A Guide to Section 12J Equity Investment

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Section 12J or S12J of the Income Tax Act of 1962 was approved by the South African government to serve as an incentive to taxpayers in the country to invest in local businesses, and in turn get a 100% tax deduction equal to the amount they invest in any company. This is a move by the government to provide equity funding to small and medium-sized enterprises or SMEs in the country.

Investors that partake in this act not only enjoy tax deductions but also contribute to the growth of the nation’s economy. In truth, these SMEs have played and will continue to play a critical role in the growth of the South African economy.

Venture Capital Company (VCC) and S12J

A venture capital company is one that is still in its early stages and requires a lot of capital. Because a VCC needs a lot of capital, they typically register as an S12J approved company.

Only such approved VCCs are allowed to receive funding and investments from the taxpayers that participate in this Act. Section 12J is very popular among venture capital companies and investors because both parties benefit greatly from it.

VCCs get the capital they need and investors in turn, enjoy the many benefits offered by the S12J provision as well as receiving shares and dividends from the companies they invest in. Investors however should note that they cannot cash out the investment amount until after 5 years.

The Act stipulates that all investments made in approved VCCs will last a total of 5 years before taken out. Investors looking to profit from their investment can check out some sites like https://anuvainvestments.co.za/investments/equity for professional help.

Benefits of S12J Investments to Investors

  1. It is a low risk, high return type investment
  2. Investment managers do not take unnecessary risks with investors’ money because the main aim of this investment is to conserve capital.
  3. Investors get to diversify their investment portfolio by participating in this Act.
  4. This investment has a higher average net return than other investments in the stock market.
  5. When the Section 12J was revised in 2014, a clause that terminates it on June 30th, 2021 was included. However, investors whose five-year investment period falls after the set end date still get paid their dividends and enjoy the tax benefits till their five-year investment period is complete.

S12J Investors and Investees Requirement

Investors Requirement

The following are the requirements investors looking to participate in this Act must satisfy:

  • Must be looking to diversify their investment portfolio
  • Must invest a minimum R100,000
  • Must have the intention of minimizing taxable income
  • Must be considering investing in companies that do not participate in the secluded activities by the Act.

Investee Requirements

  • Must be operating and residing in the country
  • Must be an independent company fully in charge of its operations
  • Must be unlisted, according to section 40 of the Income Tax Act.
  • The sum of income derived from investment by the investee must not be more than 20% of the income realized during its year of assessment
  • Must have its tax affairs in order with a tax clearance certificate issued by the South African Revenue Service (SARS) to support this requirement. You can click hereto learn more about the South African Revenue Service.
  • Must not be involved in any of the following trades restricted by the Act:
    • Any trade in immovable property, except as a hotel keeper which also includes establishments offering bed and breakfast services.
    • Financial related services such as, money-lending, banking, insurance, and hire purchase financing;
    • Provision of advisory services like legal, auditing, stock broking, tax advisory, management consulting, or accounting;
    • Operating casinos or related gambling activities which includes any game of chance;
    • Production and trade of liquor, tobacco related products or  firearms and  ammunition; or
    • Any trade operating mainly outside South Africa
    • As regarding tax for investees, the established tax rules will apply.

How Section 12J Investment Works

The taxpayer or investor upon his investment in a VCC receives a certificate showing the invested amount. This certificate allows the investor to deduct from his taxable income the equivalents of the invested amount.

This investment is a medium to long term one as investors are required to hold their stake for a minimum of five years. Taxpayers that withdraw in less than five years are disqualified from receiving the tax deductibility benefit.

Investors are taxed for capital gains or paid dividends withholding tax, as the VCC begins to make profit. Investors should note however, that when their investment reaches maturity at the end of the five-year term and they withdraw from the VCC, the base capital gain will be zero as a result of the initial 100% tax deductibility benefit.

Mitigating Risks

This type of investment comes with risks like any other investment. However, there are steps that can be taken to reduce the risks involved.

  1. Risk/Return Appetite: Taxpayers should buy into companies whose investment managers have a clear risk management strategy that aligns with their risk appetite, that is, the level of risk they are willing to take.
  2. Liquidity Risk: As stipulated by the Act, investors are required to hold their shares for a minimum of five years to fully benefit from the Act. Investors should therefore make sure that they can hold out for the required period without pulling their fund because certain penalties will be faced for withdrawal of investments prematurely.
  3. Capital Risk: Venture Capitalist Companies, being growing companies with little experience, risk losing their capital. To avoid running a loss, taxpayers should ensure they buy into companies focused on capital preservation and carry out asset-backed investments.
  4. Exit Risk: Many S12J companies have underlying companies that are illiquid and so investors may struggle to liquidate their shares at the end of the five-year term. To prevent this, a taxpayer must ensure VCCs they buy into have a clear exit plan that they fully understand.
  5. Cash Flow Risk: Taxpayers who need steady cash flow from their investments should ensure that companies they invest have regular payouts within the five-year contract term.

Conclusion

With innovative solutions like this to economic problems in Africa, it is only a matter of time before African SMEs grow into fortune five hundred companies thereby creating more job opportunities and developing the African economy. SMEs are therefore advised to take all necessary steps required to qualify for Section 12J of the Income Tax Act.