Land­mark year for VCCs

Af­ter some tweaks to the ven­ture cap­i­tal regime in 2018, the in­dus­try is set to fi­nally have its in­tended eco­nomic im­pact in­vest­ing in SMEs, writes Pe­dro van Gaalen

Financial Mail - Investors Monthly - - Section 12j -

“Funds flowed into VCCs as in­vestors looked to re­alise favourable re­turns and re­duce their tax li­a­bil­ity in a volatile lo­cal econ­omy

In an ef­fort to boost eq­uity fund­ing for SMEs, the gov­ern­ment in­tro­duced sec­tion 12J to the In­come Tax Act.

“SMEs are the lifeblood of the econ­omy. They stim­u­late growth and are the most pro­lific em­ploy­ers on a rand-for-rand ba­sis,” says James Twidale, di­rec­tor and port­fo­lio man­ager at Vir­tu­os­ity Cap­i­tal. “Of­fer­ing an in­cen­tive to help boost this sec­tor is fan­tas­tic for both the econ­omy and in­vestors.”

Since 2009, re­tail in­vestors, trusts and com­pa­nies can deduct from their tax­able in­come the full amount in­vested via a ven­ture cap­i­tal com­pany (VCC) that is reg­is­tered with the SA Rev­enue Ser­vice (Sars). The in­vested amount will only at­tract cap­i­tal gains or div­i­dends tax once re­turns are re­alised.

The VCC, which must be a res­i­dent of SA, then man­ages the fund and makes in­vest­ments in qual­i­fy­ing SMEs. “Af­ter a slow start, the num­ber of Sars-ap­proved VCCs in­creased sig­nif­i­cantly in 2015 fol­low­ing mi­nor leg­isla­tive amend­ments that made these in­vest­ments more at­trac­tive to in­vestors and in­vest­ment man­agers,” says Twidale.

Funds flowed into VCCs as in­vestors looked to re­alise favourable re­turns and re­duce their tax li­a­bil­ity in a volatile lo­cal econ­omy. Another spike fol­lowed the an­nounce­ment in Fe­bru­ary 2017 of a 45% in­come tax bracket for SA’s high­est earn­ers, as tax­pay­ers sought ways to more ef­fi­ciently struc­ture their tax.

“These driv­ers spurred in­vestor in­ter­est and fu­elled in­cred­i­ble growth in VCCs. About R3bn has since flowed into VCCs, with 2018 prov­ing to be a pro­lific year,” says Jonty Sacks, a di­rec­tor at Jal­tech. The sec­tor is on track to re­alise R1.5bn in in­flows for the cur­rent fi­nan­cial year, he says.

How­ever, in­stead of fund­ing early-stage small busi­nesses, cer­tain VCCs that have raised funds have failed to de­ploy cap­i­tal in qual­i­fy­ing com­pa­nies.

“Of the VCC funds reg­is­tered with Sars, only about 40 are ac­tive,” says Sacks. These VCCs gen­er­ally ac­count for the roughly R600m in­vested in qual­i­fy­ing com­pa­nies to date from the R3bn the in­dus­try has raised.

The Na­tional Trea­sury sub­se­quently raised con­cerns around the ap­par­ent fail­ure of VCCs to de­ploy funds in qual­i­fy­ing in­vest­ments. Opaque fund struc­tures due to a lack of in­for­ma­tion about un­der­ly­ing in­vest­ments and the ob­jec­tives and strat­egy of the VCC have also been cited as ar­eas that re­quire reg­u­la­tors’ at­ten­tion.

To pro­vide clar­ity, Sars re­leased a draft guide in June 2018 to pro­vide re­tail in­vestors with gen­eral guid­ance on in­vest­ing in VCCs.

Twidale wel­comes this, but sug­gests that re­tail in­vestors should still seek ad­vice when in­vest­ing in VCC op­por­tu­ni­ties.

In an at­tempt to curb in­dus­try abuse, the Trea­sury tabled the draft Tax­a­tion Laws Amend­ment Bill this year, which pro­posed var­i­ous in­dus­try changes. How­ever, these broad amend­ments meant cer­tain com­pli­ant funds would have been pe­nalised.

As a con­se­quence of in­dus­try-wide lob­by­ing, a col­lab­o­ra­tive process that in­cluded hear­ings by the stand­ing com­mit­tee on fi­nance in par­lia­ment, pub­lic com­ment and in­dus­try par­tic­i­pa­tion, a fi­nal amended bill was re­leased in Oc­to­ber.

Grovest CEO Jeff Miller is con­fi­dent that this will spur sig­nif­i­cant growth in the mar­ket and in­crease in­dus­try par­tic­i­pa­tion. “By root­ing out the par­ties that were abus­ing the sys­tem and not act­ing in the spirit of sec­tion 12J, more funds will also flow into SMEs. As such, these struc­tures will start to have their in­tended eco­nomic im­pact.”

Twidale says: “We are pleased to have clearer leg­is­la­tion that closes the loop­holes.” He be­lieves the amend­ments, which come into ef­fect in Jan­uary, will pro­vide greater cer­tainty and clar­ity, and there­fore more ro­bust in­vest­ment op­por­tu­ni­ties for in­vestors.

And the re­sul­tant growth is al­ready ev­i­dent, with ap­proved VCCs in­creas­ing from 116 in June to 135 as of Novem­ber 1, ac­cord­ing to the Sars web­site. Sacks says a flurry of reg­is­tra­tions oc­curred ahead of the start of cap­i­tal-rais­ing sea­son in Novem­ber. “And with less than three years left un­til the sun­set clause comes into ef­fect on June 30 2021, and a max­i­mum of 36 months to de­ploy cap­i­tal, 2018 is prov­ing to be a land­mark year for sec­tion 12J VCCs.”

Pic­ture: 123RF — TASHATUVANGO

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