In a bid to encourage financial support for entrepreneurs (or so-called ‘angel investing’), National Treasury introduced section 12J of the Income Tax Act, 58 of 1962. Effectively, section 12J allows as a deduction for income tax purposes any investment by a taxpayer in the shares of a venture capital company (‘VCC’). In other words, taxpayers are allowed a deduction equal to the amount of the share investment made in the VCC. This a significant concession.

The legislation in turn requires these VCC’s to only invest in ‘qualifying companies’, being in essence companies that have ‘real’ businesses behind them (in other words, companies carrying on a trade in respect of immovable property or companies earning in excess of 80% of its revenue in the form of investment income are specifically excluded).

The Explanatory Memorandum to the Revenue Laws Amendment Bill, 2008 (which Bill, once enacted, introduced the provision), clearly sets out the purpose of the section:

‘In order to assist small and medium-sized businesses and junior mining exploration companies in terms of equity finance, a tax incentive is proposed for investors in such enterprises through Venture Capital Companies (“VCCs”). The VCC is intended to be a marketing vehicle that will attract retail investors. It has the benefit of bringing together small investors as well as concentrating investment expertise in favour of the small business sector.’

A VCC must have as its sole object the management of investments in ‘qualifying companies’. Quite a number of other criteria are also applicable, some of which are:

• The VCC must be a South African tax resident company with its tax affairs all in order;
• Investors in the VCC only qualify for the deduction on their investment made if they are not ‘connected persons’ as defined in relation to the VCC (which would generally be the case when more than 20% of the shares in the VCC are owned by that person);
• The VCC may not expend more than 20% of its funds raised through the issuing of shares to invest in any one qualifying company;
• At least 80% of the assets acquired by the VCC must be shares in qualifying companies; and
• The VCC must be registered in terms of section 7 of the Financial Advisory and Intermediary Services Act, 37 of 2002..

Especially the last requirement is potentially quite onerous and it is this requirement which is arguably the most difficult to achieve, given the administratively burdensome process of so registering a company with the Financial Services Board. Fortunately, the SARS website contains a list of all approved and already registered VCC’s. This enables interested investors to contact these VCC’s directly to ascertain whether further equity raising opportunities exist in these companies. In addition it also presents start-up companies with a potential source of funding to which they can look for potential angel investors.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)