Investors clamouring for 12J VC incentive following tax hike – fund managers

The increase in the top marginal income tax rate to 45% for high earners is driving more South African investors to seek out the 12J venture capital (VC) incentive to offset their taxable income, say fund managers.

Under the incentive, which is managed by the South African Revenue Service (Sars), investors that invest in venture capital companies (VCCs) that in turn invest in qualifying small enterprises, can write off the full investment made in any one year from their taxable income.

In February in his Budget speech then Finance Minister Pravin Gordhan announced a new top tax rate of 45% for individuals earning above R1.5-million a year effective for tax assessments for the 2017/18 tax year. The previous top rate was 41% for those earning R701,000 or more a year.

In turn the dividends tax for companies has been increased from 15% to 20%, to discourage high income earners from opting instead to withdraw more of their remuneration in the form of company profits.

‘We’ve seen less of an impact of the dividends tax on investment’

Yet despite this, Gavin Reardon of Kingson Capital said he has seen a recent increase in interest from investors. “We’ve seen less of an impact of the dividends tax on investment. Possibly because of the immediate tax relief available,” he added.

Ismail Kajee of I-Cubed Capital agreed. He believed even with the increase in dividends tax, from 15% to 20%, the “net effect is still a benefit to the investor”.

Anuva Investments founder Neill Hobbs added that there’d been a notable “stampede” of new funds being approved by Sars since February. “There has been a definite uptick in interest,” he added.

But Richard Asherson of Westbrooke Capital Management believes “the jury is still out” on whether it would lead to an increase in investor numbers or not.

“On the one hand, the increase in marginal tax rate makes an investment into s12J more attractive, but the dividends withholdings tax reduces the benefit on exit. As we only fund raise during the latter half of the tax year, we should see the impact then.”

Investors more cautious

However the increased attention from investors might be offset by the slowing economy, with fund managers saying investors have become more cautious as a result.

On Sunday, the World Bank revised down South Africa’s expected growth for the next three years, expecting the country to grow at just 0.6% this year, down from growth of 1.1% it forecast in January.

But Grovest CEO Jeff Miller, said though investor sentiment is low he is hoping that it will pick up towards the next provisional tax deadline of 31 August.

Miller, whose company manages five funds as well as an additional 12 for other companies, added however that his company hasn’t lowered its forecast on returns for investors.

Samantha Pokroy, who heads up Sanari Capital, said the impact of the slowing economy would be felt differently in different portfolio companies.

“Local political volatility has made it difficult to get investors to make long-term, illiquid investments but the above-average returns and the tax deduction does help as the prospects of finding attractive alternative sources of equity investment returns on- or off-shore diminish,” she said.

She added that deal flow remains strong, largely due to referrals from their network, the funder’s proposition as value-adding investors and the company’s ability to enhance the BEE credentials of the companies it invests in. She said the fund targets in excess of 30% annualised returns for most of its investments.

Pockroy said there are still some challenges that investors have expressed about the tax incentive. “There are certain technical constraints that dilute the incentive somewhat, and areas where clarification is required,” she said.

She said the SA Venture Capital Association (Savca) continues to work with National Treasury to refine these challenges.

Sars spokesman Sandile Memela however said it was too early to measure the effect that the increase in the maximum marginal tax rate has had on investor interest in the incentive, adding that this would only be known later in 2018, after the end of the 2017/18 tax year (to which the increased rate applies).

*This story was updated at 10.05am on 7 June 2017 to reflect Sars’ response.

Featured image: OTA Photos via Flickr (CC 2.0, resize)