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Recently, much emphasis has been placed on the ever-growing Venture Capital Company (“VCC”) regime, particularly on the tax benefits for investors, in terms of which they can deduct the expenditure incurred in acquiring VCC shares, from their taxable income. This is not likely to change any time soon, as the 2020 tax year draws to a close and new investors are sourced. What has however enjoyed less attention, is the VCC itself, and the strict regulatory and tax requirements that a VCC must adhere to in order to maintain its status. There are several VCC managers in the market who have built an entire industry on incorporating and running VCCs. While their focus is often on the commercial side of the structure, the tax integrity of the VCC remains paramount, and the entire structure could stand or fall on a tax technicality.

VCCs are regulated by (amongst others) section 12J of the Income Tax Act, No 58 of 1962. The requirements, and restrictions imposed by section 12J, generally relate to the structure (shareholding) and trades conducted within the VCC structure. In some instances, where these rules are breached, the VCC is allowed, with due notice from SARS, to take corrective steps to rectify the transgression, while other defaults will result in immediate adverse tax consequences, including recoupments of 125% of the expenditure incurred by any person to acquire shares issued by the VCC. Such adverse tax consequences on the VCC level, could ultimately negatively affect investor returns. Set out below, are two of the more onerous structuring requirements, in a very simplified form:

  • VCC shares are required to be equity shares, which is a complex analysis of the dividend’s rights and rights of a return to the capital of shareholders. Since VCCs can, in theory, have VCC and non-VCC shares in issue, it is important to ensure that the shares for which the investor subscribes (and for which they want to claim the deduction), are indeed equity shares. Furthermore, no VCC shareholder is allowed to hold more than 20% of the VCC shares of that particular class.
  • The underlying companies into which a VCC invests on behalf of investors are not allowed to be “controlled group companies” in relation to a group of companies of which a VCC (to which that underlying company has issued any share) forms part. This effectively means that a VCC must own less than 70% of the shares in the underlying companies. Importantly, the Taxation Laws Amendment Bill, 2019, introduces a requirement that this may not have been the case since the first issue of shares by the underlying company. This effectively means that a VCC cannot incorporate an underlying company and can only subsequently subscribe for shares.

Given the clear complexities that there are in the structuring of a VCC (of which the above mentioned are only some), investors are encouraged to challenge the VCC into which they invest on the tax integrity of the structure and whether it has been thoroughly interrogated by a registered tax practitioner knowledgeable in the field.

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)

Pitfalls of VCC structures
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