Improvements to Income Tax Act expected.
Venture capital funds expect improvements to Section 12J of the Income Tax Act in next week’s Budget Speech, with the hope that further amendments will follow and so encourage investment into this asset class.
“We definitely do expect improvements to 12J in this Budget Speech and we believe there are key efforts to encourage further investment,” said Tamzin Ractliffe, founder of the Impact Trust, a non-profit organisation dedicated to growing the impact-investing ecosystem through financial and intellectual capital.
Ractliffe founded the Impact Exchange (iX), the world’s first recognised investment exchange (RIE) and regulated social stock exchange board, in collaboration with the Stock Exchange of Mauritius.
Under Section 12J, investors can write off 100% of their investment in a South African Revenue Service (Sars)-approved venture capital company from their taxable income. Based on the success of venture capital trusts implemented in the UK more than a decade ago, Section 12J aims to stimulate the economy and promote investment into small and medium-sized businesses.
CEO of the South African Venture Capital and Private Equity Association (Savca), Erika van der Merwe, said that Section 12J represents an important first step towards building a sensible and beneficial incentive structure for private sector funding. “Section 12J has been such a welcome development and we are truly excited that Sars has implemented this, as it opens up new avenues for funding of venture capital firms,” she said.
“Our feeling is that it could go further to encourage investment, making it more attractive for venture capital funds to be accredited under the act. Lessons from elsewhere in the world have shown that a sensible tax framework – one that rewards taxpayers’ contribution to enabling innovation, kindling growth and boosting job creation – pays off,” Van der Merwe emphasised.
She said that currently, there were around ten venture capital companies in South Africa.
Just three of these are both accredited by Sars under Section 12J and fully functioning, including Grovest Venture Capital Company, led by CA and start-up specialist Jeff Miller.
Improving Section 12J
“Venture capital by nature is a risky investment. Under Section 12J, assuming the maximum tax threshold, Sars takes on 40% of that risk, which means the investor keeps 60% of the risk on 100% of their investment,” explained Miller.
This tax benefit effectively adjusts the risk of investing in private companies requiring growth capital, while reducing the risk to 60% of the investment as a result of the tax deduction.
“In line with the National Development Plan (NDP) we envisage additional advantageous amendments to Section 12J in the short term,” Miller continued. Grovest feels the R20m cap on the asset size of companies eligible for venture capital funding should be increased to provide a larger scope of companies to invest in.
Miller explained that Grovest invests only in post-revenue businesses to ensure some level of traction. “These are generally early stage businesses or smaller private companies that require money for working capital or growth,” said Miller. “We are looking for highly scalable businesses and returns on equity north of 25%.”
The company has been working with SiMODiSA, a collaborative movement to accelerate the entrepreneurial landscape in South Africa, initiated by Finance Minister, Pravin Gordhan and Pieter De Villiers, the founder and CEO of mobile messaging provider Clickatell.
Miller emphasised that venture capital deserves a place in a well-balanced investor portfolio, but should remain in the 5% to 10% range in terms of asset allocation. He said it was a medium- to long-term investment offering high growth potential and a tax benefit. “The present value of the investment skyrockets because investors are getting tax back straight away.”
He said the venture capital sector in South Africa was “still in its infancy”, but growing daily. “Government and Treasury are behind it, as the development of entrepreneurs is paramount to the success of South Africa,” Miller said.
Grovest is quietly confident about additional reforms government might introduce that will further bolster venture capital investing. “We have been lobbying government for additional amendments and they have been receptive,” said Miller.
His views are echoed by Van der Merwe, who said she was encouraged by the willingness of Treasury and Sars to engage with practitioners in the venture capital industry about workable policies and incentives to attract investment.