Section 12J Venture Capital Tax Incentive – Is It The End?SimodisaPortal
The National Treasury introduced Section 12J (S12J) investments in 2009. Through S12J of the Income Tax Act 1962, a tax incentive was created which would enable investors who invest in qualifying SMEs to write off 100% of their investments in a particular tax year. The intention of the S12J incentive was always to overcome one of the main challenges to the economic growth of South African SMEs: access to equity finance, by making the Venture Capital (VC) asset class accessible for retail investors. Investing in SMEs has a lag time, as first money needs to be raised, then deployed, and startups need time to reach scale.
Unfortunately, only a handful of Venture Capital Companies (VCCs) have investment mandates to legitimately claim that they invest in SMEs.
The 2014 SiMODiSA White Paper, however, found that this tax incentive had not put more risk capital into the businesses of SA start-ups. SiMODiSA, SAVCA and other organizations in the ecosystem made recommendations to the National Treasury in regard to the enhancement of the VCC regime. The incentive was tweaked, and it started gaining momentum. In 2018 SiMODiSA released a report which looked at the progress made since the White Paper recommendations. This report found that updates to the S12J tax incentive had contributed to significant uptake amongst investors during the 2015-2018 tax years, leading to risk capital flowing to entrepreneurs. Regulatory concerns were raised as to economic impact and possible abuse by VCCs.
If there were more of these VCCs out there focused on SMEs this would likely have been a permanent incentive for the benefit of the ecosystem driving innovation, job creation and economic growth. The incentive should have been adapted and aligned to the original intent as soon as it became apparent that things were out of sync.
Was SARB’s February 2021 announcement a surprise?
The announcement not to extend the sunset clause was disappointing but not surprising given the state of affairs. The incentive was always naturally ending in June 2021 and most S12J VCCs structured the timing of their funds around that deadline. The National Treasury has made numerous changes and comments over the past few years to signal their discontent with the way S12J was applied by many VCCs. However, extensive lobbying and research into the benefits of S12J for SMEs over the recent past gave the ecosystem hope that sense would prevail with some form of extension of the incentive,
A sensible approach could have been to extend the June 2021 sunset clause while refining the ‘qualifying investee’ definition to stamp out abuse, thereby encouraging and forcing VCCs to stick to the spirit & intent of the tax incentive. Why would you not continue to back the 37% of SME Qualifying Companies that created jobs post investment?
The way forward?
In essence, SARB’s announcement means that investments in approved VCCs before the 30th of June 2021 will be 100% deductible from their taxable income, but not beyond that. Those VCCs focused on SME investment could leverage this incentive to slightly derisk the asset class for investors.
We cannot ignore the fact that policies aren’t clear and that this lack of clarity is not conducive to attracting investments into high-impact & high-growth startups. We need a holistic approach in order to attract investments into South African startups, as well as incentivise investors for investing in startups. This holistic approach is in the form of introducing a Startup Act for South Africa which embraces the value and job creation opportunities of the new economy. Countries, such as Italy & Tunisia, that have implemented Startup Acts have seen significant increases in investments in startups, revenue, value-addition and assets.
Visit www.startupact.org.za to learn more about the benefits of a Startup Act & join the coalition of organizations that are calling for this Act.
Article written by Tumi Makhubele (SiMODiSA Operations Manager) and Keet van Zyl (SiMODiSA Exco Member & Knife Capital Co-Founder)