Venture Capital Investments Ė are you missing an excellent opportunity?

taxation1Author: David Honeyball, partner Grant Thornton Cape

Small business development continues to be a focus area for economic development for South Africans desperate for faster economic growth. Therefore, the introduction of Section 12J of the Income Tax Act, which was introduced on 1 July 2009, created a welcome pooling mechanism allowing investors to channel funds into small businesses and junior mining companies.

The intention of the legislation is that by pooling funds, a Venture Capital Company (VCC) can provide equity and management services to the investee. As incentive, the VCC shareholders enjoy a 100% upfront tax deduction of the value of their investment (shares) and with no recoupment if the shares are sold within 5 years.

The deduction is based on the actual cost the taxpayer paid for the shares. The VCC does not carry on any trade, except for managing investments in qualifying companies. There are some restrictions or ďimpermissible tradesĒ which the underlying investee companies are prevented from performing.

To qualify, some restrictions and limitations apply to both the VCC and the qualifying entity or investee.

Venture Capital Companyís limitations

  • the VCC must be approved by the Commissioner and must issue the taxpayer with a certificate setting out the amount of the investment
  • the VCC must be resident in South Africa, have its tax affairs in order, its sole object must be to manage investments in qualifying companies and it must be used in terms of section 7 of the FAIS Act
  • at least 80% of the expenditure incurred by the VCC must be to acquire qualifying shares in companies. These qualifying companiesí assets and book value may not exceed R500m in the case of junior mining companies, and R50m for other companies
  • From 1 January 2015 a new provision restricts the VCC to invest more than 20% of its total share capital in any one qualifying company.

Qualifying entityís limitations

  • qualifying companies must be resident and have their tax affairs in order
  • a qualifying companyís investment income may not exceed 20% of its gross income
  • qualifying companies may not carry on ďimpermissible tradesĒ

This section provides a deduction to taxpayers who invest in qualifying start up and high growth companies. Yet to date very few VCC companies have been formed and potential investment opportunities and tax benefits are being forfeited. Consult us if you want to explore the possibilities of investing in VCC shares, or if you own a company that may be a qualifying company and you are looking for external investors.

In essence, even if we assume the tax return misrepresented the facts, SARS became aware of it and corresponded with Ackermans until July 2006. SARS should then arguably be under a legal duty to issue the additional assessments either in terms of the Constitution or PAJA. What constitutes a reasonable timeframe is debatable, but five years does seem excessive, which should mean such additional assessments should be rejected.

How does this case affect you and other taxpayers?

The main issue is that all questions in your tax return must always be answered honestly and correctly. If you fail to do this, there is a risk that SARS will raise additional assessments even if it becomes aware of the misrepresentation years from now. Well, at least within 30 years according to SARS.

As weíre approaching Tax Season, contact us to assist you in compiling a tax return that will withstand SARSí scrutiny now, and in the future.