INCE / 03 JULY 2018 - 05.13 / JONATHAN WHITTAKER
While the upfront tax deduction has been a strong draw card for Section 12J, there is more to this investment than tax relief.
Section 12J of the Income Tax Act (Section 12J) incentivises tax payers to invest in small and medium sized South African private companies, referred to in the Act as Qualifying Companies. The goal is to bring the equity investor and the Qualifying Company together, driving job creation and economic growth in the process.
The incentive, which is run through Treasury's Venture Capital Company (VCC) regime, entitles you to deduct 100% of your investment against your taxable income. The VCCs act as conduits, deploying investors' funds into Qualifying Companies.
The hope is that the funding will be put to good use, unlocking capital growth and dividend returns. Though Section 12J came into effect in 2009 it was only after recent amendments to the Act that it proliferated, with over 100 VCCs now approved with SARS and over R2.5billion in equity funding raised.
More than just tax relief
It's easy to see the appeal of making an investment that reduces taxable income or shields tax payers from capital gains tax on the sale of an asset.
However, Section 12J is first of all a private equity investment with all its accompanying characteristics (high risk, illiquidity and long investment horizon). As such, it shouldn't form a major percentage of an overall investment portfolio. But given these characteristics it's fair to expect that returns will be higher than conventional assets. The investment also offers portfolio diversification, as the return profile would have a lower correlation to the likes of listed equity or bonds.
Focus on the investment case
When investing, put the tax relief aside for a moment and focus on the investment case and credentials of the management team.
Section 12J requires that three years from the first issue of venture capital shares, at least 80% of the investments made by the VCC must have been made into Qualifying Investments. No more than 20% of the proceeds of the issue of venture capital shares may be used to purchase shares in any one Qualifying Company. The Act also has strict criteria in terms of what constitutes a Qualifying Company.
So you need to be confident that the VCC's management team has a track record in developing a well-researched pipeline of Qualifying Investments, the ability to deploy the funds raised in a reasonable time to reduce a possible drag on returns, and the requisite skills and experience to unlock long-term value for both the company and its investors.
Compliance and risk management
There are also strict requirements that the VCC must comply with in terms of the Income Tax Act, or risk facing penalties. You need to feel sure that the management team can manage technical tax requirements in an investment offering that is, in effect, tax-managed private equity. So do take the time to satisfy yourself that you're partnering with the right VCC management team, one that can manage both the asset side and the tax side.
Doing so will give you greater confidence that not only have you gained upfront tax relief, you've also unlocked portfolio diversification and the reasonable prospect of enhanced returns for your portfolio.
Disclaimer - The views expressed here are not necessarily those of the BEE CHAMBER