax-deductibility if their investment is withdrawn before the five-year period has elapsed.

Additional stipulations

• The S12J company may not invest more than 20% of all investor-acquired funds in any single qualifying investee company, ensuring that the incentive achieves its objective of supporting many privately-owned companies while simultaneously creating a diverse spread of investments to mitigate risk.

What to look out for

• Not all S12J companies are created equal. So, do your homework. S12J companies must be licensed with the Financial Services Board (FSB) and registered with the South African Revenue Services (SARS). 

• A potential risk for investors is that there may be no secondary market for their shares in the S12J company after the investment period. This risk can however be negated if the investment is professionally managed by S12J companies. There should always be a clearly defined exit strategy to create liquidity for investors.

In summary

• S12J Investors can claim the full amount used to acquire shares in the S12J company as a deduction from their taxable income in the year of that investment, provided the shares are held for at least five years. 
• The initial tax benefit cannot be recouped by SARS. However, after five years, the full proceeds from the sale of the shares will be subject to capital gains tax.
• Time is running out for investors to take advantage of the S12J tax benefits. The Section 12J sunset clause is scheduled to take effect on 30 June 2021. Whether or not it will be extended, is at this point unknown. However, as an investor, if you invest now, you will continue to receive the tax benefit on any funds invested in a registered S12J company prior to June 2021, even if the five-year investment period ends after that date.
• There is a legislated cap on the amount of funds that an investor may commit to a registered s12J company. Companies may invest a maximum of R5-million. Trusts and individuals a maximum of R2.5-million per annum.  
• The full amount invested is 100% deductible from your income in the year in which the investment is made. This applies to individuals, companies, and trusts. The total return equates to a 45% tax incentive or the equivalent depending on your tax bracket. Companies will be at 28% tax incentive. 

The S12J investment option has gained significant traction in the last few years, among individuals and businesses seeking to reduce their tax liability – and find alternative sources of return in uncertain and volatile markets. But with a pending expiration date, now is the time to take advantage of the offer.

This article is supplied and sponsored by Kalon Venture Partners.