Consequences: Kyle Mandy of PwC says the measures proposed in the Draft Taxation Laws Amendment Bill to halt abuse of tax incentives for venture capital companies are too drastic. Picture: ROBERT TSHABALALA/ FINANCIAL MAIL
Consequences: Kyle Mandy of PwC says the measures proposed in the Draft Taxation Laws Amendment Bill to halt abuse of tax incentives for venture capital companies are too drastic. Picture: ROBERT TSHABALALA/ FINANCIAL MAIL

The Treasury’s proposed amendments to the tax incentive for venture capital companies is tantamount to using "a sledgehammer to kill a mouse", a tax expert warns.

The incentive aims to encourage investment in small-and medium-sized businesses, but the Treasury says this has been abused.

Treasury chief director of legal tax design Yanga Mputa said the proposed measures in the Draft Taxation Laws Amendment Bill were intended to stamp out this abuse.

PricewaterhouseCoopers tax policy leader Kyle Mandy described the measures as using "a sledgehammer to kill a mouse". Some will apply retrospectively, with heavy financial consequences for noncompliant companies.

The Treasury gave a hint that the tax incentive under section 12J of the Income Tax Act would be tightened in the 2018 budget review, which noted that there had been a substantial increase in the take-up of the incentive.

"From only one in 2008 there are now more than 90 registered venture capital companies, with total investments of R2.5bn," the review said.

"Investment in qualifying small businesses amounts to R615m. New and existing small businesses in all economic sectors are benefiting from funding, enabling them to hire staff and grow their businesses. Legislation will be tightened to reduce the scope for tax structuring."

Section 12J tax incentive

The section 12J tax incentive provides for a full tax deduction from the income of the investor of the amount invested in a venture capital company.

Venture capital companies have to meet certain conditions and get a licence from the SA Revenue Service to qualify for the incentive.

The proposed amendments include that venture capital companies and the companies they invest in will only be allowed to have one class of shares. Noncompliant companies will lose their venture capital fund status and will be required to include 125% of all tax deductions enjoyed by its investors in their income.

Legal experts also point out that the use of different classes of shares in venture capital companies and their target companies is a worldwide phenomenon essential to differentiate between the different classes of investor who might, for example, qualify for different returns. There is also a need to differentiate between the rights of investors and management of the target company.

The requirement that there should be only one class of shares will mean that venture capital companies will no longer use section 12J, they said.

Another amendment will prohibit investors in venture capital companies from trading with target firms. This will come into effect in January 2019.

Mputa said the glaring abuse of such trading was widespread. Investors were benefiting from a full tax deduction in year one of the capital amount invested.

Treasury deputy director Ismail Momoniat insisted the Treasury would take comments on the proposals into account.

Parliament’s finance committee is to hold public hearings on the bill.

ensorl@businesslive.co.za