Was the Section 12J incentive pulled too quickly?
WORDS ON WEALTH:
Almost 12 years ago, in July 2009, the government implemented an initiative it hoped would stimulate small-business development, boost the economy and create employment. Investors, comprising wealthy individuals, companies and trusts, would receive generous tax break for investing in venture capital companies (VCCs). The VCCs, in turn, would use the money to fund qualifying young businesses with high growth potential.
These investment schemes came to be known as Section 12J schemes, after the section of the Income Tax Act that provided for the tax break.
The deal was that you could deduct the entire investment from your taxable income, provided you remained invested for five years. This was a very generous incentive, particularly for individuals in the top marginal tax bracket of 45%. A man earning R2 million a year could, by investing R500 000, reduce his tax bill by R225 000.
Naturally, the investor would be expecting decent investment growth, although a savvy investor would recognise that venture capital investments are inherently risky.
A host of VCCs sprang up, catering to high-net-worth individuals (the minimum investment, in many cases, was R500 000). There must have been good take-up, because in 2018 the government capped the annual tax-deductible amount to R2.5m for individuals.
In the past few years, Section 12J has been well promoted in the media, leading to the assumption that things were going well and that the initiative was bearing fruit.
It seems things weren’t going that well. There was a sunset clause to Section 12J: unless extended, it would end on June 30 this year. In last month’s Budget speech, the Minister of Finance made it clear the incentive would not be extended.
The reasons are given in the accompanying Budget Review document: “A National Treasury assessment determined that the incentive did not sufficiently achieve its objectives of developing small businesses, generating economic activity and creating jobs. Instead, it provided a significant tax deduction to wealthy taxpayers. The majority of investments supported by the incentive seem to be in lowrisk or guaranteed-return ventures that would have attracted funding without the incentive.”
The Budget Review says that information obtained from 100 VCCs and 360 qualifying companies showed that:
- R11.5 billion had been invested at VCC level, with R4.2bn invested in qualifying companies.
- Tax revenue from qualifying companies in 2019/20 was R207m, half of which was value-added tax.
- Qualifying companies employed 8 239 people, of which 4 035 people were in direct employment. Only 37% of qualifying companies added new jobs after receiving VCC funding.
- More than 50% of the investments appeared to be in low-risk moveable asset rental structures, lowrisk income-producing investments and guaranteed-return real estate investments.
- Since 2015/16, total tax revenue foregone due to the incentive was R1.8bn. The Treasury concludes: “Based on this information, the incentive seems to give a significant tax deduction to high-net-worth taxpayers that cannot be justified given its limited economic impact.”
Tanya van Lill, the chief executive of the South African Venture Capital and Private Equity Association (Savca), said Savca was disappointed that the Treasury was “withdrawing the incentive in its entirety rather than amending it to ensure Treasury’s objectives are met”.
Van Lill said: “It takes time to invest into qualifying companies and demonstrate the full benefits in terms of job creation and repayment of taxes to the fiscus … Treasury missed the opportunity to refine the Act to be narrower in scope and more targeted to high-risk investments, which aligns with their initial intention and where the funding shortfall for small and medium-sized enterprises (SMES) is the highest. We also note that there were no alternative measures announced to support investment into SMES in partnership with the private sector.”
Jeff Miller, the chief executive of VCC Grovest and director of the 12J Association, also bemoaned the fact that the Treasury didn’t consider amending the conditions of the incentive, and argued that hotel and student accommodation, where half the money had been invested, was not “low-risk”.
“With the reality of Covid-19, the hospitality industry, which represents close to 10% of our gross domestic product and which is our second largest export, is in dire straits. Tens of thousands of jobs have been lost already, and until international travel resumes to normal, this industry will continue to suffer major losses. I am not aware of many investors willing to support the hospitality industry without a decent incentive.
“For South Africa to get out of its quagmire we need the private sector to support SMES. The Venture Capital Trust (VCT) initiative in the UK, on which Section 12J was based, has been a massive success. By their own admission it takes time for the asset class to mature and flourish. Not only have VCTS created hundreds of thousands of jobs in the UK, but the incentive is now creating positive tax receipts for the fiscus.
“In South Africa, we were just at the beginning of this journey. It doesn’t make any sense to pull the plug when this initiative is still in its infancy.
“The proposed bill is still to be presented to Parliament for approval. I implore the members of Parliament to see the wood for the trees. If there are weaknesses in the 12J incentive, let Treasury sit around the table with the 12J Association of South Africa and work a win-win for all,” Miller said.