South African businesses of all sizes have a great opportunity to help address the country’s growing youth unemployment crisis while benefitting from a tax incentive by taking advantage of the Employment Tax Incentive (ETI).
South Africa’s unemployment rate of around 50% among people under 25 poses a threat to the country’s future sustainability and prosperity.
By helping youngsters to join the workforce, companies can develop their workforces of the future as well as help alleviate the social instability that arises when there are too many young people without work.
The Employment Tax Incentive
This crisis is weighing very heavily on the government’s mind, hence the fast-tracking of the Employment Tax Incentive (ETI) into law during 2013. Now that it is in place, the ETI offers employers some generous incentives for helping to bring the young into the workplace and helping them to develop skills that will make them employable into the future.
The ETI encourages employers to hire young people by reducing the PAYE that the employer is liable to pay to SARS based on the number of young people employed. This reduces the cost of employment to the employer while leaving the employee’s earnings unaffected.
The Employment Tax Incentive legislation will be in effect for an initial three-year period from January 2014 to December 2016. During this time, all employers in the private sector who are registered for PAYE and have their tax affairs in order can take advantage of the scheme.
Companies can claim the ETI for people they directly employed after 1 October 2013 who meet the following criteria:
- Where employed on or after 1st October 2013
- Are between 18 and 29 years of age.
- Have a RSA ID document or an Asylum Seeker permit.
- Earn more than the minimum wage or R2,000 per month (if no minimum wage) but less than R6,000 remuneration per month.
The benefit for business
These incentives mean employees have a perfect opportunity to start putting young people into unfilled jobs that they did not urgently need to fill. They can bring youngsters on board and start training them up and make them productive while they benefit from the subsidy.
They can also benefit by bringing in casuals to boost their productivity. Companies that employ a qualifying casual for R200 per day for 10 days per month will get a reduction of R1 000 from monthly PAYE for the first 12 months, for example.
If you are an eligible employer with at least one qualifying employee, a good payroll software package should be able to automatically calculate your ETI amount in respect of all the qualifying employees. You then need to declare the total ETI for the month on the new EMP201 form.
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Invest And Save 100% Of Your Tax Payable To SARS With The 12J Fund
Section 12J funds were created in response to the South African Government offering tax incentives for private investors to support funds that support SME growth in South Africa. Three experts unpack the benefits of investing in 12J funds — particularly for high net worth individuals.
What is a 12J Fund?
Clive Butkow: In 2009, the South African Government implemented a tax incentive for investors in enterprises through a Venture Capital Company (VCC) regime known as Section 12J.
These funds were set up to help early stage companies raise venture capital to stimulate economic growth and job creation. Section 12J was based on the Venture Capital Trusts (VCT) in the UK, which enable high net worth Individuals to save tax and rather invest in a VCT, which will then invest in start-ups. Individuals, trusts and companies can all invest in a Section 12J company and receive the respective tax deduction.
Neill Hobbs: The South African Revenue Services (SARS) has written Section 12J into the Tax Act, which offers taxpayers a 100% reduction in their taxable income in the year of investment for the amount they invest by way of a subscription for shares in a Section 12J VCC. The VCC then invests into small and medium-sized enterprises (SMEs) with the added intention of creating jobs and securing employment. The VCC must be approved by both SARS and the Financial Services Board.
Why is it tax deductible?
Gidon Novick: The legislation provides for a tax deduction providing the fund complies with the requirements of the Act. The intent of the incentive is to stimulate certain critical areas of the South African economy (such as tourism and hospitality) through SME growth in the sector.
Neill: Section 12J advocates investment into SMEs and junior mining exploration to act as a catalyst for a positive shift in the economy. We know that SMEs are a significant source of employment in the economy and provide a plethora of job opportunities and income security for households. This ultimately creates a positive iterative loop in the economy.
How do the tax deductions work?
Clive: The total amount invested can be deducted from the tax- payers’ taxable income. This results in a taxpayer (who is paying tax at the marginal rate of 45%), saving 45% of their investment by reducing their taxable income. For example, a taxpayer who has a taxable income of R1 million and would normally pay R450 000 to SARS will rather pay the R1 million to the Section 12J company and pay zero tax.
