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Tax incentives drive interest in new Section 12J Venture Capital Companies

7th August 2014

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Small and medium businesses are getting the serious boost they need from SARS through the development of an equity finance mechanism which will fuel growth with large scale incentives for investors. To date there has been limited take-up of the incentive, but recent amendments to the tax legislation look set to change that. This intervention will help smaller investments or businesses, that are overlooked by large institutional investors, to become financially viable private equity opportunities.

National Treasury introduced Section 12J into the Income Tax Act in 2009, to assist in the development of a venture capital industry in South Africa. The section specifically aims to help the growth of small and medium sized businesses by increasing their access to equity finance. To attract investors into this typically under-funded sector, which is critical for driving economic growth, SARS offers significant tax incentives.

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The provisions in the Income Tax Act allow a full tax deduction to be claimed on investments into qualifying 12J Venture Capital Companies (VCCs). This means that an investment into a VCC is deducted from an investor’s taxable income, creating a sizable incentive to invest.

The Taxation Laws Amendment Bill, tabled recently in Parliament, contains welcome amendments to the legislation, in line with the Finance Minister’s commitment in the 2014 Budget Speech that “amendments will be made to the venture capital company tax regime... to enhance support for entrepreneurial development.”

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The proposed amendments will further enhance the opportunity for investors to help South African small businesses flourish. The most significant of these proposed changes would increase the maximum book value of assets of companies in which VCCs may invest from R20m to R50m and remove the income tax recoupment on selling an investment in a VCC should the investment be held for 5 years.

From 1 July 2014 Broadreach Capital opened its doors to private investors, trusts, family offices and corporates seeking superior returns with the added benefit of a full tax deduction. The new outfit sports some deep experience in St.John Bungey, Senior hedge fund manager and CEO, Adam Bekker, Corporate financier and private equity fund manager, Grant Shippey - Serial entrepreneur and technologist, and Rick Basson, Private equity and venture capital professional. More information is available at www.thebroadreach.com.

Understanding Section 12J from an investor perspective:

Through section 12J, National Treasury intends to assist with the establishment of Venture Capital Companies (VCCs) in South Africa, along the lines of the UK’s successful venture capital trusts. To encourage qualifying investments, the Income Tax Act provides for a substantial tax incentive, effectively allowing investors in 12J compliant funds to write-off an investment in a VCC against their taxable income. The bottom line is that individual investors get 100% of the upside for taking only 60% of the risk (assuming a 40% marginal tax rate). Looked at differently, SARS is effectively giving investors a cheque to make part of their investment. Section 12J mandates the size of investments, as well as the sectors they can be made in. The VCC needs to comply with this mandate for its investors to qualify for the tax incentive.

The VCC must:

• Invest in companies operating in South Africa.

• Invest in companies with a book value of assets below R20m (moving to R50m in line with proposed amendments discussed above).

• Make at least five investments (no single investment may account for more than 20% of the funds invested by a VCC).

• Only invest in permitted industries and sectors.

• Be licensed by the Financial Services Board as a Category 1 Financial Services Provider.

The VCC’s investments may not:

• Operate in financial services, management consulting, auditing and similar professional services industries.

• Involve gambling-related activities.

• Manufacture, or trade, in liquor, tobacco or arms.

• Trade or own property, except for hotels and BnB’s.

To differentiate itself in this emerging investment category, Broadreach Capital has created two share classes that comply with the legislation: firstly, a Tangible Net Asset Value (TNAV) share class and second, a Growth Capital (GC) share class. The TNAV portfolio will seek investments with a high level of asset-backing, where the business invested in has tangible assets on the books. The GC portfolio will seek superior returns from mid-size private equity assets with a higher risk profile, but also higher reward. Investors can select a single portfolio or blend their investment to suit their risk appetite. Section 12J compliant investments typically range between three and seven years due to the nature of the underlying assets. The directors have a significant investment pipeline.

Contact: Adam Bekker and Rick Basson, Broadreach Capital

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