Treasury’s plan to fix abuse of venture capital incentive will kill the industry, MPs told
One of the main changes is that only one class of shares will be allowed in venture capital companies and the companies they invest in
Venture capitalists and tax professionals agree tax incentives for venture capital companies are being abused, but are unanimous in their view that Treasury’s proposed remedy will deal the industry a death blow.
The proposed amendments to the tax incentive have had a paralysing effect on the industry, the Southern African Venture Capital and Private Equity Association (Savca) said in parliament on Tuesday.
Savca and tax professionals who made submissions on the proposed amendments during public hearings by parliament’s finance committee, all agreed the incentive was being abused — for example, in the purchase of holiday homes — but said the way Treasury proposed to deal with this abuse was too far-reaching and not sufficiently targeted.
Treasury has proposed amendments to the structure of venture capital companies in order for them to qualify for tax incentives under section 12J of the Income Tax Act.
The market is in a state of paralysis with potentially no capital being raised by venture capital companies....Samantha Pokroy and Shelley Lotz, of Savca
The main proposed amendment in the Taxation Laws Amendment Bill is that there will have to be only one class of shares allowed in venture capital companies themselves and the "qualifying" companies that they invest in. Currently different classes of shares are allowed.
Also to be outlawed in terms of the proposals is trading between the investor in the venture capital company and the targeted qualifying company.
The proposed amendments will be retrospective and noncompliant venture capital companies will have 125% of the expenditure incurred by their shareholders for the issue of shares in them being included in the companies’ income.
Savca said this was a significant penalty that would make venture capital companies unviable.
Savca nonexecutive director Samantha Pokroy and head of regulatory affairs Shelley Lotz told MPs that Savca supported a tightening of the legislation but urged Treasury to withdraw the proposed amendments, which they said threatened the existence of probably all venture capital companies.
The proposed amendments should be replaced as soon as possible by amendments that focused on the specific abuse.
They said the incentive had proved to be "highly effective and beneficial" with 101 schemes approved by the South African Revenue Service (Sars) so far, and R3bn raised and R1bn invested in underlying investments under section 12J as of February 28 2018.
"However, following the release of the draft bill, virtually all section 12J vehicles have experienced a significant disruption in terms of capital raising and deployment as a result of the lack of certainty and the risks of noncompliance under the proposed amendments. Savca is extremely concerned that all momentum, progress and validation of the section 12J incentive could now be compromised.
"The market is in a state of paralysis with potentially no capital being raised by venture capital companies or invested into qualifying companies due to the risk of non compliance," Pokroy and Lotz said.
They noted that the proposed amendments did not provide venture capital companies with the opportunity to unwind their structures in order to become compliant.
"Savca is concerned that enormous damage is being done to market sentiment around section 12J which could be irreversible."
Tax professionals insisted the use of different classes of shares was essential if venture capital companies were to continue relying on the incentive.
South African Institute of Tax Professionals head of tax policy Erika de Villiers conceded that the venture capital company regime was prone to abuse. "In certain instances it is being utilised for purposes other than the original policy intent.
"However, the avoidance structures need to be defeated without undermining legitimate venture capital company structures.
"For example, different classes of shares are used for avoidance structures but are also necessary for many legitimate structures involving innocent investors. A different trigger to prevent the avoidance while protecting the innocent needs to be found," De Villiers said.
PwC senior manager for tax policy Greg Smith told MPs that some abusive schemes were being aggressively marketed by advisers. These schemes made use of the different classes of shares, but without them it would be very difficult for venture capital companies to continue.
He noted that the abuse often occurred when the investment would have been made anyway even if the incentive was not available. The incentive was just used as a "sweetener" to invest in inappropriate vehicles such as holiday homes and the purchase of capital equipment.
"If the abuse continues, the incentive will not be sustainable," Smith warned.
He noted, however, that there were legitimate and sound commercial reasons to use different classes of shares.
To ban their use would in effect be to remove the incentive entirely.
Measures were needed to support the incentive policy and the use of different classes of shares while specifically targeting the abusive schemes.