Experts have criticised an intended legislative crackdown on abuse of the Section 12J tax incentive, saying it could stifle growing SMEs just as the incentive begins to deliver results.
Section 12J of the Income Tax Act was originally meant to raise funding for development of small and medium enterprises by giving investors a tax break.
It enables investors already at the highest marginal tax rate of 45%, 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.
Sectors which qualify include hospitality, renewable energy and manufacturing.
The 2019 Taxation Laws Amendment Bill, gazetted last year, proposes that the amount coming from a single investor be capped at R2.5m per individual or trust per annum and R5m per company per annum, according to Dino Zuccollo of Westbrooke Alternative Asset Management.
The rationale behind the bill was to curb abuse, but experts have argued that the S12J industry has only recently begun gaining traction – and that abuse is difficult to pinpoint in the first place.
"The introduction of the annual investment cap is the natural progression of a successful incentive and highlights the extent of the popularity and take up thereof," says Zuccollo.
Donald Fisher-Jeffes, a director at Webber Wentzel, told Fin24 government's idea with Section 12J was to assist the socio-economic development of SMEs which would not otherwise have access to funding.
However, when the Section 12J incentive was introduced, the provisions initially seemed very vague and not very attractive to investors, he says. According to him, interest only began picking up over the last four years, and increasing numbers of Section 12J venture capital companies were established.
"Many have done good work in the entrepreneurial sector.
"Unfortunately, a small minority of businesses are using the Section 12J vehicle as a mechanism to potentially invest in either assets or transactions which are not necessarily aligned to the original purpose of the act. That gave rise to a number of subsequent regulations," says Fisher-Jeffes.
"Abuse is difficult to pinpoint. An example of 'abuse' would be a holiday home turned into a Section 12J company, claiming it falls in the category 'hotel keeper'. The SA Revenue Service has wised up to this, so it has refined the legislation."
Fisher-Jeffes notes that the Section 12J tax incentive has a sunset clause, which provides that no deductions would be allowed after June 30, 2021.
"It would be interesting to see if Treasury extends the date as it gave rise to a new industry," he says.
Gadi Cohen, CEO of Section 12J asset manager Optomise Alternative Investments, believes National Treasury's proposal to cap the amount that high net worth individuals can invest in Section 12J schemes will stifle the aim of growing SMEs just as the incentive is starting to deliver real results.
According to Cohen, the South African S12J industry has matured as more sophisticated investors became aware of the tax benefits involved. Optomise recently partnered with Stockdale Street's CCP S12J fund, to create an S12J asset manager in South Africa with R340m assets under management.
"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," says Cohen.
Jeff Miller, CEO of Grovest Corporate Advisory, says that, rather than looking to banks, which, in his view, have become more stringent in their lending, local hospitality businesses should rather consider other capital-raising alternatives such as Section 12J.
In his experience, new Section 12J hospitality projects have even contributed towards sustainable land reform. He gives the Mdluli Safari Lodge, situated within the borders of the Kruger National Park, as an example.
Francois van Zyl, a partner at 12Cape, a Section 12J investment fund that owns the newly opened Latitude Aparthotel in Sea Point, Cape Town, says the prospective growth in tourist arrivals in Cape Town will increase the demand for serviced holiday villas and self-catering apartments. He sees the hotel as an example of how the Section 12J company plans to deploy investors' capital in future.