Investors need incentives to support small businesses

South Africa's incentive scheme needs to offer greater, rather than less, encouragement to invest in small business.

Proposals by South Africa's National Treasury to cap the amount that high net worth individuals can invest in Section 12J schemes will stifle an initiative to grow small business that is starting to deliver real results, said Gadi Cohen (pictured), MD of Optomise, a Section 12J fund manager.

Section 12J of the Income Tax Act, introduced in 2009, allows an investor to deduct the full amount of an investment in a qualifying business from his or her tax liability in the year in which it is made. The object of the act, in line with similar legislation in several other countries, is to provide a pool of capital for small businesses.

Section 12J naturally appeals to high net worth individuals paying the maximum tax rate, who without this tax break would invest those funds offshore. The 2019 Tax Laws Amendment Bill gazetted in mid-July intends to limit the amount that a single investor can invest in a Section 12J scheme to R2.5 million a year.

Although the deduction allowed for Section 12J investments costs the South African fiscus 45c in the rand in taxes sacrificed in the short term, the South African economy benefits from the investment of 100c in the rand in a range of job-creating activities, said Cohen. “In time, those businesses will also start paying taxes. The multiplier effect of every rand invested in the South Africa economy is exponential.”

Optomise can attest to the success of the tax break, which really started to leverage investments after amendments to Section 12J were enacted in 2014. Optomise is an approved venture capital company (VCC). The fund manager offers clients tax compliant solutions to maximise their tax incentive through the investment into certified Section 12J companies within South Africa.

In the last 12 months, R280 million of Section 12J funds invested through Optomise have created over 500 jobs. These include 32 jobs saved through investments into struggling small hotels 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 South Africa’s employment rate,” Cohen said.

The job creating potential of small businesses is acknowledged in the National Development Plan, an adopted public policy which aims for small businesses to account for 90 percent of new employment opportunities in South Africa.

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, Cohen said.

An Economic Impact Assessment by the 12J Association of South Africa showed that three times more jobs would be created by Section 12J with no annual limitation than Section 12J with an annual R2.5 million cap.

“Our initial results from the high-level impact assessment show that for R1 million of venture capital investment (in members of the 12J Association) lost due to the introduction of the cap, an average of 5 jobs are lost to the South African economy,” said the Association, in a recent letter to the Finance Minister and the Commissioner of the South African Revenue Service.

“We argue that, in this context, 12J is an effective source of job creation in South Africa, especially in the context of other available incentives and government’s current strategic objectives,” the Association said. Cohen said South Africa’s incentive scheme needs to offer greater, rather than less, encouragement to invest in small business, given the country’s urgent need to create jobs.

 

How does S12J of the Income Tax Act work?

Investing in a Section 12J company allows investors a 100 percent tax incentive from their tax liability. Section 12J of the Income Tax Act No. 58 of 1962 was legislated by the South African Government to incentivise South African taxpayers to invest in local companies and to receive a tax deduction of up to 100 percent. The entire amount that is invested can be deducted from the investor’s taxable income.

Approved VCCs such as Optomise, provide the opportunity to invest in approved S12J compliant companies. Once the funds have been received by Optomise, the equity finance is invested into the S12J companies and the investor is issued with an S12J tax certificate and their venture capital shares. This will include the name of the taxpayer, the year in which the investment was made, the amount of the investment made, and the tax registration number of the taxpayer. The tax certificate will provide the investor with a 100 percent tax deduction for the funds invested for that tax year.