For small businesses starting up or wanting to expand, the most effective help they can receive is funding. Without funding small businesses fail or just can’t move forward. This is where the section 12J Venture Capital Companies (VCC) tax incentive has been so helpful for SMMEs. The focus of the tax incentive is to channel funds from the wealthy into small and entrepreneurial ventures that could generate more investment and growth for the economy.
This incentive was created when Section 12J was inserted into the Income Tax Act in 2009, legislating the tax treatment of investments in VCCs. The tax incentive allows a holder of shares to claim a 100% tax deduction of the cost of the shares issued by an approved VCC. Since the incentive was introduced, South Africa has seen VCCs investing in SMMEs that include education, agriculture, renewable energy, hospitality and tourism, and student accommodation.
And now, no thanks to COVID-19, SMMEs will find it even more challenging to get access to funding. Not to mention the fact that in June 2021 the VCC tax incentive will end. Where will all these investors go? We are likely to see possible investors taking their money offshore. Their risk is just too high without this VCC tax incentive, especially now with the COVID-19 restrictions imposed on businesses.
Let’s take a look at the rules of the VCC tax incentive since its introduction:
- There was an initial investment limit of R750 000 per tax year and a lifetime limit of R2.25m.
- In 2011 these limits were removed to make the incentive more attractive.
- In 2019 new caps were introduced; investments by a natural person and trusts were capped at R2.5m, and for companies, investments were capped at R5m in a tax year.
- The deduction is subject to recoupment if the VCC shares are held for less than five years.
- The incentive is subject to a 12-year sunset clause that ends on 30 June 2021.
The VCC industry body, 12J Association of South Africa, released information on the impact the investments have made up until June 2020:
- Of the 106 VCCs managed and R9.3bn in assets, there have been 5 500 investors and an average investment amount of R1.7m per investor.
- More than 360 small, medium, and micro-sized entities have been invested in, which equates to 10 500 jobs across many industries.
- The incentive also shows cost-effectiveness at an average cost per job of about R126 000 for each job created. Other job creation-focused incentives in SA allow for R450 000 for each job created.
Initially, the tax incentive saw investors with very high net worth investing significant amounts – mostly to mitigate their tax liability from once-off capital gains tax bills. But lately, the incentive has seen investors such as doctors, lawyers, bankers and business owners with a big enough tax bill jump onboard. They see Section 12J as a way to mitigate some of their tax liability while also having an alternative investment vehicle. And, in a market where equities and property are struggling, this tax incentive is one of very few channels available to persuade investors to invest their money into South Africa for at least five years.
Unfortunately, we are now seeing how the impact of the COVID-19 pandemic has hit hard many of the industries qualifying for VCC investments. This, in turn, will make it difficult for SMMEs to obtain equity capital over the next two years – and we all know what this means, a far higher unemployment rate, and corresponding lower growth in the SA economy.
Now more than ever, we need the VCC tax incentive for SMMEs. There will be fewer investors – and, therefore, fewer jobs – without the Section 12J tax incentive. It’s just too attractive an offer to pass up. And so, as the 2021 deadline creeps closer, the 12J Association of SA and other industry players are set to fight to keep the tax incentive and have suggested that it be extended until at least 2027.