Opinionista Tim Cohen 28 February 2021

What does cancelling S12J tell us about government?

The 2021/22 national budget reminds me a bit of that old Doors blues song 'been down so long it looks like up to me'; a kind of meta take on the perspective from which you view things. The budget is a huge improvement on what we were expecting in September last year, so in that sense, its a relief. But when all is said and done, revenue is down on the 2020/21 estimates by R213.2-billion

First published in the Daily Maverick 168 weekly newspaper.

Like all government budgets, there is so much information there, some interesting things happen in the fine print, and this time one of those things is the cancellation of S12J investments, aimed at supporting venture capital investments. 

Treasury’s perspective is that the scheme was designed to encourage the establishment and growth of small, medium and micro-enterprises. The scheme is pretty simple; it allows an upfront deduction on investment, as opposed to most equity investments that are not tax-deductible. 

The budget review says “The National Treasury has determined that the incentive has not adequately achieved its objectives. The incentive has instead provided a generous tax deduction to wealthy taxpayers and most support has gone to low-risk ventures that would have attracted funding without the incentive. The incentive will therefore not be extended beyond its current sunset date of 30 June 2021”. There is of course the possibility to submit appeals.

I have to say, I have a lot of sympathy for the Treasury’s decision. Even a cursory look at a lot of the companies that were taking advantage of this system and the whole thing smells of tax dodging. About half the investment was into physical structures, as opposed to zippy, high-tech apps that could one day wow the global start-up world. Yet, I know too about some great companies that have utilised the scheme for doing things like financing solar power projects. 

Government introduced the venture capital company tax incentive in 2008 to encourage the establishment and growth of small, medium and micro enterprises. The incentive aims to help them obtain funding that would otherwise not be available. Taxpayers investing in a venture capital company are allowed an upfront deduction for their investment, whereas most equity investments are not tax-deductible. 

In its response, the 12J Association of SA said Treasury was “throwing the baby out with the bathwater”. It concedes that Treasury’s problem is with property-backed businesses like hotels (whose operations are backed by real estate assets) and asset rental businesses (where risk tends to be mitigated through astute corporate structuring). You betcha. For “asset rental businesses” read millionaires putting their holiday homes on [email protected] and calling that “venture capital”.

But the association does make some good points. “We simply cannot understand the rationale for cancelling one of the few mechanisms available to convince high net worth individuals to invest long term capital in South Africa and grow our tax base at a time when capital flight is one of the key economic risks to the country,” it says.

“… on Treasury’s own conservative statistics, qualifying companies have created 8 239 jobs in a remarkably short space of time, and during a recession. Our research shows that, if the 12J incentive was allowed to continue to operate, up to 45 000 jobs would be created in the next five years”.

It also says that even though the sections was first implemented in 2008, the Section 12J legislation only gained traction following changes to the law in 2016, and the majority of 12J investments were made in the past two years. This is not long enough to decide whether it worked or not, the association says. 

Overall, the SA government grants tax incentives to businesses very sparingly. Since 2015/16, total tax revenue foregone due to the incentive was R1.8 billion, which is really a drop in the ocean. The total amount forgone through personal tax rebates in the 2018/19 financial year was   R181-billion of which the vast majority was for pension investments. 

To put it another way, the inventive system government has constructed heavily, heavily supports institutional investment but the support it provides for real physical investment in the economy is minuscule – and diminishing. Clearly, there are capacity problems at SARS, which we all know about, deciding whether companies are genuine venture capital companies or not. 

But the whole thing tallies with my experience of government members, bureaucrats and advisors. The majority have little or no personal experience of how corporations actually work, they are heavily prejudiced against business and absolutely despise rich people, so the notion that they might be assisting the rich in some way is just horrendous.  

Compare this, for example, to the support the US government has given car maker Tesla since its inception. Even while Wall Street was hugely sceptical of the future of the company, the US federal government supported Tesla by offering buyers a thumping discount of around $7500 at one point. It did so because Tesla and other battery-operated cars supported its climate change policy objectives but also because it could sense the industrial advantage that could arise once economies of scale kicked in. 

And they did. Tesla is now worth more than the next six car companies combined. DM168

This story first appeared in our weekly Daily Maverick 168 newspaper which is available for free to Pick n Pay Smart Shoppers at these Pick n Pay stores.

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  • What’s missing in article is how this regulation could have been tweaked or tightened to disallow tax dodging.
    Has the 12J Association of SA any suggestions? Are they going to interact with government how to retain its very good aspects?
    (I’m not investing in these schemes but am mortally worried about wealth leaving SA which the scrapping of the 12J will lead to.)

  • Even as a solar fan, 12J for solar is no different than property : guaranteed cashflows. Worse, the local 12J solar basically rely on finding property owners that cannot do math.

    Even owning my second EV, the Tesla analogy is a stretch. The company has not repaid one penny of its debt in its life, care of subsidies. It has no return on capital and never will have a return on capital that competes with anything real venture capital should produce.

    Yes I (ab)used 12J. Would have been dumb not to. The law was a no-brainer way to defer a certain and immediate tax expense to a future and lower taxed expense. Who knows, might get some upside, but that is cherry on top.

    Replacement? Funnel those tax deductions into places like Business Partners that have 30y+ track records of funding real SMME without the fees feast that fueled 12J. Most small business jockeys need mentoring and even basic business administration help as much as they need capital.

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