A venture capital company or “VCC”, although receiving market interest of late, is not a new thing and was introduced in 2009 as section 12J of the Income Tax Act 58 of 1962 (the “Act”). The VCC forms part of Government’s philosophy of expanding economic growth through incentivizing investment in small businesses and junior mining operations. Essentially an investor acquires venture capital shares in a VCC which would in turn invests in qualifying investment companies by acquiring shares in such companies, provided such underlying companies do not conduct impermissible trades as defined by the Act.
This mechanism then promotes economic growth by creating a funding mechanism for small businesses and junior mines. The incentive for such investment in a VCC (and in turn in the underlying companies), is that SARS, subject to meeting the required conditions, provides for a 100% taxable deduction from the income tax of the taxpayer (investor) for the actual expenditure incurred by the taxpayer in obtaining the venture capital shares in the VCC and ultimately the underlying companies.
From the above, the VCC however appears just like an ordinary investment company, using investor funds to invest in other companies. Why then the beneficial tax treatment for the investor? The answer lies in the strict requirements contained in section 12J of the Act. Non-compliance with these will affect the ability of the investor to claim the deduction.
To qualify as a VCC, the company needs to be a tax compliant resident company with the sole object of the company being the management of investments in qualifying companies, licensed as such under section 7 of the Financial Advisory and Intermediary Services Act 37 of 2002.
Once a VCC is established and licensed, the VCC must satisfy the following requirements by the end of each year of assessment after the expiry of three years from the first date of issue of venture capital shares:
|•||A minimum of 80% of the expenditure incurred by the VCC must be utilised to acquire qualifying shares in qualifying companies.|
|•||The expenditure incurred by the VCC to acquire qualifying shares in any one qualifying company must not exceed 20% of any amounts received from investors in respect of the issue of venture capital shares.|
There are also requirements placed on the taxpayer. The taxpayer would need to hold the venture capital shares in the VCC for a minimum of five years to qualify for the deduction. In the event that the venture capital shares in the VCC are sold prematurely, the proceeds from the sale would be classified as a recoupment in the taxable income of the taxpayer and increase the tax exposure of the taxpayer.
In addition to the above, the investment of the taxpayer is subject to an anti-avoidance provision contained in section 12J(3A) of the Act, which determines that in order to deduct the investment from the taxable income of the taxpayer, the investments in the VCC must be genuinely ‘at risk’. In other words, the investment must be vulnerable to the normal profit and loss model of the VCC and not due to some form of credit or debt which is converted into equity.
But if these conditions can be met, the VCC can quite correctly provide substantial tax benefits in addition to providing a potential good return on investment based on the performance of the underlying companies. Taking account of the tax benefits, the risk of investment can weigh in favour of considering the VCC as a viable investment vehicle for an investor looking to invest.
The application of section 12J of the Act will come to an end on 30 June 2021, when the provision will be reviewed and a decision made as to whether its benefits will be extended for a longer period. For now the opportunity afforded for investors by section 12J is there and our advice is to consult your financial or commercial advisor to discuss the option of the VCC for your investment portfolio should you be interested in exploring the VCC model.