Wel­come fil­lip for smaller pri­vate eq­uity in­vest­ments

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW -

THE ven­ture cap­i­tal com­pany tax regime is reg­u­lated by sec­tion 12J of the In­come Tax Act, 58 of 1962 which was first in­tro­duced in 2009 to en­cour­age in­vest­ments into pri­vately owned busi­nesses. The sec­tion specif­i­cally aims to help the growth of small and medium-sized busi­nesses by in­creas­ing their ac­cess to eq­uity fi­nance.

There are a num­ber of re­quire­ments which must be com­plied with be­fore a ven­ture cap­i­tal com­pany may ob­tain ap­proval from the South African Rev­enue Ser­vice (SARS) and qual­ify for the favourable tax regime. For ex­am­ple, it must be res­i­dent, its sole ob­ject must be the man­age­ment of in­vest­ments of qual­i­fy­ing com­pa­nies as de­fined, its tax af­fairs must be in or­der and it must be li­censed in terms of sec­tion 7 of the Fi­nan­cial Ad­vi­sory and In­ter­me­di­ary Ser­vices Act, 2002.

The in­vest­ments by the ap­proved ven­ture cap­i­tal com­pany also need to be struc­tured in a cer­tain way. The ap­proved ven­ture cap­i­tal com­pany is firstly re­quired to hold qual­i­fy­ing shares, which are shares is­sued by a qual­i­fy­ing com­pany, as de­fined. A “qual­i­fy­ing com­pany” is de­fined to be a res­i­dent with its tax af­fairs in or­der, that is un­listed or a ju­nior min­ing com­pany and not car­ry­ing on an im­per­mis­si­ble trade. A qual­i­fy­ing com­pany’s in­vest­ment in­come is limited to 20% of its gross in­come. The regime is there­fore es­sen­tially aimed at di­rect in­vest­ment in op­er­a­tional en­ti­ties.

Fur­ther lim­i­ta­tions in re­la­tion to the in­vest­ment in­clude that no more than 20% of the ex­pen­di­ture in­curred by the ap­proved ven­ture cap­i­tal com­pany can be used to ac­quire shares in any one qual­i­fy­ing com­pany (ie the ven­ture cap­i­tal com­pany will need to own at least five in­vest­ments) and at least 80% of the ex­pen­di­ture in­curred by the ap­proved ven­ture cap­i­tal com­pany must be to ac­quire qual­i­fy­ing shares in qual­i­fy­ing com­pa­nies hav­ing as­sets with a book value not ex­ceed­ing R300m for a ju­nior min­ing com­pany or R20m for other com­pa­nies. If all of the qual­i­fy­ing cri­te­ria are met, an in­vestor will be al­lowed to deduct the ex­pen­di­ture in­curred in ac­quir­ing shares in a ven­ture cap­i­tal com­pany from its tax­able in­come, cre­at­ing a siz­able in­cen­tive to in­vest.

Con­tin­ued com­pli­ance with re­quire­ments will re­quire care­ful man­age­ment but the tax in­cen­tive ef­fec­tively means that a ven­ture cap­i­tal com­pany will get the re­turn on 100% of the in­vest­ment for 60% of the cost.

There has, how­ever, been a limited up­take and ap­prox­i­mately only 10 ven­ture cap­i­tal com­pa­nies were ap­proved to date. One of the main rea­sons for the limited in­ter­est was as a re­sult of the fact that the orig­i­nal qual­i­fy­ing as­set lim­i­ta­tion cri­te­ria set at R300m for ju­nior min­ing com­pa­nies and R20m for other com­pa­nies were too low.

The SARS has recog­nised th­ese lim­i­ta­tions and the Tax­a­tion Laws Amend­ment Act of 2014 has favourably im­proved sec­tion 12J of the act. The most sig­nif­i­cant of th­ese pro­posed changes are the in­crease in the above-men­tioned book value limit to R500m for a ju­nior min­ing com­pany and R50m for other com­pa­nies. The amend­ments also pro­vide that the de­duc­tion to a tax­payer for the ex­pen­di­ture in­curred in ac­quir­ing shares in a ven­ture cap­i­tal com­pany will no longer be re­couped and tax­able where the tax­payer sells the shares, pro­vided the tax­payer held the shares for a pe­riod longer than five years. The amend­ments will come into ef­fect on 1 April this year.

Th­ese amend­ments have been wel­comed by the pri­vate eq­uity in­dus­try and are ex­pected to have a pos­i­tive ef­fect on the econ­omy by en­sur­ing greater in­vest­ments into small busi­nesses and ju­nior min­ing com­pa­nies, which will stim­u­late job cre­ation and eco­nomic growth.

Amend­ments ex­pected to help boost econ­omy

Peter Dachs and Bernard du Plessis are di­rec­tors and joint heads of ENSafrica’s tax depart­ment.

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