On July 24 2017 the South African Revenue Service (SARS) released Binding Class Ruling (BCR) 057, which deals with, among other things, the eligibility of a partner in an en commandite partnership to claim a deduction in respect of venture capital shares acquired by the partnership.
The venture capital company (VCC) tax regime, which was introduced into the Income Tax Act (58/1962) in 2009, aims to encourage investment in small and medium-sized enterprises and junior mining companies. Section 12J of the act encompasses the relevant legislation governing VCCs and provides for the formation of an investment holding company (ie, a VCC). Investors subscribe for shares in the VCC and claim an income tax deduction for the subscription price incurred. In turn, the VCC invests in 'qualifying companies' (ie, investee companies).
The deductibility of expenditure incurred by an investor in acquiring shares in an approved VCC is subject to anti-avoidance provisions. First, where an investor has used any loan or credit to finance the expenditure incurred to acquire shares in the VCC, the amount of the deduction is limited to the amount for which the investor is deemed to be at risk on the last day of the assessment year (Section 12J(3)(a)). The investor is deemed to be so at risk to the extent that – having regard to any transaction, agreement, arrangement, understanding or scheme in this regard – the incurral of expenditure or repayment of the loan or credit would result in economic loss to the investor, where no income is received or accrued by the investor in future years from the disposal of any venture capital share issued to such investor as a result of said expenditure (Section 12J(3)(b)). However, a proviso to Section 12J(3)(b) provides that an investor will not be at risk if:
- the loan or credit is not repayable within five years; or
- such loan or credit is granted to the investor by the approved VCC.
Second, Section 12J(3A) of the act provides that if – at the end of any assessment year and after the expiry of a 36-month period commencing on the date of the issue of the venture capital shares – an investor has incurred expenditure in acquiring any venture capital share issued to such investor by a VCC and, as a result of such acquisition, that investor is a connected person in relation to that VCC:
- no deduction will be allowed in respect of such expenditure;
- the SARS commissioner must, after due notice to the VCC, withdraw the approval of the company as a VCC; and
- an amount equal to 125% of the expenditure incurred in the acquisition of the company's shares by any person must be included in the company's income in the assessment year in which the approval is withdrawn if the company fails to take corrective steps acceptable to the commissioner within a period stated in the commissioner's notice.
In accordance with Section 12J(4) of the act, a claim for a deduction by an investor must be supported by a certificate issued by the VCC:
- stating the amounts that were invested; and
- confirming that the relevant company was approved as a VCC.
Section 12J(5) sets out the requirements that must be met before a company can be approved as a VCC. More specifically, a company will acquire VCC status if the commissioner is satisfied that the sole object of the company, which must be resident in South Africa, is the management of investments in qualifying companies. In addition, the company must:
- be licensed under Section 7 of the Financial Advisory and Intermediary Services Act (37/2002);
- have complied with all of the relevant laws administered by the commissioner; and
- have its tax affairs in order.
Recent legislative amendments to Section 12J have given rise to an increased participation in the asset class and use of the investment vehicle, evidenced by the increasing number of rulings that SARS has issued in relation thereto. BCR 057, which is discussed in more detail below, is the latest of these rulings.
The applicant, a company incorporated and resident in South Africa, is "engaged in the provision of trust services". An en commandite partnership will be formed by the applicant (as the general partner) and between 10 to 20 limited partners (class members).
The partnership will be formed to invest exclusively in approved VCCs. It will not borrow from third parties, but will obtain cash contributions from the class members. A class member's share in the income and capital of the partnership will be in proportion to that member's contribution to the capital of the partnership.
It is proposed that the partnership will, at the outset, invest in two approved VCCs, which will be managed by a company incorporated in and a resident of South Africa (ManCo). Notwithstanding that the investments in each of the VCCs will be made by the partnership, the applicant and ManCo will arrange for each individual class member to be entered into the register of investors in the books of the relevant VCC. Further, each individual class member will be issued a certificate contemplated in Section 12J(4) of the act (ie, an investor certificate) in accordance with that member's proportionate investment in the partnership.
Applicable law in relation to partnerships
En commandite partnerships are fiscally transparent vehicles for South African tax purposes. Each partner must account for its undivided share of the tax effects of a partnership's income statement and assets. In particular, Section 24H provides the following in regard to the South African tax treatment of a partnership.
Under Section 24H(2) of the act, read with Section 24H(5), each partner is deemed to carry on the trade or business of the partnership. Any income received or accrued by the partnership is deemed to have been directly received or accrued by the partners, in accordance with the participation rights set out in the partnership agreement and on the same date that the income was received or accrued by the partnership. Any deductions or allowances that can be claimed against such income for expenditure incurred by the partnership can be claimed by the partners in their own hands (in the same ratio as their participation rights).
Under Section 24H(3) of the act, read with Section 24H(4), the tax deductions for a limited partner are in aggregate limited to the sum of that partner's capital contributions plus its share of the partnership income. Any excess tax deductions can be carried forward to subsequent assessment years.
SARS ruled that subject to Sections 12J(3) and (3A) of the act, each class member will be entitled to claim the deduction under Section 12J(2) read with Section 24H, pro rata to its proportionate share of the investment in the partnership.
In addition, the proposed investor certificates to be issued to the class members will be acceptable for the purposes of Section 12J(4).
Notably, rulings are issued to taxpayers to provide guidance on how SARS interprets and applies the tax law to specific transactions. It is therefore important for taxpayers to be cautious when relying on rulings issued by SARS, as persons not party to the ruling cannot bind SARS thereto.
BCR 057 is valid for five years from June 30 2017.
For further information on this topic please contact Gigi Nyanin at Cliffe Dekker Hofmeyr by telephone (+27 115 621 000) or email ([email protected]). The Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.
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