Following the conclusion of the 8 May 2019 general elections, one can’t help but think of the myriad uncertainties all South Africans have regarding the future of the country.

This uncertainty spans across poor service delivery, high unemployment rates, a slipping currency and dismal economic performance, with the looming threat of junk status hanging over our heads, among others. There is, however, much optimism for South Africa’s local small and medium enterprises, which are catalysts for growing the local economy, generating revenue and subsequently creating sustainable jobs that have a positive implication for the lives of South African taxpayers.

This optimism is placed in Section 12J of the Income Tax Act, which was introduced by Treasury as a tax incentive for the purposes of stimulating investment in local small and medium enterprises. The incentive was first introduced in 2009 after the success of a similar venture capital incentive in the United Kingdom.

Section 12J in its earlier years failed to attract investors, largely due to various restrictive investment conditions. After multiple positive amendments to the legislation, the Section 12J industry has over the past few years experienced a sharp upward trend in the number of Section 12J Venture Capital Companies (Section 12J VCCs) being formed as well as large amounts of capital being invested by South African taxpayers who have reaped the benefits of the Section 12J tax deduction.

The tax incentive essentially provides South African taxpayers with a 100% tax deduction on the amount invested into Section 12J VCCs. This allows any South African taxpayer (individual, company or trust) to claim tax relief of up to 45% on their investment amount, thus reducing their capital at risk to a minimum of 55% of their original investment amount.

The Section 12J incentive, unlike the deduction from contributions towards retirement annuities and pension or provident funds, is not limited to a maximum tax-deductible contribution of R350,000 per annum and the Section 12J investor’s funds aren’t locked in until age 55, but rather a minimum investment period of five years to avoid having the tax deduction recouped. These two differentiators make Section 12J investments a very different kind of tax-deductible investment with fewer limitations on investible amount and period of investment.

From a birds-eye perspective, Treasury introduced an incentive which has created a local private equity investment class which the average South African taxpayer can access and where the normal risk associated with private equity investing is significantly reduced through the upfront tax deduction.

This unique private equity investment class was introduced by Treasury with a clear objective to provide equity funding to small and medium enterprises. Treasury’s objective is achieved through legislatively requiring Section 12J VCCs to focus their investment strategies on businesses which have a gross asset value of less than R50-million and have the highest likelihood of creating jobs.

Job creation is achieved through prohibiting Section 12J VCCs from investing in businesses which do not have a significant impact on job creation, such as residential and commercial properties, financial services businesses such as insurance companies and banks and professional services businesses such as lawyers, auditors and so on.

From an investor’s perspective, Section 12J is quickly becoming an important diversification option, allowing investors to invest pre-tax funds into sectors which generally have significant upside potential. Diversification has been one of the catalysts to the growth of Section 12J, resulting in more than R3-billion being invested within the past financial year, increasing the total capital under management by about 100% in one year.

Time is, however, running out for the investment class as the Section 12J legislation contains a sunset clause, which provides that only taxpayers who invest prior to 30 June 2021 will be able to claim the upfront tax deduction. At this point, Section 12J legislation’s efficacy in achieving the desired outcomes will be assessed in order to determine whether to continue with the incentive.

In order to encourage the Treasury to consider extending the sunset clause, the Section 12J industry is working towards preparing a report to present to Treasury, which will outline the positive impacts the incentive has had on the South African economy.

For now, investors are encouraged to continue exploring the various Section 12J investment options in the build-up to the provisional tax period and to take advantage of the incentive while it is still around. DM

Sacks is a director and Higgs a 12J Distribution Specialist at Jaltech, a financial advisory firm.