SME's - the backbone of emerging markets

All over the world there is a growing recognition that a market economy starts by establishing small and medium-sized enterprises, and then it is developed by developing these SMEs systemically. These activities of SMEs represent a big driving force behind the development of a national economy. Entrepreneurs establish companies, start businesses, and expand their businesses.

South Africa's need for SME driven growth

Being the backbone of the economy, countries around the world have structured policies that ensure the sustainability of these enterprises, encouraging more entrants into the market.

The illustration below shows that whilst SMEs are major contributors to GDP, Corporate taxes and Employment in other countries, they are less so in South Africa. It is astonishing in fact that Chinese and Australian SME’s contribute 3x more to their GDP and almost 10x to corporate taxes.

Data source: Sunstone Capital

The challenges

The two greatest challenges SME’s face today are:

1. Access to finance
2. Difficulties relating to administrative challenges

In order to assist with these challenges countries such as England introduced schemes such as the Venture Capital Trust (VCT) and Enterprise Investment Schemes (EIS) in as early as 1994 and 1995. These schemes offer a tax incentive of 30% on investments made; legislated to promote individual investors to support SME’s in the British economy. Last year alone the VCT programme in the UK was responsible for the raising of over 728 million pounds. In 2009 South Africa followed suit by introducing Section 12J into the Income Tax Act offering investors a 100% tax deduction as an incentive to promote equity investments.

Just this year China instituted a new guideline to improve the business environment for SMEs by simplifying administrative procedures as well as creating more financing channels, thereby encouraging and allowing SMEs to drive the growth and innovation that is so needed in a developing economy. 

The way forward

The strategy implemented in the South African context was simple: reduce taxes on individuals in the form of a full tax deduction as a method to promote investment into key sectors in order to grow the economy. This initiative was introduced by treasury as the Venture Capital Company scheme under Section 12J of Income tax act, and can effectively reduce the capital at risk in any investment made by the amount that can be claimed back from SARS (that's 45% for individuals in the highest income tax bracket). 

To qualify for this deduction, an investment must be made into a SARS and FSCA approved section 12J investment fund. A section 12J fund will seek to make investments into Qualifying Companies (QC's) which are aligned with the criteria for a qualifying 12J investment, as well as the funds specific mandate.

Image source: Pexels

How Section 12J is helping grow the economy

When a Section 12J fund makes an investment into a QC it has three important effects:

1. These Qualifying Companies (QC’s) are now able to access readily available and cost-effective finance. Which in turn allows them to grow their businesses, create jobs, and stimulate growth in critical sectors of the South African economy.
2. The return on investment on these investments is enhanced by the tax deduction resulting in a very attractive return profile.
3. This provides a compelling case for keeping SA capital onshore and stimulating economic growth.

At a time when South Africans are looking elsewhere, 12J offers a compelling alternative investment which serves the economy as well. Investors have saved over R2bn in taxes to date.

EasyEquities and Sunstone Capital are offering SA's first fractional 12J shares. To secure a spot alongside the South African investors who have saved over R2BN in taxes, click on the button below to apply. 

Read:
Section 12J - the basics

Avi Gordon
Fund Manager - Sunstone Capital

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