The caveat is that the taxpayer needs to hold their shares for five years in the relevant Section 12J fund, or SARS will recoup their tax saving. The tax is deductible to incentivise taxpayers to rather invest in a Section 12J company and promote the growth of the South African economy than pay tax on their taxable income.
This seems like a double benefit to investors? Is that correct and why?
Clive: There’s definitely a double benefit, as the taxpayer receives a once off deduction from SARS in the year they invest in the Section 12J company, as well as an added benefit based on the performance of the Section 12J company. Some companies are set up to invest their capital in higher risk ventures with others in lower risk ventures. The returns to investors range from 15% to 38% based on the nature of the fund and their investment strategy.
Gidon: The benefit to investors would be in the form of their tax deduction but importantly also their investment returns. Investors need to fully understand the nature of the investments the fund is making, the risks involved and their ability to cash out after the five-year minimum term, in other words, the liquidity of the investment.
Neill: Individual investors will get an immediate tax saving, up to 45% of the amount invested, in addition to any dividends and long-term capital growth. A Section 12J VCC provides self-interest value to the taxpayer in the tax saving and growth in investment, but in a broader sense, marries business value with societal value through the boost in the SME space.
What questions should investors who are interested in investing in a 12J fund be asking?
Clive: The most important question is of the experience and reputation within the management team. Money follows management in the venture capital asset class. The management team needs to have experience in the investment strategy of their Section 12J fund. At Kalon Venture Partners we only invest in disruptive digital technologies where the CEO and the board have significant experience in buying, building and selling technology companies. The CEO was the ex-COO of Accenture South Africa and prior to that led Accenture’s technology business. Another important consideration is how the Section 12J company creates liquidity for their investors as it’s important for the investor to understand how and when the Section 12J company will pay dividends of the profits and surpluses on the sale of assets. Lastly, investors must understand the governance and investment disciplines, systems and processes when making investments.
Gidon: What is the risk/return profile of the underlying investments? Who are the fund managers and what is their track record? What are the assets that underpin the investments? How will this fund make an impact on the South African economy and job creation? How will I get my money out after five years?
Neill: Confirm SARS and FSB approval. What is the VCC’s investment strategy? The VCC’s industry focus? What is the fund’s launch date? Track record? Capital raised? Targeted return? Number of investments made in qualifying companies? Annual financial statements published? Basis for valuing the underlying investment and the VCC’s dividend policy and history? Fee structure? Minimum investment?
What are the pros and cons of a 12J fund versus more traditional investment portfolios?
Neill: The benefit for a deduction in respect of a retirement annuity contribution is limited to
R350 000 in a year, whereas the contribution and benefit of an investment into a Section 12J VCC is not capped and can be 100% of taxable income.
Many SMEs require capital and management support. With the support from the VCC team, stakeholder integration and interaction takes place on the factory floor, rather than just in the boardroom. The investor management team walks the walk with the SME.
A VCC investment should be viewed as a long-term investment. The proceeds on the sale of the VCC shares will be subject to full tax recoupment if the shares in the VCC are sold within five years from the date of investment.
If the shares are held for a period exceeding five years, the sales proceeds from the sale of the shares will only be subject to capital gains tax, albeit from a zero base.
Clive: A major pro for investors is the upfront tax advantage where there is no limit to the investment that you can make, unlike an RA, which is limited to a percentage of taxable income and capped. A second pro is the fact that investors can now diversify their portfolio with 12J investments and not only invest in the traditional capital markets.
What is the amount you can invest into a 12J fund?
Neill: CIPC requires that if a VCC does not have a prospectus, then the minimum amount that can be invested is R1 million. The intention with this is to make sure that any general person from the public, who might not understand the investment they are investing into, does not invest more than is appropriate for them.
Clive: Our recommendation at Kalon Venture Partners is that an investor should not invest more than 7,5% to 10% of their net wealth into a Section 12J due to the higher risk profile of a venture capital investment.
Is there a ‘right’ time to invest in a 12J fund with regards to tax exemptions?
Clive: There is no right time to invest, however with the current rand strength we see this as a vital time to diversify one’s portfolio. The most effective time to raise capital is at the tax year end on 28 February. An alternate time of the year that capital is raised is during the provisional tax season in August or September each year.
