Beware of the hype over section 12J
CRYPTOCURRENCIES offer new ways of exchanging and storing wealth, creating incentive structures and eliminating intermediaries that, rightly or wrongly, are seen as exerting undue influence on a network or system.
However, many questions remain unanswered, and most investors support digital currencies without understanding and questioning the substance of their investment; they are simply following the hype.
Being in the venture capital space in South Africa, I have daily discussions with entrepreneurs, strategic partners and other venture capital companies where the topic of section 12J of the Income Tax Act comes up like clockwork. It is an investment option that has gained popularity since 2014 among those looking to reduce their tax liability and find alternative sources of return in an uncertain economy.
The section 12J legislation was introduced to encourage local direct investment in early stage businesses, driving the development of a local entrepreneurial culture and resulting in wider benefits to society by way of employment, wealth creation and additional tax revenue.
Unfortunately, section 12J venture capital company (VCC) structures are often “sold” to investors in a way that has created much misguided hype – not too dissimilar from that which surrounds Bitcoin.
The mechanics of section 12J allow taxpayers an income tax deduction for investments in qualifying assets or companies. The premise is that the South African Revenue Service foregoes otherwise payable income tax now, in return for future income tax payments from the investee company, capital gains from the VCC on exit, and dividends tax or capital gains tax from the investor when funds are paid out. This risk of foregoing something now in return for a possible big payout in the future is similar to how a normal venture capital investor should think.
However, the popular narrative being used to promote some section 12J investments is that individuals should invest in a section 12J VCC instead of paying tax. Apart from avoiding tax, little information is provided about the people who run the section 12J VCC, the underlying investments, and the investment thesis underpinning the company and how it will deliver long-term financial value. There’s a fundamental problem with this: investors ought to invest in real opportunities, with real clients and real products, and, most importantly, in things they understand.
I have found that many section 12J VCC entities offer low-quality investments, because they focus on the tax-saving aspects rather than the real objective of the tax concession, which is nurturing credible investment opportunities and delivering long-term economic value.
Venture capital is risky, thus prospective investment opportunities need to offer the potential of fantastic returns and be both credible and scalable. This means investing in real businesses, with real products and value, not simply chasing tax breaks and certainly not following the hype.
Notwithstanding, there are many
Many section 12J VCC entities offer lowquality investments, because they focus on the tax-saving aspects rather than the real objective of the tax concession, which is nurturing credible investment opportunities.