New limits for Section 12J investments will up capital flight and joblessness
Short-sighted approach will hit local SMEs that would have been beneficiaries of additional investment capital after assets under management doubled in a year
In the past financial year the Section 12J investment class not only attracted the attention of SA taxpayers aiming to reduce their income or capital gains tax liabilities, but also that of the Treasury. This was mostly due to the large value of investments made by SA taxpayers into Section 12J investments.
Assets under management in the Section 12J investment class doubled in just one year through the investment of more than R3.7bn by South Africans, bringing total assets under management to about R7bn.
One would assume the Treasury would be encouraged by the amount of capital invested in Section 12J investments, as the investment vehicle was introduced to provide equity funding to small and medium enterprises (SMEs) through an upfront tax incentive for taxpayers who invest in these. If taxpayers invested R100, they could claim up to R45 back from the SA Revenue Service and generate a return from the full R100 invested (if invested wisely).
There is a clear short-term upfront cost to the fiscus, but the Treasury should gain through long-term sustainable tax revenue collected from the SMEs that receive the funding. Unfortunately, due to many factors including rampant corruption and fruitless and wasteful expenditure, the Treasury is under pressure to collect as much tax revenue as possible. One approach to “protect the fiscus” the Treasury has taken is the introduction of an amendment to Section 12J that will limit the amount an SA taxpayer can invest in a Section 12J vehicle.
Due to the limit, which was enacted in November, individuals and trusts can only claim a maximum tax deduction of R2.5m and corporates of R5m per year. The consequence of this amendment is that high net-worth investors and corporates will be limited in terms of how much they can invest in the investment class, likely leading to a significant reduction in 2018’s record investment of R3.7bn into Section 12J investments. This will consequently reduce the amount of private sector investments in SMEs, likely resulting in more capital leaving our shores and fewer jobs created.
While preventing noncompliance is desirable, this amendment may adversely affect investors into Section 12J investments that invest capital at a slow rate, as their capital may sit idle for longer
This limitation won’t affect most Section 12J investors who typically invest R100,000-R500,000. Most investors, however, account for a disproportionately lower amount of Section 12J capital and hence local SMEs that would have been beneficiaries of the additional 12J investment capital will be affected. This is a short-sighted approach by the Treasury given that billions of rand are only now being made available to SMEs in vital sectors of the economy that should lead to job creation and growth over the long term.
A further unexpected amendment relates to the time frame in which the Section 12J investments must invest investors’ capital. Up until this amendment, a fund manager had three years in which to invest investors’ capital, failing which the Section 12J investment would be noncomplaint with the legislation. The Treasury has now extended this time period to allow the fund manager four years in which to invest funds under management into qualifying investments.
This amendment comes as a surprise as a number of the larger Section 12J investments have failed to invest a significant amount of capital under management into SMEs. While preventing noncompliance is desirable, this amendment may adversely affect investors into Section 12J investments that invest capital at a slow rate, as their capital may sit idle for longer.
Investors into Section 12J investments that have failed to invest funds timeously will thus likely earn a lower return from their investments. Even more concerning is that it’s likely that investors in these funds will be required to hold their investment for longer than expected due to the investment taking longer to generate the anticipated returns.
Future investors should therefore be mindful of the total percentage of capital invested by the Section 12J investment into qualifying SMEs before making an investment. If appropriate steps are taken towards timely investment, this amendment will likely not affect investors meaningfully.
The Section 12J incentive has created a new SME investment class that is only now starting to flourish, and is completely supported by the private sector, both from an investor and funder perspective and from an asset management perspective.
Hopefully the introduction of these amendments will provide the Treasury with the comfort it needs to extend the incentive, which is scheduled to end on June 30 2021.
• Sacks is with Jaltech Fund Managers.