Venture capital companies and trades in respect of immovable property

Author: Ben Strauss.

In terms of section 12J of the Income Tax Act 58 of 1962 (Act), put simply, a person who invests in an approved venture capital company may claim an immediate income tax deduction equal to the amount invested (subject to limitations).

A venture capital company will only be approved as such if, among other requirements, the sole object of the company is the management of investments in companies that are qualifying companies.

A company is not a qualifying company if, among other requirements, it carries on any impermissible trade.

Among other things, any trade carried on in respect of immovable property, other than a trade carried on as an hotel keeper is an impermissible trade.

What does the phrase in respect of immovable property mean in this context?

The phrase in respect of has on a number of occasions been interpreted to the effect that it denotes a direct or causal relationship. So, in the present case, a trade would only be an impermissible trade if there is a direct or causal relationship between the trade, on the one hand, and immovable property, on the other hand.

SARS has issued a document titled Draft Guide on Venture Capital Companies (Draft Guide).

In the Draft Guide, SARS refers to a number of cases and states the following (at page 11):

The conclusion of these cases is that, bearing in mind that section 12J is an incentive and that there was a clear intention that the incentive should not be extended to trades in specified industries, the term in respect of must be widely interpreted in the context of section 12J along the lines of in connection with and in relation to. Notwithstanding the wide interpretation, there are situations in which the connection with a listed item will be considered too remote to result in it falling within the ambit of in respect of(Footnotes omitted.)

It does not necessarily follow from the fact that section 12J of the Act is an incentive provision that the words in respect of should be given a wide meaning. The stated purpose of the introduction of the venture capital company regime is to provide a tax incentive to assist small and medium-sized businesses with the challenges they face when they try to raise equity financing (see page 66 of Explanatory Memorandum on the Revenue Laws Amendment Bill, 2008 [W.P.2 08] which accompanied the legislation that introduced section 12J into the Act). One could just as easily argue that, because the provision creates an incentive, the words in respect of should be given a restrictive meaning so that more, rather than less, trades will qualify under the regime.

SARS does not provide a list of trades in respect of immovable property that will constitute an impermissible trade.

In SARS view, the following are impermissible trades (Draft Guide at page 12):

  • Letting of immovable property.
  • Refurbishment or development of immovable property.
  • Trading in immovable property.

As to trades in relation to immovable property that SARS does not see as being impermissible trades, SARS states the following at page 12 of the Draft Guide:

Arguably a person carrying on the trade of a plumber or electrician fixing the plumbing or electrical equipment in a building is conducting a trade in respect of immovable property because plumbing and electrical installations in a building are part of the immovable property. However, taking the purpose and context of the section into account and the work that the plumber or electrician does in conducting the repairs, it is considered that this interpretation would be too restrictive and unintended and should not be adopted. (Footnotes omitted.)

On 6 June 2017, SARS issued Binding Private Ruling: BPR 274 (BPR 274). One of the issues that was considered in BPR274 was whether a company which was to provide and maintain solar facilities at the site of its customer was carrying on an impermissible trade. All of the assets provided by the company, including solar panels, transmission cables and other related facilities, would have been owned by the company and supplied to the customer in terms of an operating lease. SARS ruled that, despite the fact that solarpanels once installed may technically become part of the relevant immovable property, the solar panels were movable assets and that, accordingly, the company would not be carrying on an impermissible trade, ie a trade in respect of immovable property.

Most recently, SARS issued Binding Private Ruling: BPR 333. In that matter, the operating company would undertake farming operations consisting of planting, growing, harvesting, packing, transportation and distribution of blueberries. Vacant land required to undertake the farming operations would either be purchased or leased by the operating company. Upon securing the land, the farming operations would be established which would include fencing, netting, a drip irrigation system, cold rooms, equipment and the planting of the blueberry bushes. SARS ruled that the farming of blueberries by the operating company would not constitute a trade in respect of immovable property and, accordingly, did not constitute an impermissible trade.

So, while SARS takes the view that, technically, the phrase in respect of immovable property should be given a wide meaning, in practice it appears as if SARS is interpreting the phrase more restrictively. It seems as if SARS accepts that in cases where there is no direct link between a persons business and the immovable property there is no impermissible trade.

One could thus argue, based on the guidance and recent rulings issued by SARS, that venture capital companies who invest in the following companies would potentially meet the requirements of section 12J of the Act:

  • Contractors supplying services in relation to immovable property, eg plumbers, electricians, building contractors, quantity surveyors, and security companies. (As to building contractors, see the case of Moodley v Estate Agents Board [1982] 2 AllSA259(D).)
  • Companies engaged in the installation of certain solar power equipment.
  • Farmers.

If a person is in doubt, however, as to whether a company carries on an impermissible trade or not, it should preferably approach SARS for a ruling.