investment Archives

Take Advantage of the Venture Capital Company Allowance While You Can

13/02/2020 14/05/2021

Here’s some good news in the form of a way to save tax (a lot of tax), make a good investment, and directly boost both our economy and our SMEs – all in one go.

That’s where the VCC (Venture Capital Company) Allowance comes in. We’ll have a look at the substantial savings you (or your trust or company) can achieve by using the allowance correctly; at how it works both initially and subsequently; at the need to beware of costs; and at how “finding a gem” could give you a (very) substantial after-tax return.

We share some practical examples to illustrate, and end off with a warning to act quickly – the allowance is planned to fall away at the end of June 2021.

“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 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.

It 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.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Junk Status Is Not The End – It Can Get A Lot Worse!

20/01/2020 14/05/2021

There is a perception that we will be scraping the very bottom of the barrel if Moody’s does indeed downgrade our debt to the dreaded Junk Status – that ‘There’s no way to go but up’, that ‘This is the beginning of our rehabilitation process’ and so on.

Regrettably that’s not so at all. If our economy continues to go the wrong way there could be much worse in store for us – have a look at our table of the various categories used by Moody’s in its “Investment Grade” and “Non-Investment Grade” rankings.

We discuss the implications, and our way forward.

It is now widely expected that sometime in the next year or so Moody’s will downgrade South Africa’s debt to junk status. Many see this as the beginning of the process to rehabilitate ourselves. True, initially we will go through a difficult period as ±R150 billion of our debt will be sold as many offshore institutional investors cannot hold junk bonds which leads to a fall in the currency, higher interest rates and lower economic growth. But then we knuckle down and begin to reform the economy and embark on the process of returning to investment grade.

However – things can get much worse

Source : Moody’s

We are currently Baa3 with Moody’s and are on a negative watch with them which means they will put South Africa on Ba1 (i.e. junk status) if we don’t get economic growth on an upward path and rein in our rising debt.

As you can see, we can keep dropping to Ba2 and all the way down to C which means South Africa has defaulted on its debt obligations and there’s little prospect of recovery.

It can happen – just look at Venezuela and Zimbabwe – where optimistic assumptions are made on economic growth and government expenditure but in fact the country just raises taxes, incurs more debt, until you need to borrow money just to pay off debt that falls due. Each drop on the Rating Matrix raises the cost of borrowing and the downward spiral continues.

The ultimate problem with this scenario is that it eventually becomes irreversible, which is when default on debt becomes a distinct possibility.

The reality is that until genuine reforms are put in place, we will continue to descend along the Rating Matrix ladder.

What should we be doing?

Paying off as much debt as possible is a good start. We should also carefully consider any future expenditure and analyse just how necessary it will be, particularly if it is in foreign currency. Some analysts recommend that we should become as self-sufficient as possible (e.g. boreholes, solar power).