National Treasury has proposed that the venture capital company (VCC) tax regime again be reviewed to prevent abuse.

The tax incentive was initially set up in 2009 to encourage job creation, small business development and economic growth.

In 2018, changes were made to the tax regime to prevent the abuse of some aspects of the system.

According to the 2019 Budget Review, it has come to government’s attention that some taxpayers are attempting to undermine other aspects of the regime to benefit from “excessive tax deductions”.

The tax incentive (Section 12J), which allows investors to deduct the full amount invested in VCCs approved by the South African Revenue Service (Sars) from their taxable income in the year they invest, has become increasingly popular following legislative amendments. Wasteful spending in government has also been a selling point for VCCs hoping to lure investors. VCCs use the money raised to invest in small and medium enterprises and junior mining companies.

Over 80% of the tax expenditure related to the incentive accrues to taxpayers who have a taxable income of more than R1 million (before the VCC deduction), the Budget Review states.

“There are a small number of taxpayers in these income brackets due to some very large single investments. The majority of taxpayers benefiting from the incentive are in the lower income tax brackets and they contribute modestly to overall tax expenditure.” 

By August 2018, roughly R4 billion had been invested with VCCs and around R1.7 billion with qualifying companies. Treasury attributes the difference largely to the time it takes to identify the right investments. VCCs have a three-year window to employ the money.

Johan Lamprecht, director for financial sector and international taxation at National Treasury, says unlike the situation in the UK and the US, the Section 12J deduction is unlimited (the full amount invested in a venture capital company can be deducted from a taxpayer’s taxable income). Treasury has found that some taxpayers have benefited from “very, very high single deductions” running into “quite a few million”.

While this doesn’t necessarily mean that something untoward or illegal is happening, Treasury wants to ensure that the fiscus is getting value for the money it forgoes by supporting the incentive. (The cost to the fiscus is partially offset through the capital gains tax taxpayers incur upon exit.)

Evidence of outcomes

“We want to be sure that the tax expenditure that we are incurring – whether it is R10 million or R1 million or whatever the case may be – we want to make sure that it is resulting in job creation, small business development, all those objectives we have for the incentive.”

The proposed review is aimed at determining where the money is going, how many jobs are being created, whether it is diversified and which sectors are being supported.

The VCC regime is subject to a sunset clause that ends in mid-2021.

Lamprecht, who is also responsible for small business at Treasury, says the extension of the incentive will depend on its effectiveness.

“If we find it is very effective and it is meeting its objectives then there is no reason not to extend it, but we need to determine … to what extent is it effective, just like any other incentive.”

South Africa’s largest Section 12J asset manager, Westbrooke Alternative Asset Management, recently led the establishment of an industry body – The Section 12J Association of South Africa – to prove the viability of extending the incentive past June 2021.

“The body … aims to compile the relevant information that National Treasury can use to assist in understanding the success of the incentive and motivating to extend the legislation post the sunset clause,” the Association said in a statement.

Lamprecht says if there are organisations that do research, Treasury will consider it, but it wouldn’t only rely on that – it will gather its own data to do a proper analysis.