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.
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 R1 million into a Section 12J VCC (assuming a maximum marginal tax rate for an individual), the investor will receive a tax credit of R450,000 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?
There are two options:
- The investor may structure potential qualifying opportunities through the Section 12J VCC, or
- The investor may invest in an existing opportunity managed by the Section 12J VCC.
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, 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 the 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; and
- any trade carried on in respect of gambling, liquor, tobacco, arms, or ammunition.
Examples of Section 12J VCC qualifying businesses are:
- Franchises,
- Manufacturers,
- Student residences,
- Renewable energy companies and
- General SMMEs.
Who can benefit from a Section 12J investment?
Any South African taxpayer is allowed to benefit from a Section 12J tax deduction. Therefore, anyone who pays tax in South Africa (i.e. foreign or local companies, individuals and trusts) may invest in a Section 12J VCC and claim the deduction.
When do I claim the Section12J investment as a tax deduction?
The tax deduction is claimed in the same tax year as when the investment into the Section 12J VCC is made.
Are Section 12J VCCs utilised as a vehicle to raise funding?
Section 12J VCCs are outstanding vehicles for fund raising activities for project developers, as investors will receive an almost immediate return on their investment through the tax deduction.
How much is an investor allowed to invest into a Section 12J VCC?
An investor may invest as much as they would like into a Section 12J VCC. However, an investor will maximise his/her returns by investing up to his/her taxable income for that tax year in the case of an individual or trust or his/her current and future taxable income in the case of a company.
Is an investor allowed to use debt funding to invest in a Section 12J VCC and still claim the investment as a tax deduction?
The answer is yes. However, the investor should be liable for settling the outstanding debt regardless of whether the returns generated by the investment are adequate to settle the repayment of the debt.
What are the perceived limitations associated with a Section 12J VCC investment?
There are two perceived limitations from an investor’s perspective:
- An investor must hold his/her shares in a Section 12J VCC for a minimum period of five years in order to retain the tax deduction of the initial investment amount. If the investor disposes of his/her shares prior to the five-year period, the initial investment amount will be recouped, and the investor will be required to pay back the full tax saving with no additional interest or penalties.
- The investor’s base cost for Capital Gains Tax (CGT) purposes will be zero when the investor exits the Section 12J VCC, which means that an investor could potentially pay CGT on the initial investment amount plus growth on the investment.
How do investors exit their investments in the Section 12J VCC?
There are numerous options that will allow an investor to realise his/her investment in a Section 12J VCC.
Two of the more common options are:
- The investor could sell the shares in the Section 12J VCC to a third party, or
- The Section 12J VCC acquires the shares from the investor from the proceeds on the disposal of the underlying investment.
What are the typical fees charged by a Section 12J VCC?
VCC’s typically charge the following fees (or a combination of the following fees):
- An Initiation Fee
- An Administration Fee
- A management or performance fee, based on the performance against a benchmark.
There are more than 100 registered Section 12J Companies in South Africa currently and it is important to choose the right company with which to partner.
For more information contact your partner at Moore Stephens.