Tax incentives have helped to stimulate and grow the small and medium enterprise (SME) sector of the South African economy.

This is the word from Dino Zuccollo, chairman of the 12J Association of South Africa and principal at Westbrooke Alternative Asset Management, in this commentary:

In 2009, National Treasury introduced the Section 12J (12J) legislation into South African tax law. The incentive was introduced with an objective of stimulating private investment into SMEs and start-ups across the country to create jobs.

The incentive provides that individuals, companies and trusts who invest in compliant 12J venture capital companies (VCCs) will be allowed a 100% deduction against their taxable income in the year that they invest, provided that they hold their investments for a minimum of five years.

Although 12J was introduced in 2009, investor interest was muted until 2015, when certain favourable amendments to the 12J legislation resulted in a significant uptake amongst investors.

Since then, the asset class has grown from less than R1-billion in assets under management in 2015, to around R8,3-billion in February 2019.

When originally introduced, 12J was subject to a ‘sunset clause’ which provides that no new 12J deductions will be granted after June 2021, at which point it is expected that National Treasury will conduct a review of the success of the legislation and make a decision regarding its future.

With less than 18 months until this review, industry participants, led by the 12J Association of South Africa, have begun to assess the success of the incentive, so as to begin to make the case for the extension of the legislation.

Here are 12 ways that Section 12J has positively impacted the South African economy since 2015:

* More than R3-billion has been successfully invested into SMEs across the country. Since inception, 12J VCCs have invested more than R3-billion of investor capital into over 250 SMEs and start-ups around the country. As 12J companies are required to invest at least 80% of the capital raised within four years, it can be expected that at least an additional R3,6-billion will be invested in the coming years.

* More than 27 000 jobs have been created. Based on statistics compiled by the 12J Association of South Africa in conjunction with PwC, its members managing approximately R5,7-billion of 12J assets under management has potentially created an approximate 27 000 jobs across the country (direct, indirect and inferred). Given that not all 12J companies are represented by the 12J Association, the actual job creation figure is expected to be higher than this – at a time when the South African economy is desperately in need of new jobs.

* High-net-worth investor capital has been retained in South Africa for a minimum of five years. 12J investments are typically made by high-net-worth individuals, companies and trusts. According to the 12J Association of South Africa, the tough South African economic climate has resulted in many high-net-worth individuals, who make up approximately 75% of total industry investment, tend to invest capital offshore in an attempt to achieve the double-digit returns they require. According to the Association, 12J investments are one of the few mechanisms available to attract high-net-worth individuals to invest capital in South Africa, which in turn boosts the local economy.

* Student accommodation businesses have been funded. Since 2018, South Africa’s largest 12J manager, Westbrooke Alternative Asset Management, with around R2,3-billion in assets under management from over 1 000 investors, has been investing in student accommodation businesses across the country. At a time when the shortage of safe, clean, well-located South African student accommodation is at its peak, the 12J incentive has provided equity capital to projects which may otherwise have remained unfunded.

* Schools have been built. Another 12J manager, Skye Education, recently raised investor capital for the development of primary and pre-primary schools across Johannesburg. To date, Skye Education has opened two new schools with a significant pipeline of future opportunities and educates more than 1 000 learners aged 6 to 13.

* Start-ups have been given access to mentorship from experienced venture capital investors. The 12J incentive has also provided venture capital managers such as Knife Capital and Kalon Venture Partners with capital for investment into early-stage, high-growth start-ups across the country. These start-ups are managed by some of South Africa’s most exciting entrepreneurs, many of whom have struggled to access capital prior to the introduction of 12J.

* New 12J fund management businesses have been created. To date, more than 180 12J VCCs have been registered with SARS. This is indicative of the success of the incentive and highlights the growing number of 12J managers in the market. Many of these 12J fund managers are themselves young, growing businesses which are creating sustainable jobs and promoting South African economic growth.

* Solar infrastructure spend has increased at a time when the Eskom crisis has worsened. 12J managers such as Westbrooke and NESA Capital have also began to invest alongside entrepreneurs who provide rooftop solar infrastructure installations to clients. At a time when the Eskom crisis is deepening and load shedding is becoming the ‘new normal’ for South Africans, the 12J legislation is beginning to assist in easing the strain on the national power grid.

* Additional tax revenues have been created for the fiscus. Although 12J investors enjoy an up-front tax deduction, they are required to pay capital gains tax (CGT) from a R’nil base cost on exit. In addition, 12J funds and their investments pay corporate tax on income, VAT on revenues earned, dividend withholding tax on distributions declared, PAYE on staff salaries, etc. As is the case in the United Kingdom, given enough time, 12J has the potential to create more tax revenues for the fiscus over the medium term that is forgone in providing the up-front tax benefit.

* A vibrant venture capital and SME investment ecosystem has been created. Many 12J funds have been established by obtaining seed capital from one or two ‘anchor investors’ who in themselves are successful entrepreneurs. In many cases, the 12J tax incentive has helped to persuade these investors to invest large sums of capital in South African SMEs and start-ups as opposed to investing in other asset classes. As a result of the size of their investments, these ‘anchor investors’ have also begun to spend increasing amounts of time providing mentorship and guidance to these businesses to ensure their success.

* 12J investments have become increasingly accessible to retail investors. Following changes to the 12J legislation in 2019, the 12J deduction is now limited to R2,5-million for individuals and trusts per year and R5-million per company per year. It is expected that 12J managers will respond to these amendments by reducing investment minimums which were historically set around the R1-million mark, thereby opening 12J investments up to a larger pool of retail investors.

* Corporates have begun to invest. Although 12J investments were originally more popular amongst high-net-worth individuals (just around 25% of total industry investment has been made by companies to date), corporate investors have shown increasing appetite to invest in 12J structures on annually. The increased investment cap of R5-million per company per annum has also assisted with this. Given the perpetual nature of company income, this bodes well for the sustainability of the incentive and access to capital by SMEs and start-ups into the future.