SARS J12 – A New Regime

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SARS J12 – A New Regime

The venture capital company (VCC) tax regime was first created in 2008. Its purpose was to put in place a structure whereby investors could pool their funds in an intermediate entity, namely the VCC, which would then channel those funds into investments in small businesses and junior mining ventures.

The VCC would provide equity capital and supportive management services and, in return, would acquire a major stake in those ventures until they reached a sustainable level of maturity (envisaged as being between five and ten years), at which juncture the VCC would sell its stake at a profit and distribute any profit to its shareholders.

It was, from the outset, realised by SARS and Treasury that a VCC’s investments in this regard would be high-risk, in which a few large winners would, hopefully, compensate for losses in other ventures. Investment in the shares of a VCC would be concomitantly high-risk.

As a fiscal inducement to off-set the commercial risk, taxpayers who invested in a VCC by acquiring its shares would derive an upfront deduction for expenditure incurred for this purpose – a generous concession, given that investment in equities is normally non-deductible, being expenditure of a capital nature. On the eventual sale of the equity stake by the VCC, the proceeds so derived would be a taxable recoupment of the initial deduction.

The VCC fiscal benefits proved insufficient to attract investors

It is now accepted that the VCC tax regime did not succeed in its objective of attracting investor interest. There were few applications to SARS for approval of venture capital companies, and by the end of 2011, not a single VCC had been initiated. In hindsight, it seems that the fiscal benefits were too small, and that the statutory criteria for qualifying small business and mining ventures were excessively restrictive and complex.

The 2011 tax amendments

To address these concerns, and try to breathe new life into the VCC initiative, the amendments made by the Taxation Laws Amendment Act No. 24 of 2011 provide, by way of amendments to section 12J, for a general relaxation of the statutory requirements, balanced by anti-avoidance requirements which are intended to ensure that the VCC fiscal regime cannot be exploited to create tax-driven deductions of little or no value to the ostensible beneficiaries.

The amendments, summarized below, take effect from years of assessment commencing on or after 1 January 2012.

Investor criteria

The prior statutory ceiling amounts for deductible expenditure on the acquisition of shares in VCC companies and the restrictions on qualifying taxpayers have been completely removed. In addition, the restriction which permitted only natural persons to qualify for the deduction have been removed and any taxpayer, including legal entities, can now qualify for the deduction of expenditure incurred in acquiring shares in an approved venture capital company. The previous ceiling of R750 000 on investments has been removed.

However, three new anti-avoidance provisions have been introduced.

The first will ensure that the deduction is not available to investors who become “connected persons” as a result of, or on completion of the investment. This is intended to ensure that a deduction cannot be gained from cycling funds among closely connected parties rather than from obtaining new independent investments.

The second anti-avoidance provision allows deductions only if the investments in the VCC are pure equity investment with no debt-like features.

Thirdly, the investor must be genuinely “at risk”, in other words, invested funds which are derived from a loan or credit facility must be genuinely subject to the economic risks of the project. An investor is clearly at risk where the funds come from his own resources or from a loan or credit facility on full-recourse terms, in which the loan must be repaid even if the VCC does not achieve its objectives and the invested funds are not recouped by a return on the investment.

The amendments to section 12J provide that the “at risk” requirement will not be satisfied if the loan or credit facility is directly or indirectly provided by the VCC itself, nor if the period within which the loan or credit is to be repaid exceeds five years. This is intended to disqualify schemes where repayment is so long delayed that it becomes meaningless after inflation is taken into account.

Venture capital company criteria

The criteria for qualification as a venture capital company have been significantly relaxed in order to simplify the system and eliminate unnecessarily burdensome requirements.

Firstly, VCC’s will not be disqualified merely on the ground that they are listed on the JSE: it has been decided that there were no sound reasons to support the prior restriction in this regard.

Secondly, the VCC is now permitted to be part of a group, regardless of whether it is a controlling group company or a controlled group company. Some ownership limitations have been retained in respect of qualifying investments in respect of small business or junior mining ventures.

Thirdly, the prohibition on having more than 20% of passive income in a single year has been dropped; henceforth, a temporary cash accumulation will not be a disqualifying factor. However, the VCC is still required to outlay at least 80% of its expenditure on qualifying small business and junior mining companies as from the date that the VCC is approved by SARS.

Fourthly, the minimum investment requirements have been dropped, and the VCC is no longer required to invest a minimum of R30 million in order to acquire a qualifying company that constitutes a small business, or a minimum of R150 million to acquire a junior mining company.

Fifthly, the diversification requirements have been dropped which previously mandated that a VCC could not invest more than 15% of its total expenditure on any one qualifying company engaged in small business or that was a junior mining company; the requisite percentage has been increased to 20%. In effect, therefore, a VCC can satisfy the criteria by investing in at least five qualifying companies.

Qualifying investee companies

The 2011 amendments have relaxed the requirements relating to qualifying investee companies. As was noted above, a VCC is required to invest at least 80% of its expenditure in qualifying investee companies. Previously, qualifying investee companies engaged in small business could not have a book value exceeding R10 million and qualifying junior mining companies could not have a book value exceeding R100 million. These thresholds have been revised to R20 million and R300 million respectively.

The prior restrictions as to qualifying company ownership have also been relaxed. Previously, qualifying investee companies could not be more than 50%-owned by the VCC. This requirement was regarded as inappropriate because private equity funds (on which the VCC regime is modelled) often maintain temporary control of qualifying companies for an incubation period in order to retain managerial oversight. This threshold has been relaxed so that the previous prohibition on the VCC can own up to 70%, and the 30% margin can then attract independent participants.

Finally, the previous prohibition on franchisees has been dropped, and VCCs will be able to invest in qualifying companies that are small businesses that operate as franchisees.


Investment in the shares of approved VCC companies offers the prospect of a guaranteed deduction to taxpayers who find themselves with an embarrassment of otherwise taxable income as the end of the tax year approaches. Assuming that the shares in the VCC Company more or less hold their value, the taxpayer will be able to recoup the deduction, piecemeal if so desired, timed in the most tax-effective manner. However, a taxpayer who is thinking along these lines would probably only consider shares in a VCC that is listed on the JSE, for only then can there be an assurance of being able to find a buyer, without delay, when a decision is made to dispose of the shares.


IT Act: Section 12J
Taxation Laws Amendment Act No. 24 of 2011

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