07 Jun 2021

The sun sets on 12J VCCs – what are the lessons from the last decade?

Nosiphiwo Balfour

Property Specialist Investec Structured Property Finance

As 12J Venture Capital Company (VCC) investments and its tax incentive come to an end in June, we look back at an often controversial and misunderstood investment programme.

Why didn’t 12J VCC deliver the results the venture companies or National Treasury were hoping for?  Were investment thresholds too high for ordinary South Africans to participate? Was it exploited as a tax loophole by wealthy individuals? And what does this mean for property venture capital companies in the future?
 

Broadly, Section 12J VCC was set up to give South Africa’s economy a much-needed boost through venture capital investment.
 

It was introduced to give individuals, companies and trusts, via a tax break, an opportunity to invest in venture capital companies that showed long-term growth potential and would indirectly contribute to economic growth and job creation.
 

The main objective was to grow and assist small- and- medium-sized business in specific growth-targeted industries such as hospitality and tourism, agriculture, energy and manufacturing.
 

Student accomodation was also a targeted sector given its under supply – however, commericial property was specifically excluded from targeted industries. Albeit VCCs utulised property as an asset class to motivate their investment in the intended industries, such as hospiltaly and tourism.
 

Many 12J companies were supported by wealthy individuals and venture capital companies (VCCs). Much of the capital was driven towards property VCCs in comparison to other intended industries, as investors could benefit in the economies of scale and the larger investment pools real estate typically commands in the property market.
 

Unfortunately, instead of becoming a sweetener, the tax break itself became the main focus of the investment vehicle in the media and often the sole impetus for investors. In 2018, National Treasury put the brakes on investors exploiting the loophole by capping the tax-deduction percentages.

2009
Section 12 VCC investments launches
2014
Tax incentives introduced to make it more attractive to investors
2020
R 11 billion invested | 360 venture capital companies created | 37% added new jobs to companies after funding
2021
30 June – programme closes
The best intentions

In the end, Section 12Js didn’t raise the expected investment capital to move the needle in contribution towards GDP or create near enough job opportunities.
 

While the programme was always earmarked to end in 2021, we did expect it to be extended for a longer period. Instead, the Finance Minister in the 2021 Budget speech chose not to initiate a sunset clause.
 

For a programme that started with the best intentions and was viewed as a ‘win win’ for all stakeholders, where did it fall short in fulfilling its objectives?

Nosiphiwo Balfour
Nosiphiwo Balfour, Property Specialist | Investec Structured Property Finance

Smaller investors were left out in the cold. It didn’t allow previously disadvantaged people or our emerging affluent – in short, the economic backbone of the country – to participate in the scheme. Without scale and inclusivity, it was never going to grow.

The investment threshold was too high

As an asset class, the investment threshold for a VCC was perhaps too high, especially for individual investors.
 

To participate in a VCC required you to invest at least R100,000 and often as much as R500,000, thereby only attracting high net worth individuals in higher a SARS tax margin. As such, wealthier people turned to Section 12J VCCs as they would other tax-efficient vehicles – for example, retirement annuities and tax-free savings and investments. Some saw it as a strategy to offset capital gains tax, albeit that the tax was payable at the end of the day.
 

As most South Africans could not really benefit from the tax break, you could argue that prohibitive minimum investments was a factor in the scheme not showing the successful results in terms of its mandate one would have expected after more than a decade.
 

In fact, perhaps the greatest failing of the 12J Income Tax Act’s approach was that it failed to see its potential for greater transformation in the South African investment landscape.
 

Smaller investors were left out in the cold. It didn’t allow previously disadvantaged people or our emerging affluent – in short, the economic backbone of the country – to participate in the scheme. Without scale and inclusivity, it was never going to grow.
 

As many VCCs were property developers, these companies didn’t always receive the stimulus and venture capital they needed.

Government was not clear about the outcomes it expected

In the midst of a lot of media attention and blogs touting it as trending new investment class, it’s easy to forget that from the start (2009), Section 12J VCC was meant to build SA’s economy and create much-needed job opportunities. (The tax relief benefits were only introduced later in 2014.)
 

In setting up the Section 12J system, there were stringent legislative and regulatory compliance processes. However, it fell short in monitoring the tax-deductibility element in respect of its deliverables.
 

Treasury found that more than R11 billion was invested in some 360 S12J venture companies, but only 37% of these companies added new jobs after receiving funding.
 

Moreover, government should rather have been more prescriptive in what it expected in relation to the tax breaks (for example, a quantum of jobs created) and how it chose to monitor the investments.

Grant tax relief for the right projects and objectives

As the Section 12J, including its tax benefits, comes to an end mid-2021, National Treasury has said it will extend the tax benefit to property developers investing in city centre projects for another two years.  
 

It may be short sighted of government to only afford property developers tax incentives in city centres that are based on apartheid spatial planning; whereas it should be extended to key growth nodes outside of the city, which may very well stimulate the economic growth government was looking for in the first place.
 

An example of this short-sightedness is Cape Town’s CBD: it seems imprudent to offer generous tax cuts for investors creating expensive apartments for a niche market. While inner city renewal is important, economic development zones need to be identified for similar tax breaks for property entrepreneurs. The upside will be that more communities would benefit from a much-needed economic boost.

The future?

Although National Treasury has halted the tax breaks, what does this mean for existing investors in the 12J schemes?
 

The companies, trusts and individuals who invested in VCCs will remain invested, albeit without a tax break, and will be looking for a sound return on their investment. One of the real values of these investments for the local economy is that investors are locked in for at least five years to allow sensible and sustainable establishment and growth in the underlying investee company.
 

With SA’s economic fundamentals waning and investors continuing to search for yield, the key element will be in assessing how National Treasury can incentivise investors to keep their money onshore where it can continue to create jobs and drive inclusive economic growth.

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