Rolling Section 12 J Fund
The ideas of a madman.
Disclaimer: This information does not constitute as financial advice or a recommendation of any kind. It is merely the thoughts & opinions of myself based on the available information on Rolling Funds & the Income Tax Act. I am neither a registered financial advisor nor am I a legal attorney under SA law. This information contains interpretations of what I have read.
For more information on Rolling Funds;
visit Angelist at angel.co/blog/rolling-venture-fund-launch.
For more information on the Income Tax Act & the Section 12 J amendment;
visit: www.sars.gov.za/ClientSegments/Businesses/Pages/Venture-Capital-Companies.aspx
Earlier this year Angelist, the American fund management platform launched Rolling Funds™ under Angelist Ventures. This was an act to further decrease the barrier to entry for accredited investors investing in early-stage startups as well as to increase the pool of emerging fund managers. Instead of fund managers raising capital all at the same time, they can now raise it in tranches on a subscription basis & deploy the capital into startups immediately.
Instead of a 2–3 years capital raise, LPs subscribe to a fund on a quarterly basis. This opens up a pool of who can be an LP in a fund & decreases the fund value requirement to start deploying capital into startups.
In 2009, A provision (don’t think that’s the correct legal term) was put in the Income Tax act called Section 12 J. The aim of Section 12 J was to increase the amount available for investment in SMEs & junior mining explorations. Section 12 J is a mechanism to incentives ordinary citizens & businesses to invest in SMEs through approved VCCs. This was taken from the learnings of UK’s Venture Capital Trust & the Enterprise Investment Schemes (EIS) legislation. In 2014 the limit on the total asset of a qualifying company was increased from R20 million to R50 million. The other change was that the income tax deduction was made a recoupment on the tax paid & permanent subject to funds being held in the fund for the full 5-year term.
The incentive is that qualifying investors can claim up to 45% of their taxable income as a deduction for investment into approved VCCs.
Who qualifies as an investor?
- Any taxpayer qualifies to invest in an approved VCC.
- The qualifying deduction was changed on the 21st of July 2019. Deduction for natural persons & trusts were capped at R2.5 million & companies were capped at R5 million, per tax year (1 March — 28 February, 29 on leap years).
- SARS with the proof when the investor claims the relevant tax deduction.
- Where any loan or credit is used to finance the expenditure in acquiring a venture capital share and remains owing at the end of the year of assessment, the deduction is limited to the amount for which the taxpayer is deemed to be at risk on the last day of the year of assessment. (no idea what this means)
- No taxpayer is allowed to hold more than 20% of the VCC shares of that class. (With a post 5-year exception)
- General income tax and Capital Gains Tax (CGT) rules apply in respect of VCC shares. [1]
The Venture Capital Company (VCC) can invest in any company (Investee) with the exclusion of any of the following impermissible trade:
- Any trade carried on in respect of immoveable property, except trade as a hotel keeper (includes bed and breakfast establishments);
- Financial service activities such as banking, insurance, money-lending and hirepurchase financing;
- Provision of financial or advisory services, including legal, tax advisory, stock broking, management consulting, auditing, or accounting;
- Operating casino’s or other gambling related activities including any other games of chance;
- Manufacturing, buying or selling liquor, tobacco products or arms or ammunition; or
- Any trade carried on mainly outside the Republic. [1]
There are preliminary requirements to qualify as an approved Venture Capital Company (VCC) for each year of assessment:
- The company must be a resident;
- The sole object of the company must be the management of investments in qualifying companies.
- The company’s tax affairs must be in order;
- The company must be licensed in terms of section 8(5) of the Financial Advisory and Intermediary Services Act, 20. [1]
Plus addtional requirements after the VCC is approved by SARS each year & after 48 months from the first date of issue of the venture capital share:
- A minimum of 80% of the expenditure incurred by the VCC to acquire assets must be for qualifying shares, and each investee company must, immediately after the issuing of the qualifying shares, hold assets with a book value not exceeding:
— R500 million in any junior mining company;
— or R50 million in any other qualifying company.
— The expenditure incurred by the VCC to acquire qualifying shares in any one qualifying company must not exceed 20% of any amounts received in respect of the issue of venture capital shares.[1]
So the question now is how does this VCC thing by SARS tie into Angelist’s Rolling Funds™? Well, Angelist has effectively taken over the back office of the VC & allowed the Fund Manager to raise & deploy capital. In the age of raising Solo Capitalists more people are operating as de facto VCs. Rolling Funds™ are a bridge towards that, increasing the pool of Super-Angels & moving them to Solo Capitalists with an innovative fund structure.
This brings us to the combination of the two. Section 12 J funds have to be deployed within a 36 month period & are raised yearly by traditional venture funds in South Africa. The Rolling Venture Fund structure is a much better method of raising a smaller fund, an individual can subscribe on a quarterly basis to manage their liquidity.
Because a Section 12 J Fund is a rich people investment class it requires the capital invested be upfront within the tax year to get the benefit. That can be restrictive to someone who is not liquid. Let me make an example of this how this Rolling Section 12 J Fund could work.
The Rolling Section 12 J Fund — example
Amy, John & Karabo (made people of course) are Chartered Accountants & Senior Associates at a top 3 accounting firm, called PWG. Because this is utopia all 3 earn the same amount, R600 000 per annum, equal pay for equal work.
Amy decides she’s going to park her money in a unit trust due to the low-risk nature of the Allan Blue’s S&P 500 fund of funds. John has been living at home for the past 4 years so he has a bit of money lying around, R600 000 in fact & has an appetite for risk so he wants to put R300 000 into a Section 12 J Fund that invests into solar projects. At tax season John is able to claim 39% of his taxable income because of how Section 12 J is set up. John effectively paid R117 000 in tax & Amy paid the whole R234 000. Had John invested the whole R600 000 he would have effectively paid no tax for the year.
Karabo has been reading a lot about Silicon Valley & startups, Karabo even subscribes to Naval’s teachings; an avid fan of Venture Capital & early-stage investing, Karabo wants to invest in startups because Karabo in the Financial Services department at PWG & on track to make partner in 4 years Karabo doesn’t have time to understand how SAFE’s are implemented, plus Karabo doesn’t have the money John has. Karabo finds out about this new Rolling Section 12 J Fund investing in early-stage technology companies, Karabo likes the idea & the bonus is the fund is run by some of his friends from university. Karabo decides to put 15% of his taxable income every quarter, R22 500 every 3 months. In total Karabo invests R90 000 into the Rolling Section 12 J Fund & at tax season Karabo recoups R35 100 because of how the Rolling Section 12 J Fund is set up.
This works fine for Karabo. 15% is a comfortable amount & Karabo know the risks of investing in technology startups. Karabo believes this is a long term investment & is fully invested for a 5–10 year period.
Karabo believes this asset class would open up more investment opportunities for young professionals who want exposure in early-stage companies but do not have the know-how & time to Angel invest. The tax benefit is just a bonus.
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