Section 12J (s12J) is no longer a new alternative asset class. From relative obscurity, this investment option has gained significant traction among individuals and businesses seeking to reduce their tax liability as well as to find alternative sources of return in an uncertain and volatile market. If you are keen to reduce your tax but want attractive returns, here are 12 things you need to know.
1 Investors can claim the full amount used to acquire shares in the s12J company as a deduction from taxable income in the year of that investment. Provided the shares are held for at least five years, the initial tax benefit will not be recouped by the tax authorities. However, after five years, the full proceeds from the sale of the shares will be subject to capital gains tax.
2 A potential risk for investors is that there may be no secondary market for their shares in the s12J company after the investment period (five years or more) has elapsed. However, professionally managed s12J companies should have a clearly defined exit strategy to create liquidity for investors.
3 Time may be running out for investors to take advantage of the s12J tax benefits. SARS introduced section 12J with a sunset clause that takes effect on 30 June 2021. The current regime may, or may not, be extended. However, investors will continue to receive the tax benefit on any funds invested in a registered s12J company prior to June 2021, even if the five-year investment period ends after that date.
4 By investing with a professional s12J asset management company, you will de-risk your investment portfolio, whilst adding much needed diversification, tax efficiency and investments not generally found in a typical South African investment portfolio. However, as with any other investment, an investment in a s12J company carries risk. Investors should therefore assess that investment strategy and mandate of the s12J company in order to ensure they fully understand the associated investment risk.
5 s12J investment is not all that new. It has been around since 2009 when the SA government introduced amendments to the Income Tax Act to stimulate the private sector and the SA economy as a whole. This introduced tax incentives for investors (individuals and corporates) via tax-deductible s12J companies. For five years, nothing much happened. Then, following further amendments to the Act in 2014, which made the investor’s tax deduction permanent subject to certain strict conditions, the registration of s12J companies started to gain momentum. Today, there are more than 140 registered s12J companies.
6 Not all s12J companies are created equal. Not only do they have different roles and objectives, they also differ in their strategies and methodologies. Some might be investment club-type entities in which a few friends get together to invest in a portfolio of businesses; others are highly sophisticated operations run by professional asset management companies.
7 s12J companies must be licensed with the Financial Services Board (FSB) and registered with the South African Revenue Services (SARS). It is recognised best practice for s12J companies to also register with the South African Venture Capital and Private Equity Association (SAVCA).
8 Investors invest a sum of money to acquire shares in an approved and registered Venture Capital Company (VCC) – the s12J company – which, in turn, invests the funds in qualifying investee companies. The s12J company may not invest more than 20% of all investor-acquired funds in any single qualifying investee company, ensuring that the incentive achieves its objective of supporting many privately-owned companies while simultaneously creating a diverse spread of investments to mitigate risk.
9 There is no legislated cap on the amount of funds that an individual investor may invest in a registered s12J company, although practically an investor would limit the s12J investment to his aggregate taxable income for the year of investment. In addition, some s12J companies may have a minimum and/or maximum amount that may be invested.
10 The strategy adopted by the s12J company will determine the type of qualifying investee company in which it invests its funds. Qualifying investee enterprises could include start-up operations in high-risk industries such as high-tech, or more mature businesses with established track records in industry sectors such as tourism, manufacturing and distribution but excluding financial and advisory services.
11 A qualifying s12J investee company must be a South African entity, trading mainly inside the country and may not operate in certain economic sectors. For an investment to qualify under the s12J benefit, it may not involve companies that:
- trade in immoveable property, except to trade as a hotel keeper (includes bed and breakfast establishments);
- offer financial service activities such as banking, insurance, money-lending and hire-purchase financing;
- provide financial or advisory services, including legal, tax advisory, stock broking, management consulting, auditing, or accounting;
- are gambling operations including casinos or other games of chance; or
- are involved in manufacturing, buying or selling of liquor, tobacco products or arms & ammunition.
12. s12J companies, like any other professional investment company, charge fees for their services. These fees generally cover a range of professional services ranging from having experienced managers ensuring that the best opportunities for investment growth are selected from the dozens of privately-owned businesses that may apply for capital; to ensuring all conditions of the s12J investments are met so as not to jeopardise of the initial tax benefit.
Because Section 12J investors are usually new to this asset class, Westbrooke has created an online investor toolbox to provide full information so that those interested can fully understand the incentive prior to investing.
Jonti Osher and Dino Zuccollo, Westbrooke Alternative Asset Management, South Africa’s largest Section 12J manager