South African venture capitalists have welcomed the recent Taxation Laws Amendment Bill which introduces two changes to Section 12J of the Income Tax Act. The changes, effective January 2015, should boost investment into entrepreneurial businesses and increase the appeal of venture capital for investors.
“We believe that these more attractive tax incentives have the potential to boost greater levels of investment into entrepreneurial businesses in South Africa, many of which cannot easily access finance. More investment into high-potential smaller businesses should translate into much-needed job creation,” says Erika van der Merwe, CEO of the Southern African Venture Capital and Private Equity Association (SAVCA.)
The first key amendment is that the total asset limit for qualifying investee companies (being the businesses in which the Venture Capital Company or VCC may invest) has been increased from R20m to R50m. For junior mining companies, this limit has been increased from R300m to R500m.
Adam Bekker, co-founder of Broadreach Capital, which has a registered VCC fund, says that the original asset limits set when the VCC tax regime was first introduced in 2009, being R100m for junior miners and R10m for other businesses, were indeed too low and SARS and National Treasury have subsequently acknowledged this. “They first took the view that they wanted to encourage investment into very early-stage businesses or start-ups, so the book value of companies that VCCs could invest in was originally set very low.”
Bekker says it soon became apparent that it would be difficult to attract either investors or fund managers to use the incentives at that level. “The risk associated with very small companies is too high for most investors, and makes it difficult for fund managers to run a profitable business managing such small investments.”
In 2011 the original limits were relaxed to a degree, up to R300m for junior miners and R20m for other businesses, and we now see a further relaxation. Since the original legislation of 2009, these thresholds have been increased fivefold. Bekker says they are now at a level appropriate to the types of businesses that National Treasury is trying to support, and in line with what the VCC tax concessions are trying to achieve. “We should now see investor uptake of the incentives.”
Jeff Miller of Grovest, a S12J VCC, believes that the increasing of the asset thresholds means VCCs can now invest in larger companies that have an extensive asset base. “This amendment changes the entire VCC landscape.” Businesses across the spectrum should benefit from improved investment, ranging from small manufacturing, to hardware-based IT businesses, education, healthcare and renewable energy.
The second S12J amendment relates to the tax deduction available to an investor who subscribes for shares in a VCC. Since its inception, this deduction was immediate and for the full amount of the investment made – however, it would be recouped and become taxable if the investor sold the VCC shares at any time. SARS will now allow the investment deduction to be permanent, as long as that investment is held for a five-year period.
Grovest’s Miller explains that without the five-year rule, investors were taking on extensive risk. “Previously there was no real incentive to invest in VCCs. With the investment deduction now becoming permanent after a five-year holding period, this tax relief means that VCC investors will be getting a proper risk-adjusted return.”
While exceptionally pleased with these two amendments, Miller says there is still work to be done to make the VCC tax regime more investor-friendly. “We would like to see tax benefit being passed on to secondary investors who acquire their interests from the original subscribers. We will also be working with government to address capital gains tax and dividend withholding tax, and ideally obtain similar tax treatments as seen in the traditional private equity fund structures.”