Taxpayers are investing in the so-called Section 12J Venture Capital Companies (VCCs), and receiving substantial tax benefits. The 12J Incentive are actively marketed on the basis that taxpayers will receive tremendous tax benefits. The risks and downside seem to not receive equal publicity. One of these (VERY IMPORTANT RISKS) include the taxpayer’s duty to declare the tax benefit which, if not disclosed to SARS, can result in up to R3.6million in penalties for the taxpayer.
The Income Tax Act (ITA) introduced a Venture Capital (VC) Company (VCC) incentive in 2009 to stimulate Small and Medium Enterprise (SME) investments. The VCC incentive is extremely popular as it grants an unlimited income tax deduction for investment in VC shares issued to a taxpayer by a VCC, subject to certain caveats. The incentive has unfortunately been subject to abuse by a number of taxpayers which necessitated substantial amendment to its tax treatment in 2018.
The Tax Administration Act (TAA) contains a Reportable Arrangement regime that requires reporting to SARS by a “Participant” of various types of “arrangements”. The participant must make disclosure within 45 business days of the arrangement becoming a Reportable Arrangement, or within 45 business days of becoming a Participant. A Participant is exonerated from the reporting obligation if another Participant disclosed the Reportable Arrangement.
Not reporting a Reportable Arrangement results in severe penalties in terms of the TAA, which can be as high as R3.6 million, depending on the nature of the Reportable Arrangement, quantum of the “tax benefit”, duration of non-disclosure, and whether the Participant is a “Promoter”. Non-disclosure is subject to penalties imposed for every month that the Reportable Arrangement remains undisclosed, up to a maximum of 12 months. Tax benefit for purposes of the Reportable Arrangement regime is wide and means “the avoidance, postponement, reduction or evasion of a liability for tax”.
Reportable Arrangements include an “arrangement” that gives rise to an income tax deduction but is not disclosed as an expense for financial reporting purposes. Excluded from the disclosure obligation (by Government Notice 140 of 3 February 2016), is an arrangement in this category if the aggregate tax benefit (which is, or may be) derived by all participants does not exceed R5 million. Disclosure is also not required (in respect of this specific category) if the tax benefit is not the main or one of the main benefits of the arrangement.
VCC Investors who are obliged to produce financial statements (such as corporate investors) appear to fall into this category as invariably the VCC investment will be disclosed as an asset and not an expense for purposes of financial reporting standards, albeit that it should qualify for an income tax deduction. If the tax deduction exceeds R5 million in aggregate (for all Participants) or the tax benefit was the main or one of the main benefits of the arrangement, monthly penalties will generally be triggered within 45 business days of the arrangement having been entered into for up to 12 months until the arrangement is reported to SARS by every Participant, except if the Participant obtains a written statement as per above.
VCC Investors should carefully consider whether they are Participants in a Reportable Arrangement and should meticulously manage their disclosure obligations.
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