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Venture Capital regime needs overhaul

29 July 2014   (0 Comments)
Posted by: Author: Nicola Bird
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Author: Nicola Bird (KPMG)

In the 2014 Budget Speech, the Minister of Finance noted the importance of small business and entrepreneurship in facilitating the creation of jobs in the private sector. In this regard, the minister mentioned proposed amendments to the venture capital company ("VCC”) tax regime in order to enhance support for entrepreneurial development.

On 14 July 2014, the Davis Tax Committee, set up to "to assess our tax policy framework and its role in supporting the objectives of inclusive growth, employment, development and fiscal sustainability”, released an interim report on Taxation Considerations for Small and Medium Enterprises ("Davis report”), which sets out certain findings and recommendations in respect of, inter alia, the VCC tax regime.

In summary, the VCC tax regime works as follows:

  • A taxpayer (i.e. a resident individual, corporate, trust, etc.) is granted a tax deduction in respect of any expenditure incurred in acquiring shares in a VCC (subject to various limitations).
  • In order for the tax deduction to be successfully claimed by the taxpayer, the VCC, inter alia, must have obtained approval from SARS, must be licensed in terms of FAIS, and must have the sole object of managing investments in Qualifying Companies.
  • Qualifying Companies must in turn comply with a host of requirements, including amongst others, that it must not carry on an impermissible trade (such as gambling, any trade in respect of immovable property, the provision of financial or advisory services, or any trade carried on in respect of liquor, tobacco, arms or ammunition).

According to the Davis report, only three VCC’s have been registered with SARS since the introduction of the regime in 2009, which highlights the ineffectiveness of the regime. In our view, the limited uptake of the regime is due to the technically complex nature of the regime, which is administratively burdensome and restrictive in its application. This can be highlighted by the following:

  1. Recoupments on future disposal – in the event of a future sale of VCC shares by a taxpayer, the amount previously deducted in terms of section 12J will be recouped and included in gross income. As such, the Davis report correctly highlights that any benefit to an investor is merely a timing benefit until disposal.
  2. Secondary trading – the legislation in its current form does not provide for a deduction of expenditure incurred by an investor on a secondary sale of shares in a qualifying VCC. The provision in question only permits a deduction in respect of shares issued to a taxpayer by a VCC.
  3. Time constraints and thresholds – within 36 months after approval by SARS as a VCC, at least 80% of expenditure incurred by the VCC must have been incurred to acquire qualifying shares in qualifying companies, which must hold assets with a book value not exceeding R500m in the case of a junior mining company, or R50m for other qualifying companies[1]. Furthermore, a VCC cannot expend more than a 20% of its income to acquire shares in any one of the qualifying company (to encourage diversity). If any of the above provisions are transgressed, SARS can withdraw approval from the VCC, resulting in a recoupment in the VCC itself of 125% of the expenditure incurred (and deducted) by the investors.
  4. Limitation on the quantum of the section 12J tax deduction when acquisition of shares in a VCC is financed – where a taxpayer uses loan funding to finance his acquisition of shares in a VCC, the tax deduction is limited.
  5. .Prohibition of deductions for connected persons – no deductions will be granted to taxpayers who acquire shares in a VCC, where immediately after the acquisition, the taxpayer is a connected person in relation to the VCC. This restricts investors from acquiring more than a certain percentage shareholding, depending on the situation at hand.

According to the Davis report, it is unlikely that the VCC regime will be scrapped; however, the recommendations as to how to make the regime more accessible are unclear. Essentially, the Davis report concludes that the provision of financial facilities for SMEs should not rest with SARS or National Treasury, but is a project that must be addressed collectively by the Financial Services Board, Ministry of Small Business Development and Department of Trade and Industry.

That said, tax incentives are commonly utilised to facilitate investment in venture capital, and in the event that the VCC tax regime is preserved, it will require a substantial overhaul to, firstly, make it more accessible and less administratively burdensome and complex; and secondly, make it attractive to investors (foreign and local alike) bearing in mind the typically high-risk nature of the investments, and the positive outcome it may have on job creation in South Africa in the long-term.


[1] The monetary thresholds are based on the updated amounts as indicated in the 2014 Budget Speech

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