SA Revenue Services offer investment incentives in VCCs

For high net-worth private individuals in South Africa, investing in venture capital businesses are an interesting component of any effective tax-planning strategy, but they must also be aware that they are not completely risk-free.

The world of venture capital investments can be an exciting and daunting experience at one and the same time. Since the enactment of changes to section 12J of the Income Tax Act, which became effective 1 April 2015, we have noticed an increase in the use of venture capital investments by high net worth individuals.

These investments are undertaken as an alternative to retirement annuities for the following reasons:

• There is no annual limit to the amount that can be deducted as is the case with contributions to a retirement annuity.
• You are committed for a shorter investment period.
• You have full access to the funds upon divestment.

The main reason for the increase in these investments is that the South African Revenue Services (SARS) have offered relief whereby no recoupment on the original deduction will occur upon disposal where an investor holds the investment for a period exceeding five years. By investing in a venture capital company (VCC), an investor qualifies for a deduction from income. The upside is that any proceeds from the disposal of such investment are treated as a capital gain for income tax purposes, should all investment criteria be adhered to. This deduction is only available in respect of shares acquired after 30 June 2021.

The amount which may be considered as expenditure that qualifies for a deduction in terms of section 12J must be limited to the amount for which the taxpayer is deemed to be at risk on the last day of the year of assessment.

The investment may be disposed of at any time, but recoupment in terms of the original deduction claimed by the investor will occur, should the investment not be held for at least five years. The other effect of claiming the deduction is that the investment’s base cost is reduced to zero, therefore the full proceeds on disposal will be subject to capital gains tax. Where the disposal is before five years since the acquisition of the investment, the proceeds for capital gain purposes may be reduced by the recouped amount.

Investing in a VCC does however come with its own downsides. The fact that it is not compulsory for a VCC to be listed on a stock exchange is a key issue. This issue is compounded as the deduction is only available for newly issued shares, therefore your investment may not be so enticing for the next investor. This translates into an investment that has very limited liquidity, so where your strategy is to sell after five years it might not be so simple.

You are not allowed to claim the deduction if, after the investment, you are deemed to be a related party of the company. For this reason, an investment threshold of a maximum investment in the VCC has been put in the place and no person claiming the deduction can be a director of the company. This leads to a lower level of control over your investment.

The most important factors that you as an investor need to consider are your risk appetite and the amount of funding available for investment in such a fund. This investment could form part of a balanced strategy, which should be discussed and formulated with your financial advisor. I would suggest that your tax consultant be included in this process, as your investment strategy and the related returns thereon can be significantly influenced by the tax effect.

Note:
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions or for any loss or damage arising from reliance upon any information herein. Always contact your financial and tax adviser for specific and detailed advice. Errors and omissions excepted (E&OE).