South African government has killed Section 12J of the country’s Income Tax Act of 2009, which allows investors who make investments in approved Venture Capital Companies (VCC) — that then invest in qualifying small companies, including startups — a tax deduction. This is the most prominent shock delivered in the country’s 2021 national budget statement. Although the scheme was set to expire on 30 June 2021, after being in existence for about 12 years, it was the hope of industry players that government would consider an extension.
By the terms of the Budget 2021 statement issued by the country’s treasury, the scheme was cancelled because it did not “sufficiently” achieve its objectives of developing small business, generating economic activity, and creating jobs.
“Instead, it provided a significant tax deduction to wealthy taxpayers,” the Treasury said, in the statement.
“Far from investing in small businesses and riskier ventures, Treasury found that the majority of the S12J investments were “low risk”, and offered guaranteed returns “that would have attracted funding without the venture”.
According to the treasury department, more than R11 billion ($756m) was invested in some 360 S12J venture companies, but only 37% of these companies added new jobs after receiving funding. Many of the companies offered property investments.
Simplifying Section 12J, In Full
In simple terms, Section 12J of South Africa’s Income Tax Act of 2009, allows investors who make investments in approved Venture Capital Companies (VCC) — that then invest in qualifying small companies — a tax deduction.
Thus, by investing in a Section 12J venture capital company, the investor not only qualifies for a full deduction of the total investment amount from their taxable income in the relevant tax year, but they are also indirectly supporting the South African economy and the growth of local SMEs. Section 12J is similar to Venture Capital Trusts (VCT) in the United Kingdom, which allow individuals with high net worth to save tax and instead invest in a VCT, which will then invest in startups.
Read also: Section 12J Is Inspiring New Funds To Launch For Startups In South Africa
By operation, Section 12J follows this path:
- A South African tax-paying entity approaches a VCC with its investment.
- The VCC accepts the investment for investments in its portfolio companies and issues the investor with a certificate for the amount invested.
- With this certificate, the investor approaches the South African Revenue Service (SARS) and presents the certificate. The certificate empowers the investor to deduct the full value of the investment from their taxable income in that tax year.
- Section 12J is so attractive to investors that using it investors can offset any tax on capital gains incurred from the proceeds from the sale of an asset. What this implies is that if in the current tax year a South African taxpayer has a capital gains tax case, the taxpayer will use a portion of his/her income to make an investment in a Section 12J business and write off a portion or all of the tax on capital gains owed.
This explains why there are, today, many VC firms in South Africa and why South Africa collected more than 21% of all VC funding deals in Africa between 2014 and 2019, whereas Nigeria only received 14% of the deals, even though Nigeria is the continent’s largest economy and has more than 3 times South Africa’s population.
Some of the venture capital firms which were opened in response to Section 12J, included Kalon Venture Partners, KNF Ventures, Kingson Capital and Grovest, Entrepreneurs For Entrepreneurs Africa (E4E Africa), Vinny Lingham’s Lion Pride Agility VCC Fund, run through his investment company Newton Partners, among others.
What Will Replace Section 12J And What Happens To Newly Launched Funds Under Section 12J After June 30, 2021?
Nothing more specifically stated, but the country’s Treasury said it is currently reviewing tax incentives for research and development. Although the proposed tax incentives are welcome, it is time South Africa pushed for a law, such as a Startup Act, which will more specifically target startups, as against the wider net cast by Section 12J.
For newly launched funds under Section 12J, the implication of the Sunset Clause relating to the section is that no deduction shall be allowed in terms of the VCC incentive in respect of shares acquired after June 30, 2021.
However, there is still uncertainty as to the provision of Section of 12J which states that South Africans investing through section would also have to wait for at least 5 years to get back (if at all) their earnings, alongside the accumulated profit, if any.
In worst case scenarios, the June 30th, 2021 deadline will only have an impact on VC’s ability to raise capital after the date, and not materially affect the functioning of Section 12J on the investments made under the section before that date.
Charles Rapulu Udoh
Charles Rapulu Udoh is a Lagos-based lawyer who has advised startups across Africa on issues such as startup funding (Venture Capital, Debt financing, private equity, angel investing etc), taxation, strategies, etc. He also has special focus on the protection of business or brands’ intellectual property rights ( such as trademark, patent or design) across Africa and other foreign jurisdictions.
He is well versed on issues of ESG (sustainability), media and entertainment law, corporate finance and governance.
He is also an award-winning writer