The Venture Capital (Incentives) Act was established in 1993 to provide tax relief and other incentives to venture capital companies (investors) and venture project companies (startups). The Act contains several incentives such as capital allowance and reduction of withholding tax to investors and startups which take part in one or more of the objectives under the Act. We looked at how the Act will spur the inflow of venture capital investments into the economy.
The number of venture capital (VC) deals in Africa has been on an upward trend since 2014, with Nigeria accounting for 14% of all the total VC funding deals in Africa between 2014 and 2019. As more founders set up tents in Nigeria, the economy is set to benefit from the inflow of revenue, the creation of innovative products and services, and the development of human capital.
However, it goes without saying that the success of these startups will largely be determined by support from the government in those countries where they are located. Innovative policies, helpful legislation, tax benefits and other incentives create a fertile ground for startups to grow.
In Nigeria, several laws exist to support startups. Some of these include the exemption of small businesses with an annual turnover of less than N25m from companies’ income tax; a pioneer status tax (tax-free) incentive to startups that have been set up under specific industries or to provide certain products (to be enjoyed in their first year of operations); and the setup of a growth board on the Nigerian Stock Exchange in order to encourage companies with high growth potential to seize the opportunity of raising long term capital and promoting liquidity.
One of the earliest legislation in support of startups is the Venture Capital (Incentives) Act enacted in 1993. It was set up for the grant of tax relief and other incentives to venture capital companies and venture capital projects. The Act was enacted at a time when the Government embarked on the privatization of several government-owned institutions. It also came at a time when there was the expansion of various sectors such as the manufacturing and the finance sectors. It was therefore necessary to provide legislation that would encourage investors to put in their money for the growth and development of those industries.
In order to enjoy the tax relief and incentives under the Act, a venture capital company must make an investment that is not less than 25 per cent of the total capital required for the venture project.
Structure of the Act
The Act addresses both venture capital companies (the investor) and venture project companies (the startup). In order for either the venture capital company or venture project company to enjoy the incentives under the Act, the Federal Inland Revenue Service (“FIRS”) shall first certify that they have carried out or are capable of carrying out one or more of the objectives set out under the Act.
The objectives are listed in section 2 of the Act. They are: (a) the acceleration of industrialization by nurturing innovative ideas, projects and techniques to fruition; or (b) the commercialization of research findings with high potential for far-reaching forward or backward linkages; or (c) the promotion of self-reliance through the establishment of resource-based and strategic industries through the provision of risk guarantee and insurance; or (d) the encouragement of indigenous processes and technologies; or (e) the promotion of the growth of small and medium scale enterprises with emphasis on local raw materials development and utilization; or (f) such other objectives as may, from time to time, be specified by the FIRS.
These objectives are pointers to the country’s needs at the time which included industrialization and the growth of the economy through other industries asides oil and gas; development of human capital and entrepreneurship especially as population rapidly increased over and above the few available government jobs; and a focus on local production of goods and services in order to reduce reliance on exportation.
The Act set a threshold in section 3 for the percentage of investment that a venture capital company must contribute to the venture project. In order to enjoy the tax relief and incentives under the Act, a venture capital company must make an investment that is not less than 25 per cent of the total capital required for the venture project. Section 4 mentions the various incentives that shall accrue to venture investments undertaken by a venture capital company in line with the Act.
These incentives are as follows:
(a) Capital allowance: an equity investment by a venture capital company in a venture project company shall, for purposes of capital allowance under the Companies Income Tax Act, be treated as follows- (i) for the first year deduct 30 per cent; (ii) for the second year deduct 30 per cent; (iii) for the third year deduct 20 per cent; (iv) for the fifth year deduct 10 per cent;
(b) Exemption from capital gains tax: the amount of capital gains accruing to a venture capital company from a disposal of its equity interest in a venture project company shall be exempted from capital gains tax as follows- (i) for the disposal of capital within five years of investment, 100 per cent; (ii) for the disposal of capital between six and ten years of investment, 75 per cent; (iii) for the disposal of capital between eleven and fifteen years of investment, 25 per cent; (iv) for the disposal of capital after fifteen years, 0 per cent;
(c) Reduction of withholding tax: the withholding tax payable on dividend declared by the Federal Inland Revenue Service in a venture project company shall be reduced by 50 per cent of the prevailing rate of withholding tax in respect of dividend received by a participant in the Risk Fund and venture project company within the first five years;
The provision of attractive incentives and tax benefits have certainly played a huge role in encouraging venture capital firms to invest in startups.
(d) Application of the Industrial Development (Income Tax Relief) Act: the provisions of the Industrial Development (Income Tax Relief) Act shall apply to a venture project company. The principal act has since been amended by the Industrial Development (Income Tax Relief) Act (Amendment) 2018. The amendment provides for additional incentives for some categories of investments including a Pioneer certificate which will grant a tax holiday to companies that make investments in designated industries and/or products for an initial period of three years, extendable for one or two additional years;
(e) Application of the Export (Incentives and Miscellaneous Provisions) Act: the provisions of the Export (Incentives and Miscellaneous Provisions) Act shall apply to a venture project company to the extent of the involvement of the venture project company in the exportation of its products.
Section 5 gives the FIRS the power to determine from time to time, for the purposes of the Act, a person as a venture capital company or a venture project company.
Conclusion
Venture capital deals have exponentially increased in Nigeria and across Africa. The provision of attractive incentives and tax benefits have certainly played a huge role in encouraging venture capital firms to invest in startups. Although not a very popular legislation, venture capital firms ought to take full advantage of the Venture Capital (Incentives) Act in order to ease some of the financial strains that come with tax concerns and other pecuniary matters when investing.
Finally, it is noted that the objectives outlined under the Act which are required to be carried out under a venture project are wide enough to include present day objectives such as e-commerce and tech-related businesses. It is however recommended that pursuant to section 2 (f) of the Act, the FIRS specifically spells this out in order to match up with current realities.
Author
Emaediong Lawrence | Research Assistant, Start-Ups, Business, Jobs | e.l@borg.re
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