Venture capital company requirement onerous

The section 12J venture capital company (VCC) regime was extremely popular among private equity pundits between 2016 and 2021 when the last contributions were allowed to qualify for a beneficial tax dispensation

While the VCC regime has been on our law books since 2009, it was only in the latter years that its popularity grew exponentially While the past few years have been relatively quiet on the VCC front, activity appears to be picking up again since many early investors in those companies have remained invested for the required five-year term, after which they will not trigger tax recoupments of amounts previously allowed as a deduction for their investment The renewed focus relates particularly to the exit mechanisms employed by those taxpayers to monetise their investment or exit a cumbersome regulatory structure

Various structures or products that can absorb the investor’ s tax liability on realisation are being marketed with a greater or lesser degree of commercial success While these activities are generally aimed and marketed at the VCC investor on a shareholder level, the VCC itself should tread carefully that exiting shareholders do not result in it any longer complying with the provisions of section 12J

There is a common misconception that the strict requirements that apply to VCCs in terms of their shareholding structure also lapsed along with the sunset clause for contributions in June 2021 This is not the case, and the onerous requirements and restrictions for VCCs remain in place indefinitely and must be measured at each year of assessment VCCs face two potential pitfalls with exiting shareholders The first is that no person, whether alone or together with any other connected person , is allowed to be a connected person in relation to a VCC The connected persons referred to are those in section 1 of the Income Tax Act, which sets out the criteria for how different persons can be a connected person to a company While a particular person might not individually hold an interest in a VCC that would result in them alone regarded as a connected person, it is that person s fellow shareholders that may potentially result in a combined shareholding which breaches the relevant thresholds

So, for example, a natural person and a trust of which that person is a beneficiary will have to combine their shareholding to test whether either of them is potentially connected to the VCC When shareholders start divesting from the structure through sales or share buybacks, it could result in the VCC breaching the prevalent thresholds

Another potential issue is the limitation that no person may hold more than 20% of the issued shares of a specific class in a VCC Again, divestment through either sale or repurchase of shares, a remaining shareholder could breach the 20% limit

In both scenarios, the potential tax consequences fall to the VCC It faces a potential revocation of its status as a VCC, resulting in an inclusion of 125% of the deduction previously allowed to any shareholders

While the shareholders may not be directly prejudiced from a tax perspective, they will economically be punished for the VCC s sins, given that their investments economic value will be reduced with the tax burden of the VCC

It is so that Sars will generally allow the VCC a time within which corrective steps can be taken These corrective measures can, however, trigger a series of unintended tax and commercial consequences

The boards of VCCs are advised to carefully consider changes in their shareholding structure They must ensure they are notified of any potential share transactions prior to those being executed

A transaction on the shareholder level (of which they are not even a part) could severely impact the board

● Pieter Janse van Rensburg is a director at AJM Tax He also serves as a nonexecutive director on the board of the South African Institute of Taxation