“There are two systems of taxation in our country: one for the informed and one for the uninformed” (U.S. Judge Learned Hand)
Small and medium-sized enterprises (SMEs) have limited access to capital markets. As SMEs are considered to be the cheapest and most cost-effective sector in creating jobs, the Revenue authorities sought to address this by creating an attractive allowance for Venture Capital Companies (VCC) in 2009.
The VCC allowance gave a massive boost to venture capital in South Africa, and also to SMEs who have received R6 billion in investment since 2009 Venture capital now accounts for 2% of investment since 2009. Venture capital now accounts for 2% of GDP (in the USA this is 4%).
For you the taxpayer it offers an attractive way to reduce your tax as you are allowed to deduct R2.5 million from your taxable income if you invest in a VCC. This is in your own capacity or via a trust; if you use a company to make the investment, it can deduct R5 million.
How it works initially
Note: The examples below relate to an investment in your own personal name, and different tax rates and net returns will apply if you invest through a trust or company.
Assume you have R2.5 million in taxable income. It is 20 February, you have little more than a week before you will have to pay provisional tax and you want to reduce your tax liability and make a good investment. You have researched the VCCs and decide to invest R2.5 million in a VCC which invests in solar power.
You have saved yourself R1.125 million in tax.
To avoid having this tax deduction of R1.125 million reversed, you will need to be invested with the VCC for five years.
How it works in subsequent years
The VCC onward invests the R2.5 million in a qualifying SME (the SMEs need to be registered with SARS) which then installs solar power in, say, a block of flats. Of interest here is that the SME also gets a 100% deduction on the R2.5 million.
If you cash in on the investment after 5 years, this will be the position:
In summary, you received a tax deduction of R1.125 million and 5 years later paid R450 000 in capital gains tax.
Your investment of R2.5 million has been refunded to you. If you discount these cash flows, this equates to an after-tax return of just over 10% over five years which is pretty good as inflation is currently just below 4%, i.e. a real return of 6%. As a comparative the stock market delivered a return of just below 6% in the last decade.
This excludes any costs you may be charged.
Beware of costs
There are many VCCs out there and they charge varying fees, so be very careful of these costs as they come in many guises such as performance fees, administration costs, annual charge etc.
I t is worth getting your accountant to check these costs.
Look for the gems
As we saw above, the qualifying SME (the entity that installs the solar power), gets a 100% upfront write-off of the investment (R2.5 million in this example for a tax saving of R700 000). Some creative VCCs have used this tax saving to return income to you the investor. Take the example of a residential complex where the qualifying company installs solar power in the complex and then charges the owners of the complex for the electricity they consume using solar power (this charge is at a substantial discount to Eskom’s rate). The qualifying company returns this charge to the VCC which then pays these amounts as dividends to you, the investor.
Thus, everybody scores:
Residents of the complex don’t pay for the installation of the solar power and get cheap electricity, The qualifying company takes its profit out of the R2 500 000 investment and tax saving of R700 000, The VCC makes money from charging you fees, and You, the investor, get a return (after-tax and net of all costs) of over 20% over the 5 year period, which is excellent.
Don’t delay, the clock is ticking!
The only downside to this is that the allowances will fall away in June 2021. VCC companies are lobbying government to extend this program past June 2021, but even if they are unsuccessful, you have just under 18 months to take advantage of this scheme.
Of course this sort of investment isn’t for everyone; ask your accountant whether it might suit you.