Beware the Section 12J hype and what it entails
Being in the venture capital (VC) space in SA, I have daily discussions with entrepreneurs, strategic partners and other VCs, where Section 12J (S12J) of the Income Tax Act comes up like clockwork.
S12J 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 SA society by way of employment, wealth creation and additional tax revenue. Unfortunately, S12J venture capital company (VCC) structures are often ‘sold’ to investors in a way which has created a lot of misguided hype - not unlike that surrounding Bitcoin.
The mechanics of S12J allow SA taxpayers an income tax deduction for investments in qualifying assets or companies.
The premise is that Sars 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 dividend or capital gains tax from the investor when funds are paid out. This risk of foregoing something now in return for a possible big pay out in the future is similar to how a normal VC investor should think.
However, the popular narrative used to promote some S12J investments is rather than pay tax, individuals should invest in a S12J VCC. Little information is provided about the people running the S12J VCC, the underlying investments, the investment thesis underpinning the company and how it’ll deliver long-term financial value.
I’ve found that many S12J VCC entities offer low-quality investments, as they focus on the tax-saving aspects rather than the real objective of the tax concession: nurturing credible investment opportunities and delivering long-term economic value. VC is risky, thus prospective investment opportunities need to offer the potential of fantastic returns and also be both credible and scalable. This means investing in real businesses, with real products, clients and value.
However, there are many credible VCs that offer S12J structures. They’re doing a great job and tick all the investment manager boxes.
A good investment firm spends time and energy focusing on the right opportunities, before developing a successful strategy and working with and nurturing the entrepreneurs, with the main objective of maximising monetary returns for stakeholders.
Ian Lessem is CEO of HAVAíC