Illustration: Colin Daniel

Proposed changes to the venture capital company (VCC) tax incentive may have devastating implications for the industry, and several VCCs are at risk of losing their VCC status. 

The tax incentive was introduced in 2008 to encourage equity funding in small businesses, by providing investors with a full tax deduction on the amount invested with a VCC, provided the funds are invested for five years. 

The most critical proposed change will limit both a VCC and the companies in which it invests to having only one class of share. If the VCC does not have only one class of share, it could lose its VCC status. In the year in which it loses its status as VCC, the fund will have to include in its income 125% of all the tax deductions enjoyed by its investors.

The main reason for the proposed change, which is contained in the Taxation Laws Amendment Bill (TLAB), is tax structures that fall outside the rules of the regime.

Some of the classes of share could be deemed loans, rather than equity, defeating the objective of funding small companies with equity rather than debt. 

Pieter van der Zwan, an associate professor in the Taxation Programme at North West University, says any tax structure that abuses a tax incentive places the incentive at risk. “I do think it makes sense for National Treasury to stop anything which causes a different outcome to what was intended with the incentive.”

However, requiring the VCC and the small businesses in which it invests to have only one class of share, will cause a problem.

According to industry players, most VCC structures will have to be amended. If this cannot be done, the structures will have to be unwound.

The proposed change will disqualify existing structures that have more than one class of share (for example, those with different types of ordinary shares), even if they were approved by the South African Revenue Service.

Companies issue different classes of share to differentiate in terms of voting, dividend or capital rights.

Van der Zwan says many VCCs invest in small businesses via at least two classes of share, to allow the financier the first right of return on its capital. The remaining profits in the small businesses are divided between the financier (VCC) and the owner, on the basis of shareholding.

“If Treasury wants to restrict the number of classes of shares, I would suggest that the qualifying company should be allowed to issue at least two classes of shares.” 

Van der Zwan, who is a member of the South African Institute of Tax Professionals’ business incentive work group, says a restriction of one class of share is too narrow and will affect bona fide structures. 

The TLAB also proposes several amendments to bring greater clarity on the tax treatment of cryptocurrencies, such as Bitcoin.

Candice Gibson, a senior associate at Norton Rose Fulbright, says the amendments include changing the definition of financial instruments to include cryptocurrencies; including cryptocurrencies under section 20A of the Income Tax Act, which addresses the ring-fencing of assessed losses when dealing with certain trades; and amending the VAT Act to include cryptocurrencies as a financial service.