Part one: All you need to know about Section 12J 

Ventureburn will be kicking off its first webinar series at the start of September 2020. Held in partnership with Kalon Venture Partners, a registered Section 12J Venture Capital Company, these informative webinars will offer insight into everything you need to know about Section 12J. 

Ventureburn will be hosting its first-ever webinar series focusing on Section 12J

In preparation for the webinar series, venture capitalist Clive Butkow of Kalon Venture Partners shares the answers to the most frequently asked questions regarding Section 12J. 

A Section 12J investment provides the investor with a unique opportunity to invest in a tax-deductible investment vehicle. 

In an effort to afford small and medium-sized entities in the South African market equal access to equity funding, the South African government has added Section 12J to the South African Income Tax Act. Section 12J acts as a catalyst for equity funding for SMEs, specifically because SMEs have been identified as one of the primary contributors to projected future economic growth.

By investing in a Section 12J venture capital company, the investor not only qualifies for a full deduction of the total investment amount from their taxable income in the relevant tax year, but they are also indirectly supporting the South African economy and supporting the growth of local SMEs.

What is Section 12J of the Income Tax Act?

 The South African National Treasury is incentivising taxpayers to invest in the economy via an approved Section 12J Venture Capital Company (Section 12J VCC). Section 12J of the Income Tax Act allows an investor to deduct the full amount invested in a Section 12J VCC from their taxable income for the specific tax year. Kalon Venture Partners is a VCC investing in disruptive technology startups. 

VCC’s can raise capital by accepting investments in exchange for shares from any taxpaying entity be they an individual, a trust, or another company.

The investor will benefit from both the tax deduction and a return on the investor’s full investment.

 By way of illustration: if an investor invests R 1-million into a Section 12J VCC (assuming a maximum marginal tax rate for an individual), 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. Effectively an investor’s risk exposure will be 55% while earning a return on 100% of their investment.

What is a Section 12J VCC?

  It is a pre-requisite for Section 12J VCCs to register as a Financial Services Provider (FSP) with the Financial Sector Conduct Authority (FSCA) and all Section 12J VCCs need to be approved by the South African Revenue Service (SARS) as a Venture Capital Company.

 Section 12J VCCs manage investments in qualifying companies with the single objective of stimulating investment in local small to medium enterprises (SMMEs) with the ultimate aim of leading to GDP growth and job creation.

 How does an investor make a Section 12J investment?

 As a taxpaying entity, you would approach a VCC with your investment. The VCC would invest this sum within their own company and issue you with a certificate for the amount of 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 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. 

What type of businesses is a Section 12J VCC allowed to invest in?

 Section 12J of the Income Tax Act allows Section 12J VCCs to invest in most industries, although some are prohibited.

 If any of the following elements exist within the business, the Section 12J VCC will not be allowed to invest in the target company:

• The gross asset value of the target company exceeds R50 million on the date of the investment by Section 12J VCC
• The target company earns more than 20% of its income from investments
• 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. student residences and serviced apartments comply)
• Any trade in the financial services sector (e.g. banking, insurance, moneylending, etc. this does not prevent a Section 12J VCC from investing in technology relating to these sectors)
• Any trade carried on in respect of financial or advisory services including legal services, management consulting services, and auditing or accounting services
• Any trade carried on in respect of gambling, liquor, tobacco, arms, or ammunition.

Section 12J VCC qualifying businesses are:

•  Technology companies,
•  Manufacturers,
•  Student residences,
•  Renewable energy companies and
•  General SMMEs.

Ventureburn will be sharing part two on all you need to know about Section 12 J. 

This content has been created in partnership with Kalon Venture Partners, a registered Section 12J Venture Capital Company.

Read more: Here are 4 things Kalon Venture Partners looks for when picking startups [Q&A]
Read more: New Section 12J impact study shows scheme has been a success says association
Read more: Experts raise concern over new Section 12J rule that limits deductions for investors

Featured image: Kalon Venture Partners CEO Clive Butkow (Supplied)