How to get the most out of the Section 12J incentive this tax year
Financial advisors have been quick to recognise the attractiveness of Section 12J (12J) investments which include a 100% tax deduction, an uncorrelated underlying investment, attractive returns, the ability to stimulate the SA economy and create jobs according to Dino Zuccollo, Co-Head of Section 12J at Westbrooke Alternative Asset Management (SA’s largest S12J fund manager) and Chairman of the 12J Association of South Africa.
He says, “12J investments with established, reputable asset managers that have an established track record of successfully managing third party capital are fast becoming a standard allocation in client portfolios.” Key to this is that a 12J investment is 100% tax deductible in the year of investment provided that a client holds shares for a minimum period of five years as well as the attractiveness of the underlying investment.
Since July 2019, there is a limit to the amount that a taxpayer may invest in a 12J company, previously uncapped, of R2.5m per individual/trust per annum and R5m per company per annum. Zuccollo explains, “This change highlights the increasing popularity of the asset class and is likely to open up 12J investments to a wider base of investors.”
Some of the most popular uses of 12J investments for the upcoming February 2020 individual tax year include:
An alternative / complementary investment alongside a retirement annuity (RA): when compared to an RA, a 12J investment has a larger annual investment cap (R350 000 per annum for RAs), can be exited after a minimum 5 year lock-up period (RAs require the investor to be over 55) and provide the investor with the potential to make an uncorrelated, private-equity style underlying investment which may pay an annual dividend (whereas RAs are limited by regulation 28). The tough local investment environment and associated appetite for alternative investments has further increased interest amongst wealth advisors.
A tax efficient annual investment for high-income earners: high-income earners such as lawyers, accountants, bankers, doctors, entrepreneurs, etc. can work with their wealth managers to efficiently manage their investable assets and if required a portion can then be invested in 12J companies at the end of each tax year.
The Naspers / Prosus share split: on 25 March 2019, Naspers announced its intention to list its international internet assets separately through a European-listed entity, Prosus. Investors were given the option to take up an allocation of either Prosus shares or to receive additional Naspers shares. Many financial advisors recommended that their clients take the option of receiving Prosus shares, which resulted in these clients triggering a capital gains tax event equal to approximately 10% of their initial Naspers shareholdings at the time. 12J investments can be used as a mechanism to shield this adverse tax consequence for their clients’ tax year ended 29 February 2020.
Other capital gains tax events: 12J investments are used successfully to shield once-off capital gains tax, including sales of properties, shares, businesses and other assets. Capital gains tax events are subject to a 40% inclusion rate for individuals, and an 80% inclusion rate for corporates and certain trusts. As such, investors are able to invest less than their actual gain whilst still effectively shielding their tax using 12J.
Zuccollo recommends that, “Financial advisors should conduct an extensive due diligence on the range of 12J managers in the market including an analysis of each manager’s track record, skill and experience in managing third party capital, as well as the amount of funds they have invested alongside their clients, prior to advising their clients to invest.
As South Africa’s largest Section 12J manager with an established track record, Westbrooke’s Section 12J funds have outperformed traditional local and international benchmarks. From 1 March 2016 till end August of this 2019, a basket portfolio of Westbrooke’s 2016 S12J funds (14,9%) substantially outperform the MSCI World Index (9,5%), the JSE Top 40 (5,5%) and the SA Listed Property Index (-0,9%).
How Section 12J works
Section 12J is an investment tax incentive which was introduced by SARS to boost the economy by encouraging investment into private companies of a specific size which operate in select industries. Individuals, companies and trusts can benefit from up to 45% immediate tax relief, 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 investment in a Section 12J company provides investors with relief 100% tax deduction on the amount invested. This means that if an individual invests R100 000, and he is paying tax at the maximum marginal rate, he will receive income tax relief of R45 000 in the year of investment, making the net cost of the investment only R55 000. The tax benefit applies to individuals, companies and trusts alike.