Limiting tax incentives to investment in SMEs is shortsighted
The Treasury’s proposal to cap section 12J investments will inhibit a virtuous cycle of funding, job creation and growth
The Treasury’s latest proposed amendments to impose a R2.5m cap on the amount an investor can put into a section 12J investment in any single year will have the unfortunate effect of limiting the funds available for small business development.
The main purpose of section 12J of the Income Tax Act, which allows investors in specified vehicles to deduct 100% of the amount invested from their income tax liability in that year, is to retain funds in SA to stimulate business growth and create additional jobs.
By its nature, 12J appeals to high-net-worth individuals, who without this tax break would invest those funds offshore. Small businesses in SA have struggled to access either equity or conventional bank finance, particularly in the last few years as banks have become more risk-averse.
Section 12J has helped to fill this need. Although the deduction allowed for section 12J investments costs the country’s fiscus 45c in the rand in taxes sacrificed in the short term, the economy benefits from the investment of 100c in the rand in a range of job-creating activities. In time, those businesses will also start paying taxes. The multiplier effect of every rand invested in the SA economy is exponential.
The section 12J industry association is currently surveying venture capital companies to measure the amount of capital raised by the industry, the amount of capital deployed, the number of jobs created and what sectors are attracting this funding.
But we can cite examples from our own experience at Optomise. In the last 12 months, R250m of section 12J funds invested through Optomise have created over 500 jobs. These include 32 jobs saved through finance put into a struggling small hotel and 120 jobs retained in the retail sector, which is under pressure from weak consumer spending.
As the industry has only begun gaining traction over the last three years, it is still young, but over time the multiplier effect of the growth of businesses and job creation will provide additional impetus to raising SA’s employment rate.
Investing section 12J funds in sectors like hospitality, renewable energy and manufacturing means more assets are available for businesses, spending in the domestic economy increases, more revenue is generated and a virtuous cycle of economic activity is the result.
The latest unemployment figures have underlined SA’s critical need to grow its small business sector as an engine of job creation. The National Development Plan (NDP) intends that the sector should contribute 90% of jobs by 2030. That target is a long way off.
Stage one of the baseline study of small businesses in SA conducted by the Small Business Institute (SBI) shows that there are only 250,000 formal employing small, micro and medium enterprises (SME) in SA. While 98.5% of all businesses in SA are small and medium-sized, they account for only 28% of job creation, far below international benchmarks of 60%-70%, says the SBI.
SA is not the only country to offer an incentive for local investment in job creation. Ireland has an employment and investment incentive (EII) scheme, which was designed to encourage investment in Irish SMEs. It was introduced in 2011 as a revised version of a previous scheme. The Irish EII allows private investors tax relief of up to 30% in year one on equity investments of up to €150,000 (R2.4m) a year in a broad range of SMEs, provided the investments are held for three years. If it is proven that additional jobs were created or the capital was used for research & development, another 11% relief is available at the end of the holding period.
An October 2014 report by Ireland’s department of finance showed that in 2013 the EII attracted €41.5m of investments at a cost to the fiscus of €12.4m. A survey of the companies that benefited from the scheme showed most were in the information and communication, and manufacturing sectors and 40% of those expected to generate up to five jobs and 39% expected to generate between five and 10 jobs in the three years that followed.
Other countries in Europe have similar schemes. For example, the UK has the enterprise investment scheme, designed to help SMEs raise finance by providing tax relief of 30% for up to £1m invested in the shares in those SME companies. No capital gains tax is payable on profits from those investments.
According to a 2018 article on Startups.co.uk (a UK small business advice platform), since this scheme was launched in 1993, more than 27,000 companies have attracted investment and £18bn has been raised. As in Ireland, a large proportion of the businesses that benefited were in the ICT sector.
Just as each country has tailored its tax incentive scheme to meet its particular needs, SA’s incentive scheme may need to offer greater encouragement to invest in small business, given the country’s far more urgent need. It is not merely a question of creating jobs and promoting self-sufficiency, but also a greater political imperative to address longstanding inequalities in wealth.
• Cohen is Optomise MD.