The investment that is 100% tax deductible
It would be a mistake for South African taxpayers who are making investments into South Africa not to consider structuring their investments through a Section 12J Venture Capital Company (VCC), as they are significantly incentivised with rebates of up to 45% for individuals, funds and trusts and 28% for companies.
For example, if an individual was planning on investing R10 million into a business and structures the investment through a VCC, he/she will receive R4.5 million in the form of a reduced tax bill. This means that the individual receives the full R10 million investment exposure for just R5.5 million.
Section 12J of the Income Tax Act is a piece of legislation that is used to structure South African taxpayers’ investments in a way, which affords the investor the opportunity to receive a rebate on 100% of their investment. This means that the entire amount invested is deductible from the investor’s taxable income.
According to the South African Revenue Service one of the main challenges to the growth of small and medium-sized businesses and junior mining exploration is access to equity finance. To assist these sectors in terms of equity finance, the government has implemented a tax incentive for investors in these enterprises through a VCC regime.
VCCs are intended to be a marketing vehicle that will attract retail investors and they have the benefit of bringing together small investors as well as concentrating investment expertise in favour of the small business sector.
“While Section 12J may encourage an investor to invest in enterprises which they may not have previously considered, it also provides an investor with the opportunity to receive a rebate on an investment, which he/she may have made without the rebate being in place”, says Gaurav Nair, co-founder and director at financial advisory firm Jaltech.
While there are limitations as to the industries in which a VCC can invest in order to qualify for the rebate, the main challenge is to ensure that the VCC has the necessary compliance processes in place, to take full advantage of the tax incentive while not falling foul of any related provisions.
Currently the law does not allow a Section 12J deduction for investments in financial services, property development (other than in the hospitality industry), the sin
industries (tobacco, alcohol and gambling), arms and ammunition or professional services consultancy firms.
“It is important for an investor to partner with the right firm that understands the legislation and regulations governing VCCs thoroughly. Such a firm should also have a track record in structuring such arrangements. “If they do not, then investors can run into serious challenges and harsh penalties,” says Nair.
“There has been increasing VCC activity in South Africa and there are exciting and lucrative opportunities to be had in the variety of industries that are able to take advantage of the Section 12J deduction”, Nair adds.
Substantial investments are being made in renewable energy developments including commercial and residential rooftop solar solutions to large photovoltaic projects, wind energy farms and across the hospitality sector.
“Having structured multiple renewable energy projects in both the wind and solar sector, we have seen, first hand, the enhanced tax benefits for investors associated with projects through Section 12J VCC,” Nair says.
There are, however, ways for project investors to achieve an even larger uptick in return through additional adjustments in the finance structure. An example of one of these adjustments is for the investor to raise debt for a portion or the entire funding requirement. Both debt and equity can be invested into a Section 12J VCC.
Provided that the debt qualifies, the investor will not only be eligible to claim a tax rebate on the full investment amount, but be able to pay off the debt in a shorter period of time.
By way of illustration, should a project developer invest equity of R30 million and debt of R70 million into a Section 12J VCC, the developer will receive a tax rebate on the full R100 million (a rebate of R28 million for companies and up to R45 million for trusts and individuals).
Assuming the developer has sufficient taxable income, he/she could effectively repay close to half of its debt in year one in the case of a company, and close to two-thirds of the debt over the same period in the case of a trust or individual.
In addition, a Section 12J VCC can be structured in such a way that the developer can still benefit from the Section 12B tax rebate for renewable energy projects.
“Having the right structure in place can significantly boost the project’s return on investment by more than 20%,” says Nair.