UPDATE ON GRANDFATHERING PROBLEMS FOR VENTURE CAPITAL COMPANIES

By Theunis Claassen,Aneria Bouwer,Wally Horak Monday, December 09, 2019
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In our recent newsflash we commented on the new deduction limits for investors in venture capital companies (VCCs), as included in the Taxation Laws Amendment Bill (TLAB) released on 30 October 2019.

The maximum deduction claimed by an investor in terms of section 12J of the Income Tax Act, may not exceed ZAR 5 million for a company, and ZAR 2.5 million for any person other than a company.  This limitation applies with effect from 21 July 2019, the date of the introduction of the draft Taxation Laws Amendment Bill (Draft TLAB).

In our 1 November newsflash, we highlighted the problem this limit presents to VCCs with larger investments.  We took the example of a VCC which has to raise ZAR100 million for its planned or pending investments.  The VCC has already issued shares to two VCC investors, each investing ZAR 20 million and has received commitments from another three investors to each invest ZAR 20 million. 

The new deduction limits mean that in order to raise the further ZAR 60 million, the VCC will have to find 12 corporate investors investing ZAR 5 million each, or 24 other investors investing ZAR2.5 million each: 

  • The limit restricts the ability of the VCC to raise the necessary funds.  A VCC such as the one in this example may not be able to rely on commitments of investors to the extent that those investments exceed the new deduction limits and will thus have to find more investors.
  • Another potential problem was the restriction that no shareholder may be a connected person in relation to the VCC (section 12J(3A)) or that no shareholder should own more than 20% of the equity shares in a class (section 12J(3B)).  These limits must be complied with within 36 months after the first date of the issue of shares by the VCC (in the case of section 12J(3A) or 36 months after the first date of the issue by the VCC of shares of a particular class (section 12J(3B)).  Failure to comply with this could result in the VCC losing its VCC status and in the inclusion of an amount equal to 125% of the amounts invested by VCC shareholders, in the income of the VCC.

The TLAB addressed the second problem, but not the first one.  The effective dates of sections 12J(3A) and 12J(3B) have been amended to provide that these sections will only apply to shares that have been issued for the first time on or after 21 July 2019.  Shareholders who subscribed for shares in VCCs before this date will not trigger the application of either section 12J(3A) or 12J(3B). 

While the implementation date was postponed to 21 July 2019 in order to ensure that the new deduction limits will not trigger non-compliance for existing investors, it could also provide relief for any other VCCs or VCC share classes which do not comply with sections 12J(3A) or (3B).  If the shares in question were issued before 21 July 2019, sections 12J(3A) or 12J(3B) will not apply irrespective of whether the non-compliance was triggered by the new deduction limits. 

For example, section 12J(3B) was introduced in 2018 in order to address perceived abuse in respect of so-called ‘silo structures’.  No person could thus own more than 20% of the shares in a class of shares, if the shares were issued on or after 24 October 2018.  However, as section 12J(3B) will now only apply to shares issued on or after 21 July 2019, this may provide some relief to VCCs who are still struggling to comply with the requirements of section 12J(3B).

However, the TLAB does not address the commercial problem that a larger VCC may be unable to raise sufficient funds as a result of the new deduction limits.  The fact that the deduction limits would not trigger non-compliance with sections 12J(3A) or (3B) would be cold comfort for a VCC who is unable to raise sufficient funds and to make investments as a result thereof.