Twelve things about the section 12J tax incentive

You can save on tax by investing in small and medium-sized enterprises

MANY SOUTH Africans will be considering whether to reduce their February tax liability by taking advantage of the section 12J tax deduction. For every R100 invested in a section 12J company an investor (an individual, company or a trust) can reduce his or her tax by up to R45, making the net investment only R55.

There are more than 100 registered section 12J companies in South Africa, and it is estimated that the market has raised more than R3.6 billion in investments at the end of 2018.

Here are the 12 most common questions asked by financial advisers and investors when making a section 12J investment.

How does section 12J help 1 me to save tax?

Section 12J is an investment tax incentive which was introduced by the SA Revenue Service (Sars) to boost the economy by encouraging investment in small and medium-sized enterprises that operate in select industries.

Individuals, companies and trusts can benefit from tax relief of up to 45 percent, reducing the cost of the investment while providing downside protection and enhancing overall returns. However, the investment must be held for at least five years.

The section 12J asset class is particularly attractive to taxpayers who have incurred capital gains tax (CGT), because the 40 percent inclusion rate for individuals allows investors to invest less than the total cash realised on a capital gains event.

However, a section 12J investment carries a base cost of zero and therefore on exit from the investment the investor will be liable for CGT on the full proceeds.

Is this investment right for 2 me?

If you are a South African taxpayer, you could consider a section 12J investment, because your taxable income can be offset by this investment – for example, salaries, bonuses, CGT, interest or rental income. Section 12J investments range from lower-risk asset-backed investments to higher-risk venture capital investments, and it is therefore necessary to assess your risk appetite.

What are the risks? 3

As with any private equity-style investment, an investment in a section 12J company carries risk. It’s important, therefore, to assess the investment strategy of the section 12J company to ensure you understand the associated investment risk, as well as the expertise and track record of the asset manager.

4 Which section 12J investment should I pick?

This depends on your desired risk/reward profile. Investors may elect to invest in diversified section 12J portfolios, to spread risk.

What is the minimum investment? 5

From what can be seen in the market, section 12J investments start at about R100 000.

What returns can I expect? 6

This depends on the fund in which you have invested and the skill of the managers. Investors in lower-risk strategies can expect to earn returns of between 15 and 25 percent, and investors in higher-risk strategies can potentially expect investment returns of 40 percent a year or more.

The investor would have to unpack the targeted investment returns quoted by the manager and also understand the assumptions used and the track record of the manager to achieve these returns. Section 12J is considered a private equity-style investment which carries different levels of risk depending on the underlying investment strategy, and there is the potential to lose your initial investment.

Can I use debt or gearing 7 to make an investment into a section 12J company?

Yes, you may use a loan or gearing to make an investment into a venture capital company, as long as you comply with section 12J(3)(a) of the Income Tax Act. Most importantly, investors must be seen to be “at risk” for their investment.

When and how do I claim 8 my tax deduction?

An investment into an approved section 12J company is 100 percent tax-deductible in the tax year you invest.

Investors can claim the tax relief either by reducing their estimate of taxable income when submitting provisional tax returns or obtaining a tax refund through the annual income tax assessment. To benefit this year, your investment needs to be made by February 28, 2019.

What is the annual limit per 9 investor for investment into a section 12J company?

There is no annual limit, but investors should not invest more than their taxable income.

What is the term of my 10 investment?

The minimum term of the investment will be five years. However, certain funds might have a longer minimum period.

Make sure your section 12J provider has a clearly defined its exit strategy, to ensure investors understand the route to liquidity on exit prior to making the investment. It can take a number of months (or years) to receive your payout after the stated target exit date

What if I invest and then 11 I die or emigrate?

On death during the five-year investment period, your investment will be treated as if you had sold your shares, and Sars will recoup the tax benefit, unless you specifically state that you have left your section 12J investment to your surviving spouse in your will. If you emigrate within the five-year period, your investment will be treated as if you had sold your shares, and Sars will recoup the tax benefit. You should consider these implications upfront before making your investment.

12 What are the fees?

Fees in section 12J investments are not legislated so check this carefully when you invest. You can pay:

◆ An upfront capital raising fee. ◆ An annual asset management fee.

◆ A performance fee on exit. Check whether targeted returns quoted by the manager are before or after fees. Jonti Osher and Dino Zuccollo are the founder members of the Section 12J Association of South Africa and are fund managers at Westbrooke Alternative Asset Management.