Venture capital tax relief: this is how real estate investors killed the goose that laid the golden eggs – Expert fiscal SA

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South Africans have spoken out against the abuse of public funds at the hands of politicians, with former President Jacob Zuma and his friends helping themselves with money through elaborate trade deals. The accounting fraternity has helped the bad guys, with KPMG executives increasing wealth for themselves and for the KPMG empire by feeding into the system. Elsewhere in the economy, smart accountants have shown investors how to take advantage of tax breaks designed to boost small business development and, in turn, spur job creation to, instead, buy property. They haven’t done anything illegal, but their actions explain why the government redesigned a clause that intended to increase the number of start-ups, but instead helped real estate investors build portfolios. Accountant Sinesipho Maninjwa dissects the figures to highlight a tax game that is hampering job growth. – Jackie Cameron

By Sinesipho Maninjwa *

Synopsis

Reflection on the last Tax Indaba (held the last week of August), one of the main themes of the seminar was the future of Article 12J Venture capital deduction, which has a sunset clause that takes effect on June 30, 2021. There has been intense lobbying to extend the deduction despite the industry adjusting to a new amendment that came into effect on July 21, 2019. The amendment says that in the next tax year, tax-deductible investments in licensed companies, which in turn invest in start-ups, would be limited to R 2.5 million. To register its complaint, the industry formed an association to fight with the tax authorities over the moderating effect of the amendment on the allocation of capital, hence the advisability of financing the venture capital activity.

Context and context

In 2009, the South African Revenue Service (SARS) introduced Section 12J into the Income Tax Act. The provisions of the law allowed individuals and / or businesses to amortize investments in new businesses. Write-off includes expenses incurred in exchange for the issuance of shares of a qualifying venture capital company not engaged in a prohibited business activity during the tax year. Put simply, an investor can deduct from his taxable income the value of shares purchased from a registered venture capital firm. The Venture Capital Company (VCC) operates as a small, medium or microenterprise (SMME) fund that invests in new businesses.

The overarching objective of the legislation is to encourage private capital to invest in the creation and development of new businesses in the country and to solve the following problems,

  • Funding Gap: According to the report released by the South African Banking Association, there is a funding gap of between R 86 billion and R356 billion for SMEs.
  • Unemployment: Recently released statistics from South Africa show that the official unemployment rate for 2019 rose to 29% in the second quarter (an increase of 1.4% from the first quarter from 27.6% in the first quarter) .
  • Gross domestic product: The latest GDP figure, released on September 3, 2019, shows the economy grew 3.1% (compared to a 3% contraction in the first quarter). This development is largely attributable to the mining and manufacturing sectors and more particularly to the rise in resource prices and the stability of the electricity supply.

The requirements for qualifying recipient companies have been structured to be flexible enough and to allow venture capital investment in all sectors except sectors that attract sin taxes and financial services, in particular. general so that eligible assets do not exceed R50 million (R500 million for minors).

How did Section 12J work?

The legislation has been in force for a little over 10 years. Since the introduction of the scheme in 2009, 165 registered funds but only 120 are currently active. Assets under management currently total a staggering 6.7 billion rand. Again, the scheme prescribes that investors can claim the full amount used to acquire shares of the s12J company as a deduction from the taxable income in the year of that investment. Therefore, at first glance, the recently enacted amendment to cap the amount of the deductible may appear to have a negative effect on the industry, thus appearing counterintuitive to the scheme’s incentive to a greater allocation of capital in favor of SMMEs.

Table 1: Section 12J – Asset allocation

Sector Capital allocation Risk profile Rating
Goods 58% Moo
Asset rental / Renewable energy 20% Average
Capital investment 18% High
New venture capital 4% High

* Source: Jonty Sacks s12J – Jaltech (2019)

Although a significant amount of capital has been raised, the unintended consequence of the flexible requirements has been an under-allocation in new businesses, indicated at 4% above. The tax authorities had sought to prioritize new businesses with this regime, but it was rather the real estate sector that benefited the most from the tax relief. In addition, the asset allocation gap shows that the s12J companies that benefited from the increase in tax value came from more secure traditional asset classes. Thus, despite government efforts to introduce incentives towards new riskier assets, the scheme has been applied more as a tax avoidance measure by taxpayers benefiting from excessive tax deductions. In addition, according to the National Treasury, the four-year average expenditure incurred by a new VCC shareholder to obtain VCC shares was between R 1.3 and 2.1 million per year. This statistic justifies the ceiling set at R2.5m and denies the assertion of the S12J community with the amendment.

Conclusion: the way forward for Section 12J

Section 12J forged a new community of investors, but failed to direct capital to new ventures. In terms of basic investor logic, what should make anyone invest in any asset class is the belief that the returns are of sufficient value to justify the outflow of money. after tax exemption. The motivation should always focus on the possibility of good returns, amplified by a favorable tax regime. Ahead of the June 2021 sunset clause, the hope is that the amendment will lead the reform towards an increase in new investment in venture capital. The downside seems to be that the tax deduction has preoccupied the growth of the s12J community and informs the rigor of lobbying to expand the regimes. If this were to happen, it would be prudent for the government to be more stringent in balancing the development of new businesses with sufficient tax incentives and BBBEE requirements. There are very few blacks or even women in the industry – an overhang or in keeping with the general demographics of South Africa’s financial services sector.

  • Sinesipho Maninjwa CA (SA)

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