National Treasury announced in its 2021 Budget that the Section 12J tax incentive, introduced in 2008, will not be extended beyond its sunset date at the end June. What was National Treasury’s objectives of this decision and how did the industry react?
“The review process for section 12J (venture capital companies) has concluded. Government introduced the venture capital company tax incentive in 2008 to encourage the establishment and growth of small, medium and micro enterprises. The incentive aims to help them obtain funding that would otherwise not be available. Taxpayers investing in a venture capital company are allowed an upfront deduction for their investment, whereas most equity investments are not tax deductible.
The National Treasury has determined that the incentive has not adequately achieved its objectives. The incentive has instead provided a generous tax deduction to wealthy taxpayers and most support has gone to low-risk ventures that would have attracted funding without the incentive. The incentive will therefore not be extended beyond its current sunset date of 30 June 2021,” according to the Tax review statement.
This comes after industry players assumed that various statistics would have supported an extension of the incentive rather than the termination. “We are experiencing boom conditions in this space, against a backdrop of economic depression. All of these 12J projects are creating jobs, while the state pays nothing out. Its support comes from taxes forfeited. A low-pain way of securing big gain. We have more than two dozen new ventures being spawned against an economy ravaged by widespread business closures. But there is a sunset clause in 12J, which means that from some time in 2021 the benefit will expire. It must surely be in the interests of the government, companies and taxpayers for this facility to be extended…” according to Chris Hart, executive chair of Impact Investment Management in a 2020 Business Report article.
The 2021 Budget Review says that information obtained from 100 VCCs and 360 qualifying companies showed that:
- 5 billion had been invested at VCC level (on which a 100 per cent tax deduction was applicable), with R4.2 billion invested at qualifying company level.
- The total tax contribution from qualifying companies was R207 million for 2019/20, half of which was VAT
- Qualifying companies employed 8 239 people, of which 4 035 people were in direct employment. In total, only 37 per cent of qualifying companies added new jobs after receiving VCC funding
- Over 50% of the investments appeared to be in low-risk moveable asset rental structures, low-risk income-producing investments and guaranteed-return real estate investments.
- Since 2015/16, total tax revenue foregone due to the incentive was R1.8 billion, of which R1.7 billion went to individuals who had a taxable income and VCC investment above R1.5 million per year.
Reaction from 12J industry
Various industry players have indicated their surprise and even disappointment following the announcement that Section 12J VCC sunset clause will not be extended past 30 June 2021.
“The Section 12J incentive has been very successful in raising funding from private individuals and corporates to invest into businesses meeting the Section 12J investment criteria as set out in the Income Tax Act,” the Southern African Venture Capital and Private Equity Association (SAVCA) commented. “Following the incentive review, National Treasury missed the opportunity to refine the provisions in the Act to be narrower in scope and more targeted to high-risk investments, which aligns with their initial intention and where the funding shortfall for SMEs is the highest. We also note that there were no alternative measures announced to support investment into SMEs in partnership with the private sector.”
“This (the announcement) came as a huge surprise to the Section 12J industry, largely because the Section 12J Association conducted a survey that reflected over 15 000 jobs were created and supported, and over R4 billion has been invested into more than 300 small, medium and micro-sized enterprises (SMMEs) in South Africa,” Jonty Sacks, a partner at Jaltech Fund Managers writes in Moneyweb.
“As an industry, had more capital been invested in SMMEs, then the argument for an extension would have been far more convincing, as one would assume that the job creation numbers would have been significantly larger, tax revenue collected from the SMMEs would have been significantly higher, and so on.”
According to Sacks, taxpayers who intend to invest before the end of June should have a firm understanding of the amount of capital under management by the fund manager, and what percentage of that capital is sitting in cash. Consequently, he highlights two important notes for prospective investors:
- “Many taxpayers will find themselves investing in Section 12J investments where the total capital under management is insufficient for the fund manager to cover its costs, as most fund managers are reliant on an annual fund management fee, which is generally a percentage of total capital under management.
- Investors who invest in Section 12J investments with high weightings in cash investments (in other words, low deployment rates) are, in my view, going to see very poor returns as their capital will be at the back of the queue and remain in cash for far too long to generate a reasonable return (if any). In addition, these investors will likely struggle to exit investments on time.”