Hundreds of millions of rands flowed into start-up investments this week as the sun set on section 12J of the Income Tax Act, which gave South Africans a 100% tax rebate on investments made through approved venture capital companies (VCCs) into small businesses.
Introduced in 2009, 12J took off after amendments were made in 2015. However, it had a sunset clause: an expiry date of June 30 2021 for new investments. There were high hopes it would be extended but, in the national budget delivered in February, the National Treasury said 12J had not achieved its objectives of developing small business and creating jobs. Instead, “it provided a significant tax deduction to wealthy taxpayers”.
As the deadline approached, a range of 12J funds in sectors ranging from technology start-ups to novel property concepts to cannabis cultivation made final pitches to potential investors.
“I was very surprised at the last-minute rush,” said Jeff Miller, CEO and co-founder of the Grovest Group and VCMS, pioneers of section 12J venture capital.
“Normally taxpayers have a call to action at 28 February when they need to make a physical payment of their final provisional tax payment. Investors woke up in June and realised this was the last chance. In the last 10 days, Grovest set up a 24-hour hotline to take care of investors’ last-minute requirements. The June raise was better than expected,” said Miller.
He estimated that R14bn-R15bn was invested in the asset class across all funds by end-June. Grovest itself has a total of more than R3bn in 12J assets under administration, and more than R2bn in assets under management.
“It has allowed entrepreneurs to raise capital for their businesses. These start-ups would never have been able to raise funds from traditional sources. It has really exceeded my expectations. A whole new asset class — being alternative asset investing — has been born in South Africa. Investments that were historically only open to private equity funds and family offices were made available to the ordinary man in the street.”
Other funds also reported a last-minute rush. Clive Butkow, CEO of the tech-oriented Kalon Venture Partners, said it “had an exceptional year” and raised more than quarter of a billion rands. Leor Atie, co-founder of Lucid Ventures, said its Lucid 12J Retirement Living Fund had between R450m and R500m invested.
Atie said the tech space may have made the most sense from the South African Revenue Service (Sars) perspective of trying to promote investment in a high-growth industry, but the risk with such investments was not attractive to all investors. “Investors were very attracted by the tax benefits, particularly if they could find investments where the risk of losing money was mitigated,” he said.
Keet van Zyl, co-founder and CEO of Knife Capital, which evolved from Mark Shuttleworth’s Here Be Dragons, said the last-minute rush this week was “in line with the kind of section 12J rush we usually experience every February tax year-end”.
“Our Knife Capital fund — KNF Ventures II — raised pretty much the same amount in June 2021 as we raised in February 2021, and this is also in line with what was raised in the previous two February time-periods in KNF Ventures I. Because of the focus on the sunset clause there was a lot more general noise about s12J out there, and likely more competition for the taxpayers’ rands. Many of our current KNF Ventures investors reinvested in the fund as they knew it was their last opportunity to top up.”
He agreed with Miller that the incentive had met its objectives. “Section 12J did go some way in addressing the challenge of access to equity finance that inhibits the growth of small and medium-sized enterprises in South Africa. Section 12J also gave many retail investors access to the venture capital asset class. That will hopefully have a lasting effect of reinvesting proceeds and co-investing with VC funds in future. But it is going to leave a massive gap.”
Atie said significant lessons had been learnt from 12J. “Taxpayers are always looking for ways to reduce their tax burden and Sars can definitely leverage this to drive behaviour. However, if there are loopholes or alternatives that asset managers can find to reduce risks or enhance returns for investors, then these will be found and pursued, even if they are not in line with the behaviour that Sars is trying to promote.
“They repealed the section as they were clearly unhappy with the type of investments made by VCCs. In truth, these investment types were completely predictable and should have been anticipated, based on the wording of section 12J. With this knowledge in hand, amendments can be made to the legislation to ensure Sars’ objectives are met. There is still capacity for a win-win solution.”
Miller concurred: “I believe it was a short-sighted decision by Sars not to extend the 12J regime. The 12J industry had only started to really get momentum in the last five years. I would suggest that Treasury introduce a new tax incentive which would require investment into identified key growth outcomes in the economy.”
These, said Miller, should include job creation in priority sectors for growth, like tourism, infrastructure, manufacturing, agriculture, education, and technology, as well as regional development, import substitution and export promotion.
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