Section 12J tax breaks for investors abolished in SA’s national budget

The Section 12J tax breaks for investors, which offered rebates to South Africans if they made investments through approved venture-capital companies, has been abolished.

The scheme, so-called because it was part of Section 12J of the Income Tax Act, was introduced in 2008 to encourage investments in startups and SMEs, riskier investments that nonetheless could help to create jobs and stimulate economic growth.

A myriad of VC firms have launched such funds, including Kalon Venture Partners, Knife Capital and E4E Africa, with funds still being announced as recently as this month.

It was set to expire on June 30 of this year, and though it had been expected to be renewed, South Africa’s Treasury announced in its Budget 2021 statement that its objectives had not been “sufficiently” achieved.

Rather, the regulations had provided a significant tax deduction to wealthy taxpayers, as rather than investing in small businesses and riskier ventures, the majority of the S12J investments were “low risk” in sectors such as property that offered more guaranteed returns. More than ZAR11 billion (US$754 million) was invested in 360 S12J venture companies, but only 37 per cent of these companies added new jobs after receiving funding.

VC firms that have been making investments in startups via such vehicles, however, expressed disappointment, though there was an acceptance that the incentives as they stood were not working as well as they should.

“I believe Treasury has taken a very short-term view rather than a five-year time horizon which would have been very beneficial for the fiscus,” said Clive Butkow, chief executive officer (CEO) of Kalon Venture Partners.

Keet van Zyl, partner at Knife Capital, said the intention of the Section 12J incentive was always to overcome one of the main challenges to the economic growth of South African SMEs – access to equity finance – by making the VC asset class accessible for retail investors.

“Unfortunately, only a handful of VCCs have investment mandates to legitimately claim that they invest in SMEs. The likes of Knife Capital’s KNF Ventures, Kalon Venture Partners, Sanari Capital, Kingson and Anuva Investments lead the charge. If there were more of these VCCs out there focused on SMEs this would have been a permanent incentive for the benefit of the ecosystem driving innovation, job creation and economic growth,” he said.

“While a bitter pill to swallow, I can understand the reasoning behind the move. I would have wished for an extension of the June 2021 sunset clause with refinement of the ‘qualifying investee’ definition to stamp out abuse and encourage and force VCCs to stick to the spirit and intent of the tax incentive. Why would you not continue to back the the 37 per cent of SME Qualifying Companies that created jobs post investment?”

Scale-up mentor Guy Harris said removing the tax breaks without replacing them with something more effective showed a lack of foresight, and demonstrated the “ongoing dominance of big business and big government” of the South African economy.

“When the tax engineers started exploiting there should have been refinement then rather than complaining about loopholes being validly used but contrary to objectives,” he said.