Gidon: An investor should only consider a 12J if they have the taxable income and don’t need access to the funds they have invested for at least five years. Investments must be made before the tax year-end (ie 28 February) to qualify for the deduction in that year.
Neill: Section 12J is particularly attractive to high income earners. It’s also attractive to those taxpayers who have made a capital gain, which will be subject to capital gains tax. For example, an individual who realises a capital gain of R5 million in the 2018 tax year, will only have to invest the inclusion amount of 40% (R2 million) into a VCC to avoid capital gains tax completely in the 2018 tax year.
A VCC investment is the only recognised manner in which a corporate employee, who is subject to PAYE on their salary, can receive a refund of PAYE deducted by the employer. Although there is no provision for a directive for the reduction of the PAYE amount, an employee who earns R2 million per annum, and makes a R2 million VCC investment, could receive a full refund of PAYE on the submission of their annual tax return.
The sunset clause is currently 30 June 2021. This means that funds invested before that date must remain in for the five-year period, but any funds invested into a 12J fund after that date will not enjoy the current tax benefits. This date could be re-assessed and extended.
Silver Linings For Smaller Businesses In Budget 2018
As expected, the Finance Minister and Treasury have proposed some tough measures to address South Africa’s tax collection shortfall, growing budget deficit, and new spending priorities in the 2018 Budget Speech. Sage software can ensure your business remains compliant through these upcoming changes.
Higher VAT, fuel levies and import duties on luxury goods will crimp consumer spending, which could be bad news for SMEs, but we are pleased that the Finance Minister has raised his GDP growth projections and proposed interventions to help grow South African SMEs.
Government is taking steps to restore fiscal credibility, rein in spending, and hold off another credit ratings downgrade, such as:
Growth, reviewed competition policy and improved market access
The hopes and concerns of entrepreneurs and SMEs were extensively covered, including how low market access and high barriers to entry are constraining the growth of the country’s SMEs.
While government will take action against anti-competitive behaviour that harms these businesses, big businesses should also play a constructive role in nurturing the growth of SMEs through mentoring and partnership.
An increase in SME funding
The Departments of Small Businesses and Science & Technology and the National Treasury developing a R2,1 billion fund to benefit SMEs during the early start-up phase is good news, but it’s important that the funding is spent efficiently and productively.
We’d like to hear more details about how government will choose to allocate this money.
A shift in public procurement participation
Government using public procurement to support Black Economic Empowerment, industrialisation and development of SMEs see its billions of rand in procurement spend used to empower SME owners — we look forward to more details about how government will increase participation of small and micro businesses in procurement opportunities.
It’s also critical that government follows through on its promise to pay small businesses within 30 days of invoicing. Cash flow is a major challenge for small businesses and few of them can afford to wait three to six months for payment on a big project.
The rise in the VAT rate
The VAT hike will take some money out of people’s pockets, but will probably have less impact on business confidence than higher corporate taxes, and less impact on consumer spending than further personal tax increases.
SMEs will need to ensure their systems are ready to cater for the new VAT rate, but this should not be too much of a challenge for those with automated accounting systems. By international standards, VAT in South Africa is still relatively low — we can just hope that this increase is not followed by another in the next year or two. n
Managing the VAT Transition
The VAT Act stipulates that the time of supply will be either when an invoice is issued or when payment is received — whichever happens first. For example, if you invoice for a sale on 31 March but are only paid on 30 April, the VAT rate of 14% will apply. If you receive payment on or after 1 April but have not yet invoiced for the sale, then VAT should be charged at 15%.
Cloud-based, automated accounting solutions, like Sage One, were VAT-ready on 1 April.
Businesses using these solutions don’t have to worry about staying on top of the different VAT rates because the system will automatically generate the correct VAT invoice, quote and debit or credit note.
The VAT Act states that displayed pricing and adverts must include VAT (unless the product is zero-rated). You have until 31 May to complete this work. Until then, you can display a notice at the till point, stating that prices do not include VAT at the new rate and will be adjusted at the tills. But why delay and risk confusing your customers?
The next VAT201 return you submit to SARS will be more complicated because you will need to calculate input and output tax at different rates, not to mention the apportionment rate that will need to be calculated for contracts and services taking place before and after 1 April. If you’re using manual processes, you might need to consult an accountant to make sure you’re not over or under reporting VAT on your reconciliations.
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