In South Africa, taxpayers are often on the lookout for ways to considerably reduce their tax liability and there are several tax incentive structures that, if utilised correctly, may afford such relief. Section 12J of the Income Tax Act No. 58 of 1962 (“Income Tax Act”) provides investors with a unique opportunity to invest in a tax-deductible investment vehicle. It provides small and medium size entities (“SME”) within South Africa equal access to equity funding specifically as SME’s have been identified as one of the primary contributors to projected future economic growth in South Africa. However, it is crucial for taxpayers to first consider the full extent of this type of tax incentive and to determine if it is indeed a fitting vehicle for their business and tax affairs, as there are several requirements that first need to be met.
The section 12J of the Income Tax Act venture capital companies (“S12J VCC”) is an incentive for taxpayers to invest in the South African economy via approved S12J VCC’s, the investor will benefit from a tax deduction and a return on the investor’s full investment. S12J VCC’s allow an investor to deduct the full amount invested in a S12J VCC from their taxable income for a specific tax year in which the investment was made.
A venture capital company (“VCC”) requires capital as it grows and through private equity funds a VCC can raise capital by accepting investments in exchange for shares from any taxpaying entity. If a VCC is a registered Section 12J company, investors would invest their capital and receive the Section 12J benefits in the form of tax deductions.
The following are pre-requisites for registering a South African Revenue Services approved S12J VCC –
- the company must be a resident of South Africa;
- the sole object of the company must be the management of investments in qualifying companies;
- the company’s tax affairs must be in order; and
- the company must be a licenced financial services provider in terms of section 8(5) of the Financial Advisory and Intermediary Services Act No. 37 of 2002.
The practicalities of a S12J VCC would be as follows: as a taxpayer you would approach a VCC with your investment, the investment must be a minimum of R100 000 (one hundred thousand Rand) and if the investment is made by a natural person and trusts it will be capped at R2.5 million, for companies the investments will be capped at R5 million. The investment amount can then be deducted from your taxable income in that current tax year. As an investor you will be paid out in dividends, this pay out will then be taxed for the first time as capital gains tax or dividends withholding tax.
It is essential to note that when the S12J VCC investment reaches maturity and the investment is withdrawn, the base for the capital gain will be zero due to the initial 100% (one hundred percent) deductible tax benefit. It is also important to take note that as an investor you will not qualify for the tax benefit if you withdraw your investment before a 5 (five) year period has lapsed.
On face value the S12J VCC tax incentive appear to be attractive due to the tax deduction incentives available, however there are several tax implications related thereto as mentioned. If you are not looking to commit to a minimum of 5 (five) year investment, the S12J VCC may not be the best suited option, as the investment will not reach it’s full potential.
VDMA’s team of experts are available to assist you with setting up a S12 VCC as well as providing legal advice regarding the investment in a S12 VCC.